The stars have rarely aligned so well for Arni Thorsteinson and his fellow investors. The veteran real estate man and CEO of Temple REIT has pretty much everything going for him. The economy in Western Canada, where most of Temple’s hotels are located, is strong. Interest rates are at millennial lows, which is padding the bottom line.
Best of all, the orphaned small- to mid-size real estate trust sector was crushed by the financial crisis. The pickings are good for an acquirer with a good balance sheet, such as Temple – itself something of a stock market orphan. That’s reflected in its underappreciated stock, which I own and intend to hold for the foreseeable future.
The Winnipeg-based REIT owns 12 hotels with 1,516 rooms. Of those, nine are in Alberta, with a particular concentration in red-hot Fort McMurray. Temple has almost half that market by room count. There are also two hotels in Saskatchewan, including the recently acquired Regina Wingate Inn. Temple got a good price for that hotel; the cap rate – a measure of the cash the property throws off relative to its price – was an attractive 12 per cent using 2012 estimated income.
In fact Mr. Thorsteinson has been finding a lot of good deals lately. He picked up the Radisson Hotel and Suites in Fort Mac this month from Holloway Lodging, another orphaned REIT, solidifying Temple’s grip on that market.
But he didn’t stop there: Temple last week also bought 20 per cent of Holloway’s shares, and Mr. Thorsteinson bought another 5 per cent. Holloway owns 18 hotels – 10 in Alberta, three in B.C. and three in the Maritimes, and about 1,700 rooms. (The other two hotels are in Myrtle Beach, S.C., and Yellowknife.)
Like many real estate investment trusts, Holloway borrowed too much and was clobbered during the financial crisis. The distribution disappeared in mid-2009, assets have been shed and last month the trust had to exchange a pile of convertible debt into equity. Result: 720 million additional shares outstanding.
Here’s the good news: Holloway now has no debt outside its mortgages, revenues are firming and the income-oriented owners of the convertible debt are now holding a penny stock that pays nothing, and they’re selling it wholesale. The stock is trading for a third of its book value.
Who else is buying? Insiders en masse. Mr. Thorsteinson says he sees value in the Holloway shares, which are quoted at 6¢. Insiders appear to agree.
As for interest rates, they are proving a great ally. Temple’s interest expense dropped by 15 per cent in the latest nine-month period, adding perhaps 8¢ per unit of value. And of course the economies of Fort Mac and Western Canada are doing well. Occupancy is strong and revenue per available room is also rising. No wonder Temple was able to raise its distribution by 20 per cent in October, and no wonder Mr. Thorsteinson, already a big owner, bought a lot more stock about a year ago.
I expect the trend to continue. Temple announced a hasty deal to raise money yesterday. Will it be used to buy the rest of Holloway? Or something else? There is no shortage of targets.
And there’s organic growth. Temple completely renovated its hotel and conference centre in Red Deer, Alta., rebranding it Sheraton. Red Deer is halfway between Edmonton and Calgary. The hotel has always done well with conventions, but the massive renovation, by my math, could contribute 25¢ or more to already-rising distributable cash per unit.
The biggest realistic risk is a drastic and sustained drop in oil prices. But given the rewards, I think it’s a risk worth taking.
And investors should scour for orphaned stocks like these. There are many of them, and we’re finding new ones all the time: smaller but solid businesses with high yields or upside. In a world of negative real interest rates, it’s inevitable that money will eventually flow to these names. Being early will pay off.
Fabrice Taylor publishes The President's Club investment newsletter, focusing on off-the-radar small to mid-cap companies trading at a discount to net asset value. His letter and The Globe and Mail have a distribution agreement. He can be reached at email@example.com.
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