Description

ALEX – Alexander & Baldwin

Price Target: $28.00 (+35%)

ALEX is nearing the end of a decade-long transformation from a Hawaii-themed, grab-bag holding company into a streamlined Real Estate Investment Trust, owning high-barrier retail, industrial and ground lease properties in the Aloha State. This investment ticks all three boxes for us: (1) a high-quality, highly-coveted portfolio; (2) an attractive valuation with 25% upside to NAV and 35% upside to comparable trading values; and (3) an impending catalyst as they market one of their last remaining non-core assets.

Alexander & Baldwin is a large Hawaiian landowner.  It has been written up on VIC twice prior to the spinoff of Matson, a Jones Act shipping and logistics business.  This catalyst delivered a successful investment for those who timed it right (2011-13), but the performance of ALEX since then has been weak: a flat-to-negative total return over the past six years. 

There are a number of reasons for the underperformance, but the main theme is that A&B’s transformation from a real estate-themed holdco into a simplified REIT has taken longer than hoped, while values of some of the noncore assets have disappointed. However, the last twelve months saw ALEX bring non-core assets below 20% of GAV, and we think this will fall close to 10% over 2020 – a level that REIT investors can easily look past, allowing the stock to re-rate.  Here are the key elements:

High Quality Assets: 80% of ALEX GAV ($110mn 2020E cash NOI) is in cash-flowing, Hawaiian CRE.  Hawaii has obvious geographic supply barriers, as well as other supply barriers (environmental, political, NIMBY) that are arguably even more daunting.  The breakdown is 2/3rds retail, 15% industrial and 15% ground lease. The industrial & ground leases are highly-coveted assets with long-term leases, solid rental growth, and minimal CapEx burden. High-barrier industrial REITs trade at 20-50% NAV premiums (3-4% cap rates), while the only ground lease REIT trades at an even pricier valuation. The retail portfolio may not be quite as attractive, but A&B’s portfolio is one of the most e-commerce resistant portfolios out there: it is skewed toward grocery-anchored community & lifestyle centers, while the geography makes delivery-to-the-home more complex and expensive than it is on the mainland. ALEX’s blended retail ABR is $32.50 PSF, which is higher than any strip center REIT peers. Finally, note that high-barrier strip center REITs (e.g., FRT, REG, AKR) trade at slight premiums to NAV, despite the discounts that persist for lower-quality retail REITs.  As a whole, ALEX’s portfolio has been printing low-to-mid single digit SS NOI growth, which is above average for REITs.

In addition to the high-quality CRE, they have ~$0.5bn in “other assets,” which we view in three pools:

• Grace Pacific – they purchased this materials & construction business in a related-party transaction in 2013 for $300mn, and it has been a disappointment since.  After numerous attempts at a turnaround, they have finally begun marketing it for sale. As part of this process, they took an impairment in the most recent quarter, valuing the business at around $200mn.  My own view is not so optimistic – I would be happy for them to get anything above $100mn (which is where I am valuing it), and I think the market might be happy if they can give it away, given how poor the operating results have been for the past few years. As bad as Grace’s operating results have been, there should be substantial value in the assets of a materials and aggregates business with a large market share on an island with strong construction demand. I expect them to announce a sale in the next couple of months.
• Kukui’ula – this is a high-end, resort-type residential development on the south side of Kauai that they started over 15 years ago. The project has been a financial disaster (though it does look very nice), and they just took a write-down of nearly $200mn, to a held-for-sale book value of just under $150mn. Despite all the historical issues, this project reached an inflection point this year, as cash flows from lot sales have grown to a point where the project no longer consumes A&B cash.  They claim to be eager to move on from this project, but I don’t expect any progress on that front in 2020.
• Legacy Landholdings – they have 25,000+ acres of undeveloped land on Maui & Kauai.  As with all land banks, the vast majority of NPV lies in a small minority of the acreage.  In this case, they have 1,000 acres that are either entitled for development or in the entitlement pipeline, which we value at ~$150mn.  In addition, they have 12,000 acres of agricultural land and another 14,000 acres of conservation land, which we value at $50mn. Over the past twelve months, they have sold nearly 50 acres of entitled land for $725k/acre and 41,000 acres of agricultural land for $6k/acre, so there is material upside to my valuations.  Finally, they have $50mn in active development/CIP.

Management is Taking the Right Steps: Alexander & Baldwin’s long-term track record for capital allocation is poor – the value destroyed through Grace Pacific & Kukui’ula is in excess of half a billion dollars(!).  However, the individuals responsible for those missteps are gone, and management has been doing the right thing for the last few years. They have exited or cancelled longer-term/riskier developments; they are working to sell Grace Pacific and Kukui’ula; they have greatly accelerated the pace of land sales; they converted to a REIT; they initiated an appropriately-sized dividend; and they have been deploying the proceeds into quality, stabilized CRE that can be easily analyzed by REIT investors.

Discounted valuation: We value the operating CRE portfolio at a blended 5% cap rate and non-core assets at $500mn against $750mn in net debt + liabilities to get to a NAV of $26.50.  A 20% discount to NAV is pretty attractive in a world where REITs are trading at NAV, especially considering that ALEX’s asset mix trades at a premium in the REIT market (5-10% GAV premium on a weighted average basis).  Put another way, investors in ALEX at $21ps are paying NAV for the operating CRE & CIP, while getting Kukui’ula, Grace Pacific, and 25,000 acres of undeveloped Hawaiian land for free.

Risks:

• Noncore asset sales process stalls – if they are unable to find a buyer for Grace Pacific, the stock will take a hit.  We believe we are buying with a margin of safety here – at a valuation that assumes no value for Grace Pacific – but the stock would take a short-term hit regardless
• Poor capital allocation – this has been an issue that has plagued A&B in the past, though the last few years give us comfort.  It also helps that their last remaining long-term development (Kukui’ula) no longer consumes cash.
• Geographic concentration – the portfolio is 100% Hawaii, so they are fully exposed to any adverse economic or political developments.  In particular, the state legislature tried to remove the state corporate income tax exemption on REITs a few months ago.  The bill was vetoed by the governor (our understanding is that it would have met much more resistance in the state legislature were the veto not widely expected), but this is a risk that could reduce the fundamental value of ALEX stock by a few percent.
• Low cash flow – given the high-quality assets, the FCF yield is low: less than 5%, even after selling down non-core assets

How does this play out? After rallying to $25 per share earlier this year on optimism that ALEX had become a “normal” REIT, the stock slid over the past few months. We believe this has been driven primarily by pessimism surrounding the non-core assets: ongoing weak fundamentals at Grace Pacific, combined with a slowdown in monetizations (after reporting ~$300mn in non-core asset sales in 2018). Our thesis is that the company will announce a sale of Grace Pacific in the coming months, along with another substantial ag land sale in 2020.  Once this happens, the market will see a simplified REIT with high quality assets in a high barrier market with a NAV of $26+ and an asset mix that would imply a valuation of $28-30.  I’m not sure if the stock will make it to the high end of that range, but I do think that a further-simplified ALEX should be able to overtake its 2019 highs by another 5-10%.

Catalyst

• Sale of Grace Pacific
• Additional agricultural land sales
• Continued growth of the core portfolio
• Growing acceptance by REIT investors