Description

Long Idea: Cousins Properties is one of the foremost diversified real estate development companies in the United States. The Company creates shareholder value through the development and operation of high-quality real estate. With headquarters in Atlanta, Cousins is a fully integrated, self-administered equity real estate investment trust (REIT) which actively invests in office, retail, industrial, medical office and land. Cousins Properties has been in the real estate business for more than 40 years and has proven experience in the development, leasing, management, acquisition and financing of properties. On December 31, 2004, the Company’s portfolio consisted of interests in more than 7.2 million square feet of office and medical space, 3.1 million square feet of retail space, and more than 3,000 acres of strategically located land for future commercial development. Cousins Properties became a public company in 1962, elected REIT status in 1987 and was listed on the New York Stock Exchange in 1992.

INVESTMENT THESIS

In addition to earnings power, Cousins also provides us with a tangible margin of safety. Cousins' net asset value of $1.78 billion is 16% higher than its current market cap of $1.53 billion. Assets include 12,800 residential housing lots and 3,300 acres held for development, as well as a portfolio of office, retail and industrial properties worth more than $1 billion.

BUSINESS MODEL

One of our key strategies for many years has been to actively manage our investment portfolios and, at appropriate times, recycle our capital from mature, stable properties, where we believe we have maximized our value creation, into new projects that offer better opportunities to create value for our shareholders. This recycling helps us avoid the need for additional equity funding for new development, and over time it allows us to generate higher returns for our shareholders.

At Cousins, we are intensely focused on total shareholder returns. Other factors, such as the size of the Company, or even short-term consistency of earnings and FFO, are secondary. This focus has allowed us to generate high returns for our shareholders over a long period of time – as illustrated by the compounded total return of 18.9% per year over the last 25 years. Since we often “recycle” our capital from stable assets into development projects, our earnings will vary from quarter to quarter and from year to year. In fact, our FFO will be less in 2005 than in 2004 because of our smaller asset base, special dividend and the high level of new development projects that are not yet producing income. We believe our FFO will grow as our development projects become operational, and our total returns should be higher in the long run, due to our smaller equity base. Our focus continues to be on total returns to shareholders.
-Thomas D. Bell, Jr., President & Chief Executive Officer

I would note that when Cousins Properties’ top management discusses shareholder returns, remember that the officers of this company own over 28% of the company’s stock.

Cousins' growth is generated by “retained earnings.” Cousins can finance future projects out of retained earnings, making Cousins' managers capital allocators before you label them anything else related to the real estate market. CUZ is managed individuals whose primary skill is capital allocation. Through residential and commercial land development, Cousins pays $1 today for land and other property and develops it until it's worth $1.20, $1.30, $1.50, or more tomorrow. By comparison, most REITs are content to pay $1 for $1 worth of property, and then collect annual rents. After REITs collect rent, they pay out 90% of their earnings to shareholders in the form of dividends. There's not much left over after that. Most of their financing comes from preferred stock and debt. Like all REITs, Cousins pays out 90% of its earnings and it uses preferred stock and debt, too. But there's a difference between its business model as a developer and the business model most REITs follow.

As a developer, Cousins buys land and other property, develops it, and then sells it. However, according to accounting rules, there is a difference between the money Cousins makes from collecting rental income and the money it makes from selling development property. REITs are commonly judged by an earnings number called funds from operations, or FFO. The key point to note is that FFO excludes gains (or losses) from sales of property. But Cousins is a developer and developers make money by buying, developing and selling property--not from FFO.

The difference between Cousins' FFO and its net income for the last five years:

Diluted net income per share
$7.84 (04)
$4.83 (03)
$0.96 (02)
$1.41 (01)
$1.25 (00)

Diluted FFO per share
$2.13 (04)
$2.53 (03)
$2.27 (02)
$2.15 (01)
$1.96 (00)

Difference:
$5.71 (04)
$2.30 (03)
-$1.31(02)
-$0.74(01)
-$0.71(00)

Gains on the sale of property dramatically change Cousins' results from year to year. Yet the process of creating the value continues as seen in years like 2004 and 2003. Those two years nicely illustrate Thomas Bell’s quote from earlier. Cousins' big special dividends are paid out of capital gains on the sale of property. In 2004, Cousins sold about $1.3 billion worth of office property—they netted around $500 million after paying their investment partners. Cousins paid their shareholders a $356 million special dividend and used the balance of the net proceeds to retire debt.

VALUATION

Averaging out the past five years, CUZ trades around 9 to 10 times net income, or 12-15 times FFO. While not bottom of the barrel cheap, it is certainly not expensive either. Cousins' ability to generate cash and retain earnings translates into solid coverage of its interest expense. Cousins' trailing-twelve-month EBITDA covers interest expense 22x. Most REITS average around 5x EBITDA (TTM) to interest expense.

Most REITs operate with ample leverage—typically they carry a debt-to-equity ratio greater than 1.0 (they carry more than $1 of debt for $1 of equity in their business). Cousins operates at 0.55 debt-to-equity. A REIT without retained earnings must finance their acquisitions and projects with debt. Cousins’ strength is that it has the financial flexibility to employ its retained capital and less leverage when it develops future properties.

Most of Cousins' development is either office buildings, retail, or residential. Cousins owns 11,583,000 square feet of retail, office, and medical office space which includes space owned by joint venture partners. Cousins owns 8,952,000 square feet, net of all joint ventures. Most of Cousins' office and retail properties are in Atlanta.(They also have major holdings in descending order in North Carolina, California, Texas, Tenn., Florida, Alabama, and Va.)The geographical concentration is also favorable—they operate in states experiencing solid population growth.

Cousins' emphasis is on developing and owning top quality properties-- its office and retail tenants are almost all solid credits such as BofA, Bell South, IBM, etc.

Using $125 per square foot to value the property portfolio, I come up with a value of roughly $1.11 billion. That's about double the carrying value on Cousins' balance sheet, $530 million. In addition, Cousins owns a net total of 10,390 residential lots remaining to be developed and/or sold. Let’s assume they are valued at $40,000 each, or a total value of $415 million. Lastly, Cousins owns 3,300 acres of land held for investment or future development. Using the 2004 10-K, Cousins executed seven transactions that took place in 2004 and early 2005 for prices averaging about $350,000 per acre. As I have learned with Tejon Ranch (TRC), developers normally end up giving away some of the land in order to satisfy local interests and comply with environmental guidelines. So I rounded the average sale price down 20% to $280,000 per acre. With those assumptions Cousins' 3,300 acres is worth $924 million.

If I total the assets and net out $364 million in long term debt and another $200 in preferred equity, I get a net asset value of $1.89 billion. Cousins’ current market capitalization is about $1.53 billion, or about a 23% discount to Cousins' net asset value using my assumptions.

Cousins Properties (CUZ)

Office, Retail, and Industrial Portfolio
$1,110,000,000

Residential Lots
$415,000,000

Land Held for Future Development
$924,000,000

Total Asset Value
$2,449,000,000

Minus Long Term Debt
- $364,000,000

Minus Preferred Equity
- $200,000,000

Net Asset Value
$1,885,000,000

Market Cap @ $30.25/share x 50.55 mil. Shares outstanding
$1.53B

Discount to Current Market Capitalization
23%

Historically, CUZ tends to trade around its net asset value because it pays out so much of its income in dividends. I think real estate development is also viewed as a risky business, so folks are cautious about over paying for a company focused on development. Right now, Cousins' stock is selling at over a 20% discount to my estimate of its value. This is a long-term story driven by smart management who know how to effectively allocate capital.

Catalyst