Description

FRP Holdings is an undervalued and underlevered real estate holding company with near term catalysts that owns high quality assets.  While the shares trade between $42 and $43, we believe that NAV is roughly $64 per share as of today and the intrinsic value will increase at about $4-5 per year going forward.  The catalysts are a potential REIT conversion and the consolidation of a large development onto the income statement upon stabilization.  Both events could occur by year end 2017.  It is also important to note that there is a quality management team in place that owns a sizable amount of shares.  Hence, their behavior and incentives have historically been aligned with minority shareholders.               

http://www.frpholdings.com/assets/2016_Annual_Meeting_-_FRPH_FINAL.PDF

FRPH used to be called Patriot Transportation.  In early 2015, the Company spun off the trucking business into Patriot Transportation and retained the real estate business as FRP Holdings (Florida Rock Properties Holdings).  We will attempt to provide a NAV calculation following the three segments reported in the Company’s most recent 10-Q:

1)      Asset Management Segment $325mm or $33 per Share – Includes 42 warehouse buildings primarily in the Baltimore area and strategically located within 2-3 miles of Interstate 95.  The entire footprint can be accessed via car in a few hours.  The buildings total 3.9mm square feet.  The Company built 27 of these warehouse buildings and others were purchased via 1031 exchange when they sold off land parcels in the past.  As of Mar 31^st 2017, the revenue and NOI were $7.29mm and $5.69mm for the quarter.  On a run rate basis, the revenue and NOI figures are $29.2mm and $22.8mm.  Most of the leases are triple net which is why the NOI margin is so high.  Over time we have gotten comfortable with the warehouse assets and believe that they are high quality.  M&A Transactions in the market occur at low 6% cap rates.  FRPH also buys them at low 6% cap rates when they execute 1031 exchanges.  Applying a conservative 7% cap rate, we arrive at a $325mm figure or roughly $33 per share.  As a sanity check, this amounts to roughly $83 per sqft.  Via our discussion with management team, the warehouses have the right clearing height, the doors are spaced out at a certain length, and the walls are designed and built in such a way that if a large tenant left, they can quickly re-purpose the building for multiple tenants.  I believe the lease even have clauses that the tenant must vacate all equipment and improvements if they leave thus returning the space to an easier to lease state.  The Baltimore/Maryland region is a vibrant and land constrained area that did not experience significant distress during 2008/2009.  The Company’s occupancy rate fell to the 70s during the recession mostly because they were previously more aggressive with building on spec (under a different management team).  They had three buildings come to market when the portfolio size was roughly 2.5mm sqft.  The current plan is to develop only 1 spec building a year and as many built to suit as possible.  Management has indicated that the occupancy will likely be in the 80s in the next crisis.   

2)      Mining Royalty Lands Segment $185mm or $18 per share  – This segment comprise of over a dozen rock quarries sitting on 15k acres of land that the Company lease to mostly Vulcan Materials.  The sites are primarily in Georgia and Florida with a single site in Virginia.  FRPH does not have operating cost overrun risks nor any meaningful capital expenditure requirements.  FRPH collects a percentage of royalty per ton of rocks extracted and sold by their lessees.  There is also a minimum fixed payment that equates to roughly $4mm a year regardless of how little extraction occurred.   The estimated reserve is 415mm tons as of September 2016 while 6.9mm tons were consumed in fiscal 2016.  Management has said that they will sell everything else before they sell the mining royalty.  Aggregates, stones, and sand quarries are great businesses and truly defensible against Amazon and all Silicon Valley threats unless they bend the laws of physics.  It’s simple.  For example, crushed rocks may cost $10 a ton in a certain market but it cost 15 cents per ton mile to truck it.  Thus a competitor located 100 miles away will add $15 of trucking cost before it reaches the incumbent’s market.  Quarries have a tremendous amount of pricing power.  If one looks at Vulcan Material’s presentation, you will see that in the years following the housing bubble burst, unit prices flattened and then continue to rise despite volume dropping by 50%.  This is the complete opposite of a commodity product.  This is the definition of a company with pricing power in its local market. 

This is the hardest segment to value, but we will try anyway.  We will utilize $/ton of reserve, prior transactions, management guidance, and EV/EBITDA. 

Vulcan Materials and Martin Marietta trade at $1.22 and $1.00 per ton of reserves respectively.  FRPH is not exactly apples to apples with these two companies.  FRPH is in essence a landlord/reserve holder while Vulcan and Martin tend to be landlord plus operator.  Given FRPH’s ownership of the valuable land parcels upon reserve depletion and the lack of cost overrun risk or cap ex requirement, FRPH owns a very valuable part of the business.  We believe that it is fair to assign 50% of the value to FRPH.  This would assign a $0.56 per ton of reserve to FRPH which would equate to a $230mm valuation.  Let’s be conservative and assign 40% of the value to FRPH because it does not own the operation and merely collects the royalty.  This would equate to $184mm.  Keep in mind, FRPH participates in both volume and unit price increases of its lessees.  As Vulcan has been increasing production and pushing through price increases (sometimes doubles digit price increases in recent years), FRPH benefits from both levers as FRPH receives a % of the revenue as royalty. 

During 2012 and 2013, Plum Creek Timber completed two volumetric production deals with Vulcan where Plum Creek paid $153mm and $74mm for 255mm and 143mm tons of reserves respectively.  These transactions were for the volumetric production only and do not include any land.  The transactions value the reserves at an average of $0.56 per ton of reserve.  These transactions were done 4 and 5 years ago when the aggregates were worth less.  We also believe that FRPH’s ownership of the land should provide FRPH with a higher valuation.  The volumetric production figures provides another data point valuing the aggregate business at $230mm. 

We have also looked at four private transactions by Martin Marietta and Vulcan in 2008, 2013, and 2014, we have an average of $0.77 per ton of reserve. 

Another method is to use a EV/EBITDA multiple.  Vulcan trades at a 16x 2017 EV/EBITDA and Martin Marietta trades a 14.9x 2017 EV/EBITDA.  We think that FRPH will soon approach $7.0mm of EBITDA.  Applying a 15.5x values the Company at $108mm.  Let’s adjust for some differences.  FRPH has no cost overrun risk and sits on 15k acres of land.  FRPH’s EBITDA is very close to its revenue figures as it is a royalty business.  FRPH deserves a much higher multiple.  As a matter of fact, FRPH acquired a parcel in Lake Louisa near Orlando in 2012 for $11mm which generates royalty revenue of $621k.  This would imply a price to revenue multiple of 17.7x.  Applying this multiple on $8mm of revenue would imply a valuation of $141mm. 

So what is in the 15k acres of land in this portfolio?  It varies.  We have actually seen many of these parcels.  For example, the Company owns 1,993 acres in Fort Myers.  They have an agreement with Vulcan Materials to expedite rock extraction on the site.  In a similar fashion to Superman/Lex Luthor and the San Andreas fault line, the mining of the rock reserves on the site will result in a hole in the ground that will naturally fill with water and form a lake.  FRPH stated that they will eventually sell 105 one-acre waterfront lots to homebuilders when the rocks are depleted.  Management has mentioned in the past that one-acre waterfront home lots were selling for $500k to $1mm a couple years ago as the homebuilders will put $3-4mm houses on them.  So there is the possibility of a $52.5mm to $105mm proceed from these lot sales in the future.  Applying a discount rate of 15% and 3% annual land inflation rate would result in a net present value between $22mm to $44mm.  Let’s examine how a cashflow multiple approach will massively undervalue FRPH.  The Company will likely receive about $1mm in royalty when mining begins in Fort Myers.  When The Company eventually sell the lots, it will likely be worth $52.5 to 105mm.  This is 50 to 100x of annual revenue.  We have personally seen many sites in Georgia and Florida.  The Company also owns 1,196 acre site in Lake Louisa, FL near Orlando.  The Lake Louisa site is surrounded by new single family housing developments.  We see excellent potential for land appreciation in the future.  We have seen sites in George where the neighborhood houses sell for $500-800k.  There are also some sites where the land value is minimal.  For example, the 4,280 acre Brookville Quarry JV is only worth about $15mm according to management despite having zoning approval already as the area is distressed.  The Brooksville Quarry JV is in addition to the 15k acres of land.  The point of the exercise is to highlight the fact that the mining royalty land should be viewed as a Covered Land Play where FRPH’s shareholder is getting paid $7mm a year to wait for the land to appreciate overtime.  DCF massively undervalued the principle market value of the asset.       

Lastly, we have outright asked management what they think private market value for the royalty business is.  They thought that it is worth between $150mm to $200mm in the private market.  This commentary took place roughly 1.5 year ago before Trump was elected and before management start to publicly state that they are bullish about the aggregate business on their conference calls.  From our experience, the management team tends to err on the side of being conservative.   Please see my commentary on the management team regarding how to calibrate the management team. 

3)      Land Development and Construction Segment$161.6mm or $16.32 per share – This segment owns a collection of valuable land parcels that is actively being developed.  The crown jewel of this segment is a 5.8 acre parcel of land in Washington DC on the Anacostia River right next to the Washington National stadium.  The area is gentrifying quickly and FRPH owns the premier site that is zoned for 1.1mm sqft of development to be developed over 4 phases.  The first phase, Dock79 consist of over 305 luxury apartment rental units and five commercial tenant space on the bottom totaling roughly 18k sqft.  As of April 23, the residential portion is 79% leased and the retail portion only has one remaining space out of five units.  The progress has been better than projected while the costs are below estimates.  Per our conversation with local developers, we believe the building should be worth $150mm upon stabilization which equates to $500k per apartment.  Netting out $65mm of construction loan and $17mm of EB5 financing, and a roughly 1/3 take for the MRP Realty, the development partner, we arrive at a $45mm equity value for FRPH in the Phase I, Dock79. 

There is  800k more sqft of development on this 5.8 acre site.  Assuming $70 per sqft of buildable land, this would amount to $56mm.  You can use whatever you are comfortable with.  As a reference, the $150mm valuation for the phase I building values the finished building at $500 per square foot.  A $70 per buildable square foot is 14% of the finished product.  Our valuation seems reasonable and we may even be too conservative as urban infill land that are zoned tend to trade at higher % of the finished product in the private market.  The Company is looking to break ground on Phase II, a 250k sqft multi-family building.  The following links provides more details on the Dock 79 building and the neighborhood and the transformation in the last decade.  Phase III and IV build out will likely occur after 2020 as they need to work on the bridge before it can commence.  There is also another 2 acres site further down river called Square 664E or Buzzard Point.  We value this 2 acre site at $13mm.  

https://www.dock79.com/

http://www.jdland.com/dc/index.cfm

The Company also owns 973k  sqft of warehouse land that are on existing industrial parks/site.  These are sites that have completed horizontal development and range from ready to build to almost complete with construction.  We believe that the Company will build 100k sqft each year on spec.  From our conversation with local brokers, we believe that a $35 per sqft buildable is fair for the sites that are preparing to build.  This would include the 287k sqft in Lakside, MD, 165k sqft in the Windlass Run Business Park, MD that is a 50/50 JV with St. John Properties, 103k sqft in the Patriot Business Center, Manassas, VA and 320k sqft at the Hollander 95 Business Park, MD.  The aggregate of these parcels is 873k sqft and we attribute $30.6mm to the parcels.  There is a 99k sqft building that is 86% pre-leased and ready for delivery in spring of 2017.  We believe it is worth $100 a sqft (due to new construction) and we value it at $9.9mm.  Other miscellaneous land parcels include the Hampstead Trade Center which we value at the net book value of $7.1mm. 

Overtime, assets in this segment will be developed and moved over to the Asset Management Segment which will make it easier for the rest of the market to value over time.  

Phase I (Dock 79) - $45mm equity value

Phase II, III, III - $56mm at $70 per sqft buildable

2 Acres Site (Square 664E/Buzzard Point) - $13mm

873,398 sqft buildable industrial/office land - $30.6mm

99k sqft new warehouse building - $9.9mm

Hampstead Trade Center Residential Development - $7.1mm

Total - $161.6mm or $16.32 per share

4)      Total Asset Value

Asset Management $325 mm

Mining Royalty Land $185mm

Land Development and Construction $161mm

Less Debt of $39.7mm

NAV - $631.3mm or $63.76 per share

Management Quality

It is rare to find a high quality management team.  The first thing that they state on the call with us is “Do No Harm.”  Generally the management team believes that they are sitting on an attractive collection of asset.  They are developing on spec 100k sqft of warehouses per year.  If anyone wants a built-to-suit building, the Company will build as many as the tenants want.  This is a much lower risk profile than an aggressive spec build strategy.  There is also a plan to develop a 250-300k sqft multi-family on the waterfront in Washington DC every 2-3 years.  If the Company sells any excess land parcels, they intend to execute 1031 exchanges to defer taxes.  There is no empire building mentality.  Yet, there is a clear and simple away to convert land parcels into income producing assets.  The insiders with large shareholding came from the family of Florida Rock Industries which was taken over by Vulcan Materials in 2007 for $4.6 billion.  We think very highly of any management who sold their business in 2007.  In an interview, the current Chairman of FRPH and Former CEO of Florida Rock Industries, John D. Baker II, cited that they received a price that was too good to pass up and they have fiduciary duties to their shareholders.  This is all despite that Florida Rock is a family business and they had no intention of selling prior to the bid.  

Additional evidence of good management quality includes the decision to spinoff the real estate business to 1) highlight the value in the real estate holdings and 2) to segregate liabilities, i.e. trucking accident that results in big fire balls that may reach its claws into the combined holding company.  The Company’s disclosure has improved and they break out segment data which makes it easier to value.  The Company is very conservative with use of leverage as can be shown by the general lack of leverage.  It is more important to pay attention to how they treat recourse on the debt.  The Dock 79 development use non-recourse debt.  The only asset at risk was the Phase I portion of the 5.8 acre site.  Phase I could’ve failed as a development and they will still keep Phase II, III, and IV.   The CEO, Thomson S Baker II, recently left to take an executive position at the $16 billion Vulcan Materials that bought Florida Rocks.  John D. Baker II will take over as CEO.  We believe that the president of the Company who is in charge of warehouse and multi-family development is a key executive and so is the CFO who is a tax wizard.  All the keep pieces are intact.  From a career perspective, it probably makes a lot more sense for Thompson S. Baker II to go work for a $16 bn company rather than stay as CEO of a $435mm small cap company.     

The Company has also stated that there is too little leverage on the Company and will increase leverage over time as the FFO has grown to over $20mm a year now.  From our interaction, we also believe that The Company will sell if they receive a fair bid.       

What if The Market Continues to Ignore the Company?

Investors will do quite well.  If we look out to 2020, it is very possible that the Company will own two stabilized multi-family buildings in DC and the warehouse portfolio will grow to roughly 4.3mm sqft.  In addition, the consolidated NOI will likely reach $45-50mm by 2020.  There are opportunities to invest capital and accomplish two objections 1) Generate a good return on the invested capital in both the warehouse and multi-family development and 2) convert non-cash flowing assets into cash flowing assets that the market can readily value.  We believe that intrinsic value increases are roughly $4-5 per year.   This is attributed to $2 per share of cash builds and another $2-3 of return on development and asset appreciation.  In 2020, the Company will trade at over a 10% cap rate based on today’s price and it will still have excess land parcels.     

Risk

1)      Macro and interest rate – Because the Company has such low debt to asset ratio, we believe that interest movements and Macro will affect the Company less.  After assuming the non-recourse debt associated with the multi-family building in DC, the debt to asset (market value based) ratio is only about 16%.  It is important to understand that we are buying at 68% of NAV on a minimally levered company.  This is very different from owning a REIT that has 50-60% debt to asset ratio.

2)      More Leases Than Usual Up for Renewal in 2017 – This is temporary and the market is currently strong 

Catalyst

FRPH recently announced that they have implemented all the steps needed to convert into a REIT.  The reason is simple, the management/insiders own a lot of stock and they do not want to pay taxes.  They are waiting on the news of a Trump tax cut.  If the Trump tax cut is dramatic, they will likely remain a corporation but the income tax will drop dramatically.  If Trump can’t pass through the tax cut, then FRPH will definitely convert into a REIT.  It’s a win-win either way.  We either receive a tax cut or convert into a REIT.  If a REIT conversion does occur, shareholders will likely receive a special cash dividend as a way to purge all previous earnings.     

By year end 2017, FRPH should consolidate the income and operating expense results from its Dock 79 multi-family building.  Through some scuttlebutt in the local market, we believe that FRPH will consolidate $10mm of revenue and $6.5mm of NOI onto the income statement.  The incremental accretion to operating cashflow may only be $2mm (sanity check: net of distribution to partner and at 5% cap rate would equate to $40mm of value).  But the income statement should consolidate 100% of the revenue and cashflow before adjusting for the JV partner’s take.  This will make it easier for the rest of the investment community to value the assets.  Total run rate revenue will approach $50mm upon consolidation.  We believe that FFO will approach $22-24mm.  Despite owning a collection of valuable non-cash flowing land parcels with near term plans to monetize them, FRPH is starting to trade inline with traditional REITs.  The stabilization of the Dock 79 building also demonstrates that there is significant value for Phase II, III, and IV on the same site.  It’s amazing that this site was nothing but a concrete plant years ago.