Description

Ticker	GDC
Exchange	TSX
Current Price (C$)	5.50
Market Cap (C$ MM)	254.6
Enterprise Value (C$ MM)	266.5

Genesis Land Development Corp is a Western Canadian based real estate development company. Since the Company’s inception in 1992, Genesis has accumulated a land portfolio that includes ~2,000 net acres in Calgary, Alberta, and ~2,800 net acres in British Columbia. Over the past couple of years, Genesis has begun to transition from a primary focus on land acquisition, entitlement, and sales, to a vertically integrated land development, homebuilding, and commercial real estate development company. Given the particularly attractive economics in the Calgary market, Genesis is currently spending the majority of its time and capital in developing its assets in this market rather than in British Columbia.

At its current market price, Genesis is trading at a roughly 40% discount to a net asset value that only incorporates conservative values for the land portfolio. Furthermore, we believe the inherent leverage of Genesis’s land portfolio to Calgary’s rising real estate prices in both the intermediate and longer term will cause the Company’s net asset value to increase. Finally, if the Company successfully transitions into residential and commercial development and capitalizes on particularly attractive economics for homebuilding and shopping center development in Calgary, the net asset value has considerable upside from its pure land value.  In fact, we believe that one of the Company’s shopping center developments (Sage Hill Crossing), located on roughly 4% of GDC’s Calgary acreage and scheduled for completion in 2009, will have a value nearly as large as the entire enterprise value of the company when completed. As the Company aggressively moves toward fully integrating its operations, our models, which we believe to be conservative, suggest that they should ultimately realize value of at least two times the current stock price.

 

Alberta & Calgary Macroeconomic Background:

Before profiling the Company’s Calgary land portfolio and the real estate environment in Calgary, it is important to provide a background on the macroeconomic landscape of the entire province of Alberta. In recent years, Alberta has benefited tremendously from the significant capital spending, exploration and production in the oil sands in the northeastern part of the province. The oil sands are believed to host hundreds of billions of barrels of oil, second only to Saudi Arabia worldwide. Capital spending in the oil sands is expected to exceed over C$100 billion over the next decade. This has trickled down to other sectors of the Alberta economy, and in fact, energy as a percentage of GDP has actually decreased from 36.1% in 1985 to 28.3% in 2005. Although located roughly 500 miles to the south of the oil sands, Calgary is the corporate headquarters for the majority of the major oil sands companies.

Alberta has experienced the strongest provincial GDP growth in Canada, posting 7% real GDP growth in 2006, as well as GDP per capita 56% above the national mean.  The job market is also very strong; unemployment in Alberta is currently 3.4%, well below the national mean of 6.3%.  In 2006, the population of Alberta grew by 3.0%, versus 1.0% nationally.  In addition, investment per capita in Alberta is more than double the national average.  We expect this to continue, due to the continued development of the oil sands and Alberta’s pro business tax structure, with a corporate tax rate of 32%, one of the lowest combined provincial/national rates in Canada.  Alberta also has no provincial capital or payroll taxes, as well as the lowest personal income tax rate in the nation.

Calgary is the largest city in Alberta with just over 1 million people after experiencing population growth of 3.7% in 2006.  Unemployment is at historic lows, dropping to as low as 1% during the fourth quarter ‘06, and averaging 3.2% for the year, the lowest rate among major metropolitan areas in Canada.  All of these factors, coupled with a relatively limited supply of fully entitled and serviceable land, have created a very tight housing market.  The average combined residential price rose 27.6% year over year in March, as well as 5.6% compared to January, to C$415,000.  Despite these price increases, housing in Calgary remains more affordable than other major Canadian cities, including Vancouver, Toronto, and Montreal, based on the Royal Bank of Canada affordability index, which compares housing prices to income per capita.  We expect the housing market to remain strong, and at the beginning of the year, the Calgary Real Estate Board estimated annual real estate price increases of 7.5% for 2007 (which has already been exceeded in the first two months).  Although housing starts have increased considerably over the past year, demand growth has more than offset the increased supply. In March, the sales/listing ratio was 98.74%, implying that the average listing time per unit was just over one month. This compares favorably to a historical sales/listing average of ~70%, and is obviously also well above the current average in the U.S. markets of roughly 20%.  Additionally, updated statistics on the Calgary residential real estate market can be found on the Calgary Real Estate Board's website, www.creb.com.

The same strength exists in the commercial real estate market, where extremely low vacancy rates, increasing lease rates, and cap rate compression have led to significant appreciation in market values. More specifically, the office markets are experiencing vacancy below 1%, and lease rates have nearly doubled over the last two years, with new lease rates for class-A buildings above C$40/sq ft. Similarly, shopping center economics have trended upward considerably, with vacancies at less than 1%.  Lease rates have also experienced positive trends, and range from C$20-25/sq ft for a neighborhood strip center to C$90/sq ft for a high end shopping center. Calgary currently has approximately 24 million sq ft of retail space, with nearly 6 million sq ft of retail space in the development stage, expected to be completed in the next 3 years. According to real estate brokerage firm Colliers International, the typical major metropolitan area has 35-40 sq ft per capita. Given Calgary’s current supply of approximately 24 sq ft per capita and future sq ft per capita of approximately 30, it appears that Calgary retail economics will remain favorable for the foreseeable future.

 

GDC’s Calgary Portfolio:

Genesis has five significant tracts of land in the greater Calgary area. A map of these tracts is available on the company website, www.genesisland.com. Unlike some of their competitors, the majority of Genesis’s land (~70%) has sufficient infrastructure (such as sewer and water) and is developable. The majority of the Company’s Calgary land is being slated for residential use (~85%), with the balance slated for commercial use. In three of the Company’s locations, Symons Valley, Northeast Calgary, and Canals North, Genesis is the largest land developer in the market.

Although the Company has historically had little turnover in its portfolio except for select lot sales to external homebuilders, Genesis is now entering a much more aggressive phase for turning over its land portfolio. This plan has three significant parts: (1) internal homebuilding under the Majestic (higher end), Evolution (middle market), and Reliant (entry level) brand names (2) more aggressive lot sales to external homebuilders, and (3) commercial real estate development. The paragraphs below profile each of the Company’s land parcels and their specific development plans:

 

Symons Valley:

Genesis owns 685.5 net acres in Symons Valley, a subdivision located in Northwest Calgary. Genesis began building upscale homes in Symons Valley in 2006. As of March, the average price of new homes there is C$575,000, up ~25% from a year ago.

Genesis is also planning an 85 acre, 850,000 square foot shopping center in Symons Valley called Sage Hill Crossing.  Of the 85 total acres, Genesis plans to sell 30 acres, encompassing 350,000 sq ft of retail space, to two large box anchor tenants, in 17 and 13 acre lots.  The Company is projecting sales prices of C$1.3 MM per acre, for a total sale price of C$39 MM.  Genesis plans to retain ownership of the remaining 500,000 sq ft of retail space, with leasing expected to begin in early 2009.  Currently, build-out costs are running approximately C$200 per sq ft, and rental rates are averaging approximately C$30 per sq ft. In addition to the 850,000 sq ft of retail space, Genesis had planned a 40,000 sq ft office building to be built in Sage Hill Crossing.  However, the company is currently in talks with the city to expand this office building to 1 million sq ft by expanding vertically.  This is currently in the planning stage, but the Company maintains that interest from the city has been high.

 

The Canals North & Bayside:

Genesis owns 569 combined net acres in the Canals North and Bayside, which are located in Airdrie, a suburb north of Calgary located just off highway 2 which connects the city to Edmonton. These subdivisions have been under development since 1997, and Genesis currently has homes for sale there.  The development incorporates a canal system throughout the property, and many of the homes have direct access to the water.

Genesis is also planning a 50,000 sq ft commercial property in Bayside.  This commercial property will be used to anchor the Canals North and Bayside communities, and will be primarily retail space with a maritime theme.  The development is partially pre-leased, with current lease rates projections of C$30 per sq ft.  The project is under construction, with an expected completion date of mid 2008. 

 

Taralake:

Taralake is located in Northeast Calgary, a 15 minute drive from downtown Calgary.  Genesis owns roughly 205 net acres in this development, which it has been developing and selling for several years. More recently, the Company began building and selling its own homes in Taralake.  In addition, Genesis is building a commercial development called Taralake Plaza, with 50,000 sq ft of retail space.  The company expects lease rates to be in the low C$30’s per sq ft.  This building is currently under construction, and is expected to begin leasing in mid 2008. 

 

Municipal District of Rocky View:

Genesis owns 450 acres in Rocky View.  This is divided between Mountain View and the Northeast Calgary land.  Mountain View is a 144 acre plot of land, and is projected to yield 41 single-family lots.  Genesis currently has approval to sell these homes on 2 and 4 acre plots, significantly larger than any of their other Calgary single-family lots, where they typically get 5.5 lots per acre.  Management is hopeful that they will be able to increase the density of this development over time.  The Northeast Calgary LP land consists of 315 net acres, which yield 1,900 net lots.  The LP land was acquired in 2005 as part of Genesis’ ongoing plan to replenish land inventory.  This was just before the Municipal District of Rocky View announced a plan to construct a regional sanitary sewer and potable water system, which caused a sharp increase in land prices in this Municipality.  Both properties are in their development stage, and Genesis anticipates approval and rezoning for the LP land to occur in late 2007.

 

Mitford Crossing:

Genesis land owns 160 acres in Cochrane, in a development called Mitford Crossing.  Cochrane is roughly 35 minutes west of downtown Calgary.  This development has been put on hold due to municipal approval delays.  The expected yield for this plot is 360 lots.

 

British Columbia:

 GDC also owns roughly 2,900 combined acres in a few locations throughout BC.  Most of these properties are in their developmental stage, and given that British Columbia has not seen the same explosive economic growth that Alberta has, they have considerably less value than the property in Calgary.  The land in British Columbia is divided into three parcels, Radium Hot Springs, The Woodlands in Prince George, and Buena Vista Ranch in Kamloops.

The Company recently announced the purchase of 1,140 acres in Radium Hot Springs for C$5.7 MM a deal that is expected to close in April 2007.  Located roughly 100 miles west of Calgary, the development is just west of Banff National Park, a premier destination for hiking, skiing, and other outdoor activities. Genesis expects to develop approximately 1,200 single-family lots and 200 multi-family lots.  The project is currently in the planning stage.

The Woodlands is a 121 acre plot in central BC.  This project was put on hold in 2000 because of weakening economic conditions in the area; however it has since been reinitiated in late 2006.  Since then, 58 lots have been completed, and are ready to be sold in mid 2007.  Genesis plans to sell these lots to third party home builders.

Genesis owns a 1,623 acre plot in Buena Vista Ranch, roughly 150 miles northeast of Vancouver and 250 miles west of Calgary.  The Company plans to develop a nature and outdoor themed concept there, with interconnected trails for cycling, horseback riding, and other attractions.  Genesis believes that this development will attract residents from Alberta and Lower Mainland BC.  This land is not yet annexed; however Genesis believes that the land will be annexed in the near future, due to strong economic growth in Kamloops.

 

Valuation:

Our analysis suggests that at conservative estimates for current land valuation, Genesis has over C$8 per share of net asset value. Calgary land valuations were determined using discounted pricing from comparable transactions and analyst reports on other companies with comparable Calgary acreage (Genesis does not currently have any analyst coverage). British Columbia land valuations were determined based on significant discounts to Company estimates, and in the case of Radium Hot Springs (which has yet to close), at cost. The table below summarizes our valuations for each parcel of Genesis land.

 

Property Summary:

Calgary	Acreage	Value per Acre (C$)	Value (C$MM)
Symons Valley (Residential)	600	$325,000	$195.0
Symons Valley (Commercial)	85	$750,000	$63.8
Taravista and Taralake	205	$275,000	$56.4
Airdrie	475	$250,000	$118.8
Rockyview	459	$75,000	$34.4
Cochrane	160	$50,000	$8.0
Total	1,984	$198,664	$476.3
British Columbia
Radium Hot Springs	1,140	At cost	$5.7
Buena Vista Ranches	1,623	$12,000	$19.5
The Woodlands	112	$20,000	$2.2
Total	2,875	$14,052	$27.4
Total	4,859		$503.7

 

C$ MM
Current Share Price	$5.50
Market Cap	254.6
After Tax NAV of Property	388.9
Other Assets, net	-12.1
Current NAV	376.8
Current NAV per share	$8.14

 

Although our NAV analysis is theoretical as the company is not liquidating, it is an important analysis for measuring what we believe to be the Company’s conservative land value in the current market environment. Land is not the most liquid of assets, but we believe our estimates include enough of a discount to account for the land’s illiquidity. While land prices obviously don’t always appreciate, we believe that economic signals point to continued land price appreciation over the next two or three years for the Company’s Calgary properties, which will in turn increase the Company’s net asset value. It’s also worth pointing out that in the majority of the Company’s locations, the land is zoned for at least 5 lots per acre, and individual lots have been selling for a minimum of C$150,000 per acre, implying a value of at least C$750,000 per acre. This value is well north of any of the values ascribed to residential tracts in the NAV analysis above.

Furthermore, our NAV analysis gives no credit to value that will be added to the pure land value from the Company’s commercial development and homebuilding operations. Of the two, we are particularly excited about the roughly 280 acres that the Company has designated for commercial development, most notably the 85 acre Sage Hill Crossing project.  Although still a couple years away from opening, the valuation metrics of the project are extremely compelling. For the purposes of our NAV analysis above, we valued the Sage Hill property at C$750,000 per acre, a value that was reportedly offered to Genesis for the property a couple years ago. In reality, we expect the property to have a far greater value as the Company proceeds toward the opening of the property. In our discussions with management, they have indicated that they plan to sell a combined 30 acres / 350,000 square feet to two big box retailers for a price of greater than C$1.0 million per acre, representing a total pre tax value of approximately C$30 million. In addition, Genesis plans to build out and lease the remaining 55 acres / 500,000 square feet at very favorable terms. Under current market conditions, the Company can build out this remaining property for approximately C$200 per sq ft, and lease the space for at least C$30 per sq ft, representing a return on invested capital of 15% (excluding the land, which they own for a minimal cost basis). Therefore, for a capital investment of approximately C$100 million, the Company can earn net rental income of at least C$15 million. Given that shopping center cap rates in Calgary currently range from 5% to 7%, the Company’s C$100 million investment will create a property that has between C$214 million and C$300 million in value. These values nearly exceed today’s entire enterprise value plus the C$100 million investment, on just 4% of the Company’s Calgary acreage. We expect Sage Hill Crossing to move from the development phase to construction during 2007, and are hopeful that a number of announcements surrounding the project will make for positive catalysts to the stock price during 2007.

Our feeling is that the homebuilding operations will not add nearly as much value as Sage Hill Crossing, but if executed appropriately should add incremental returns of 10+% to the pure land sale alternative. A typical Genesis home takes approximately 8 months to build, and in current market conditions where homes are selling in just over a month, the Company’s expectation for 18+% gross margins and 7% SG&A as a percent of sales should yield at least the aforementioned 10% incremental return. We remain a bit cautious, however, because the Company is attempting to go from no home sales in 2004 to nearly 200 in 2007, and up to 1,500 by 2009. However, their recent acquisition of Point Grey Homes, which has proven annual capacity to produce 150 homes, should help them as they make the transition. Unless the homebuilding operations actually yield negative operating margins (which is difficult to imagine), they won’t detract from the underlying land value, which typically sells for 2x book value and has an incredibly low cost basis.

Melcor (ticker MRD on the Toronto exchange) is really the only publicly traded comparable, and Genesis’ valuation stacks up quite favorably when comparing the two. Melcor owns approximately 6,500 net acres in Alberta, with approximately 1,800 located in Calgary. Melcor’s Calgary acreage is far less valuable though, as it is far less attractively located and only a small portion of it is serviced/developable. Using the same conservative land price valuation on Melcor’s land as used for the Genesis analysis, Melcor trades well above its net asset value, without even accounting for the fact that Genesis’s land is far more developed. Since Desjardins Securities initiated coverage on Melcor in September of 2006, Melcor’s stock has appreciated by over 65%, and volume has increased roughly threefold. By comparison, Genesis’s stock price has only increased by approximately 15% over the same time period, and volume has only increased marginally. One major difference between the two companies is that Melcor has some income producing property, and we are hopeful that the valuation discrepancy will reverse as Genesis itself moves toward a significant income producing component with its Sage Hill Property. We would also not be surprised to see initiation of analyst coverage of Genesis in the coming months as the Company begins to report on its transition to more aggressive land and home sales.

 

Risks and uncertainties:

As we see it, there are five primary risks related to an investment in Genesis: (1) oil price risk, (2) management/operational risk, (3) construction cost risk (4) liquidity risk, and (5) currency risk.

As we mentioned earlier, the recent boom in the Calgary real estate market has been largely tied to the strength in the Canadian oil sands, which has in turn been highly correlated to the significant price increase of crude oil in recent years.  Due to the higher cost structure of the oil sands, the oil sands require a much higher breakeven price for crude oil, and are therefore more sensitive to changes in crude prices. If oil prices were to drop significantly, it would potentially have a negative effect on the Calgary real estate market. We are comforted, however, that the major oil sands players have already locked in significant long term capital spending commitments, and believe that unless crude prices drop substantially below USD $40 per barrel, the Calgary market should continue to thrive. 

The second risk worth noting is management and operational risk. As we have described earlier in this report, management is attempting to make the difficult transition from a pure land developer to a fully integrated land developer, homebuilder, and commercial developer, with fairly limited experience outside of pure land development. There is certainly the possibility that they may struggle in one or more of these areas, and this may negatively affect the valuation and the market’s perception of the Company. It’s also worth pointing out that management owns roughly 40% of the outstanding stock, giving them significant insider control.  While this is certainly a concern, it is also reassuring to know that management has “skin in the game”, and key personnel have the majority of their net worth tied to the success of the Company.

Genesis is also exposed to construction cost risk. As unemployment has reached record lows in Alberta, wages for skilled contracting labor have increased significantly. Though material cost inflation has slowed somewhat of late, these costs have also increased considerably in recent years. As Genesis expands its internal development operations, they will have to increasingly contend with these input cost components. We are hopeful, however, that these will be more than offset by rising home prices, as has been the case over the past couple of years.

Liquidity risk is also worth noting.  As of the time of this writing, the stock has traded roughly 90,000 shares per day over the last three months, representing only USD $400,000 value traded per day. On many days, the stock will trade ‘by appointment’, and the average volumes are skewed by a handful of days where significant blocks have traded.  While Genesis’s relative illiquidity is a concern, we are hopeful that institutional interest in the story will increase over time, and volume will increase as a result.

Finally, Genesis is exposed to Canadian dollar currency risk as it conducts all of its operations in Canada and uses the Canadian dollar as its functional currency.

 

Conclusion:

On April 2^nd, Genesis reported its 4Q 06 financials, posting numbers that are beginning to reflect the Company’s transition toward a more fully integrated operating model and aggressive monetization of its land portfolio. For the quarter, the Company sold 37 homes under its internal brand, up from 15 during the third quarter, and 11 in the second quarter. Additionally, after selling only 18 lots to external builders in the first three quarters of 2006, Genesis sold 63 lots to external builders during the fourth quarter. The Company also forecasted that in 2007 it expects to sell at least 180 homes under its internal brand and an additional 370+ to external builders. Also, Genesis believes they will experience gross margin expansion in their homebuilding operations, as they take advantage of economies of scale and increased single family home prices in Calgary.

We believe that Genesis represents an attractive long term investment, and believe that our NAV estimate of C$8.23 per share is well on the conservative side, providing considerable downside protection to our investment. We are also confident that as the Company begins to aggressively pursue a strategy of asset sales and internal homebuilding and commercial development, the net asset value should prove to be quite a bit higher, perhaps even by multiples. We expect the 4Q 06 earnings, expected at the end of March, to represent the start of a string of positive news flow reflecting the Company’s strategic transition. As mentioned earlier, we are also particularly excited about the Sage Hill Crossing shopping center development, and believe that it alone might have almost as much value as the entire enterprise value of the Company. We believe that investors with a long term orientation will be rewarded by investing in Genesis Land.

 

 

Catalyst

(1) Additional updates on the status of their flagship commercial development, Sage Hill Crossing
(2) Subsequent earnings releases, demonstrating the Company's ability to transition to a fully integrated homebuilder and commercial developer
(3) Continued strength in the Calgary residential real estate market
(4) Initiation of sell side coverage