Description

Company / Investment Overview:

We originally wrote up Genesis in April of this year. In the meantime, while its net asset value has increased, the stock has traded down along with everything exposed to residential real estate, regardless of the fact that the Calgary real estate market remains strong and has minimal correlation to the widely profiled problems in the U.S. We believe this is a classic case of throwing the baby out with the bathwater. At its current market price, Genesis is trading at a roughly 50% discount to a conservatively valued net asset value, at less than 10x 2007E EPS, and approximately 6x 2008E EPS.

Since the Company’s inception in 1992, Genesis has accumulated one of the largest land portfolios in Western Canada, including ~4,000 net acres in the greater Calgary area, as well as ~2,800 net acres in British Columbia (for a more detailed description of Genesis’ land holdings, please review our original write-up dated April 5, 2007). Because of the particularly attractive economics in the Calgary market, Genesis is currently spending the majority of its time and capital developing its assets in this market rather than 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. Our net asset value of approximately C$10 per share is purely based on the Company’s land value, and gives no credit to the value added through the Company’s internal residential and commercial development group. Within Calgary, the Company has identified roughly 80% of this land for residential development and the remaining 20% for commercial development. These two development fronts will benefit each other as Genesis builds out its largely contiguous land parcels, controlling much more than just the residential components of the community. As an example, Genesis is the largest single landholder in a highly attractive, upper class suburb of northwest Calgary called Symons Valley, where the Company not only controls much of the residential development (both for internal homebuilding and external lot sales), but is also building the second largest shopping center under development in all of Calgary. Genesis recently announced the sale of 17 acres to Wal-Mart, who will become the anchor tenant of the property, for C$1.3 MM / acre (which of course the market didn’t react to). Wal-Mart’s plans to open their first Super Center in Calgary exemplifies the quality of Genesis’ surrounding acreage and the attractive demographics of the region.

Alberta & Calgary Macroeconomic Background:

In recent years, Alberta has benefited tremendously from the significant capital spending in the oil sands, which is expected to exceed C$100 billion over the next decade.  While the overall Canadian economy resembles those of other developed nations, Alberta is exhibiting growth rates similar to those of an emerging market. In 2006, Alberta’s real GDP grew 7%, with both unemployment and population growth significantly stronger than the national averages. 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. Investment in the booming energy sector 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.

What has changed since our last write-up:

Although transaction volumes have come off their peak in Calgary’s residential market since the summer, the market remains very strong, with the average home on the market for just 46 days, and the average home selling for ~C$450,000.  Prices have stabilized sequentially, and are still up approximately 10% year over year. These statistics obviously compare very favorably with U.S. markets, with the average house on the market for more than 10 months. The markets in Calgary are also well insulated from the issues that U.S. housing markets are facing. In particular, the residential mortgage market in Canada is far less exposed to sub-prime lending, with only 5% of Canadian mortgages classified as sub-prime, compared to 20% in the U.S. All high ratio mortgages (mortgages with less than 25% down) must be insured through an organization like the Canada Mortgage and Housing Corporation (CMHC). Unlike the aggressive lending practices seen in the U.S., there are no mortgage loans that finance more than 100% of the value of a home. Overall, mortgage loans in arrears, or late on payment, are at 0.5%, near record lows. The default rate on Canadian sub-prime mortgages is at approximately 2.1%, less than one-sixth the U.S. rate.

As mentioned in our previous write-up, Genesis is in the process of ramping up their homebuilding and lot sales operations.  Over the last twelve months, the Company has sold ~135 SF homes and ~265 SF lots (separate from the SF homes), up from just 33 SF homes and 18 SF lots in the first nine months of 2006. Although the Company has fallen short of their volume targets in 2007 due to tightness in the labor markets for land servicing, this has been more than offset by higher than expected average selling prices and margins. In particular, single family lots have been selling for ~C$200k, and the Company has realized gross margins of nearly 70% on each sale.  This compares to our projections of C$150k and 50% gross margins.  As a result, the Company will most likely still earn C$0.50+ per share, which is in line with the estimate by Desjardin’s Securities, the only sell side firm that covers them.

Genesis also purchased additional land since our original write-up. These purchases were made just outside of Airdrie and in the Hamlet of Delacour, and consist of large tracts of undeveloped land near the Company’s existing land holdings, but outside of the currently annexed boundaries of Airdrie and Calgary. None of these transactions have closed yet, and given the long term nature of these projects, which most likely will not begin selling for 4-5 years, we do not include them in our NAV calculation.  We value this land at cost going forward.  In addition, most of the land is being purchased using external capital raised through LP agreements that Genesis manages (with very low cost of capital), and will not require the Company to invest any additional capital.

Given that approximately 20% of Genesis’s land holdings are slated for commercial use, it is also important to provide an update in this area. The commercial market in Calgary remains very strong, with retail vacancies at approximately 1.3%, near all time lows. Since our original write up, the Company has made significant progress toward opening its 850,000 square foot flagship shopping center called Sage Hill Crossing in Symons Valley. Most notably, the Company recently announced that it has gone under contract to sell ~17 acres of land on the property to Wal-Mart for C$1.3 MM / acre. In addition, management has indicated that it plans to sell another parcel of land within Sage Hill Crossing, most likely to Lowe’s. Based on our conversations with the Company as well as real estate professionals in Calgary, we believe the sale will be for ~14 acres, and will sell for C$1.4 MM / acre, a slight increase from the Wal-Mart sale.

Valuation:

Our analysis suggests that at conservative estimates for current land valuation, Genesis has over C$10 per share of net asset value. Calgary land valuations were determined using discounted pricing from comparable transactions, analyst reports, and brokers in the greater Calgary area. British Columbia land valuations were determined based on significant discounts to Company estimates. The table below summarizes our valuations for each parcel of Genesis land. Note that land purchases that have not yet been completed are not included in the property summary, and are held at cost for valuation purposes in our internal models. We believe that over time, however, the Company will be able to realize additional value as they implement their value added entitlement process (as they have for existing property).

Catalyst