Description

Leon’s is a 100+ year old retailer of furniture and appliances based in Canada (American equivalents would be Bob’s Discount Furniture / Ashley Furniture), still ~70% owned by the Leon’s family. Leon’s is a well-managed, high-quality asset, averaging ~18% returns on net tangible capital over the past 10 years (’13-’23), and compounding earnings per share at an ~8.8% rate. 

More importantly, Leon’s has a substantial amount of real estate carried at cost on their books and made it clear to any readers of their annual reports that the value on their books is not the market value of those assets, and that they intend to monetize them: 

Our stores and warehouses sit on a vast portfolio of real estate which is reported at historical cost and represents significant opportunity to unlock value through sale or development 

– 2020 Annual Report

LFL Group’s real estate assets are reported at historical cost, meaning the balance sheet does not reflect its market value in an environment that has seen meaningful long term price appreciation.

 – 2022 Annual Report

The market value of our real estate assets is well above the historical cost of $256 million we report for accounting purposes. Our two-part strategy to unlock that value includes (1) creating a Real Estate Investment Trust, and (2) developing the properties that remain within LFL Group

–2023 Annual Report

So what is this real estate worth? Management is signaling, through significant share repurchases, it is a large number. In July 2021, the first non-Leon’s family member became CEO and by November 2021 he repurchased 10% of the shares outstanding at a price of $25 per share (current price is ~$21). In September 2022, Leon’s announced another buyback program to repurchase 5% of shares outstanding for a total of 15% repurchased when completed.

In May of 2023, Leon’s announced their plans to monetize their real estate via either a spin or IPO of the assets into a REIT and in Q3 the board approved the resolution to launch the REIT via an IPO. They announced that they have 5.6mm sq ft of cash-flowing retail / industrial assets that have a book value of C$256mm ($34 / sq ft in USD) or $3.71 / share. While it is admittedly difficult to value given the assets are both retail and industrial assets spread across Canada, CBRE estimates rent per sq. ft. nationally for industrial assets will be $15 for 2024 (retail is higher), valuing it at a 6-8% cap rate would translate to C$1.1bn-C$1.4bn. This works out to $15-$20 / share or nearly all of their current market value of C$1.5bn. This also excludes additional owned land that will be vended into the future REIT over time, such as the 40 acres of land they have in Toronto that they are partnering with developers to build 4,000 homes on which itself could be another several hundred million dollar asset:

This playbook has been used before. In 2013, Canadian Tire IPO’d their real estate into a REIT and the stock appreciated ~40% over the 6 months it took them to complete the transaction. Also in 2013, Loblaw spun off their real estate into a REIT with stock appreciating ~44% over the 8 months it took them to complete the spin. The main differences with Leon’s and these comparable situations are 1) CT and Loblaw both announced the value of their real estate when they announced their intention to separate it whereas Leon’s has so far just announced their intention to separate it without stating what it is worth. Considering it took Loblaw and CT 6-8 months to complete the separation, Leon’s is likely further behind, and second half of 2024 seems more plausible considering they announced the potential IPO in May 2023 and the CFO commented recently at the CIBC conference that the REIT is near term not medium term. The second difference is that the valuation gap appears larger in terms of the potential value for Leon’s versus these comps. Both CT and Loblaw had real estate worth ~60% of the value of their preannouncement market cap, whereas in Leon’s case their real estate assets are worth ~70-90% of the market cap excluding their other land assets. 

As for the value of the furniture business, assuming Leon’s can continue to generate current revenue per store levels of $8.1mm (it has grown at a 4% CAGR since 2013), they can sustainably generate $2 in FCF per share (or more with additional buybacks). At a 10x multiple, that values the furniture business at $20 / share, plus the midpoint of the real estate assets, that works out to a combined value per share of $37.50 / share (~80% upside). In a stress case, if revenue per store resets back to 2018 levels of $7.4mm (9% drop, in line with what happened post GFC) their FCFPS is $1.84. Using a 10x multiple, that works out to $18.40 per share, plus book value of real estate of $3.71 per share, you get ~$22 a share, slightly above their current share price.

While furniture sales could very well decline in a downturn, even in a severe recession, Leon’s earnings power supports the current valuation. When marking to market their real estate assets, you are essentially getting the furniture business for free. In the meantime, you collect at 3.4% dividend while you wait for the REIT to play out with hopefully some more shares repurchased along the way.

Catalyst

• Separation of real estate assets carried at cost on their books into a REIT