Melcor Developments Ltd.
Melcor’s revenue per share (red line) has mostly trended down since 2014. This was due to a lower pace of new home building in Alberta. But revenue increased modestly in 2020 and sharply in 2021 as as home-building activity had picked up. It then declined in 2022 becasue no lots were sold in the US. And it has increased in 2023 to date as lots were sold in the U.S.
(Adjusted) earnings per share have been quite volatile but always positive on an annual basis but have trended down since 2014. The company is quite cyclical. Adjusted earnings fell sharply in 2019 due mostly to weaker housing starts. This weakness finally reversed in the later part of 2020 and has been relatively stronger since then but declined in 2022 with no lot sales in the US. There is an increase in 2023 to date as lots were sold in the U.S.
Book value per share has trended up over the years. Recently it was boosted by share buy backs at prices far below book value.
While book value per share has increased at an acceptable 5.9% compounded annually over the past ten years, overall it is certainly not an impressive chart.
| MELCOR DEVELOPMENTS LTD. (MRD, Toronto) | |
| RESEARCH SUMMARY | |
| Report Author(s): | InvestorsFriend Inc. Analyst(s) |
| Author(s)’ disclosure of share ownership: | Author(s) hold shares |
| Based on financials from: | Dec ’22 Y.E. + Q3 ’23 |
| Last updated: | November 23, 2023 |
| Share Price At Date of Last Update: | $ 11.36 |
| Currency: | Canadian $ |
| Generic Rating (This rating does not consider the circumstances of any individual investor and is therefore not specific advice for any individual): | Buy rated at $11.36 |
| Qualifies as a stock that could be bought with confidence to hold for 20 years? | Yes but expect only modest and below market returns |
| Has Wonderful Economics? | No |
| Has Excellent and Trustworthy Management? | No |
| Likely to grow earnings per share at an attractive rate over the next decade? | Expect modest but not attractive growth |
| Positive near-term earnings outlook? | Uncertain |
| Valuation? | Seemingly Very Attractive |
| SUMMARY AND RATING: The graph of adjusted earnings per share demonstrates essentially no growth and some volatility going back ten years. Not impressive. Book value per share has grown at an average of 5.9% annually since 2012 including fair value gains (and since 2020 fair value losses) on its rental buildings. This together with the dividend that averaged about 2% of book value suggests an achieved average effective ROE of around 7.9%. In the trailing 12 months ending Q3, 2023, the adjusted ROE was very weak at 4.8%. Overall the economics of the business have not been good as it appears that the gross profits on lot prices have not been high enough to reflect all the years that equity is tied up before the sale. With quite cyclical or volatile earnings, the earnings-related and other value ratios are somewhat unreliable but would currently suggest a (higher) Buy or higher rating based on the price to book ratio of 29% and the P/E of 6.3 but tempered by the weak ROE. The outlook for lot sales appears “okay” given the strong Alberta economy but tempered by the impacts of higher interest rates on housing affordability. The outlook for the commercial rental building segment is for stability in revenue but lower earnings due to higher average interest rates. Recent positive developments include two asset sales at significant gains and recent dividend increases. Management quality however is questionable. They appear to have little ambition to improve the ROE. The controlling family appears to have little regard for increasing the share price. The insider trading signal is negative. It’s not entirely clear that they have any lasting competitive advantage although they have strong market knowledge and abilities in a field that is probably not that easy to enter for new competitors (but why would they want to enter?). The balance sheet is relatively strong. And interest expenses are relatively large as a percentage of earnings. Note the thin trading liquidity. Overall we rate this a (higher) Buy at this time based on the extremely low price to book value and the 5.6% yield and the nature of the assets but tempered by the low ROE history and the apparent complacency of management. We acknowledge that it has been a poor investment for many years except when purchased after very steep price drops which occurred with the financial crisis in 2008 and with the pandemic in 2020 and which seemingly is occurring again at this time. In the longer term we would like to see a substantial share price gain which would be an opportunity to exist this apparently inherently low return business. | |
| MACRO ENVIRONMENT: Higher interest rates are a major headwind due to depressed home building, lower market value of land and buildings, higher interest costs and downward pressure on P/E ratios. Offsetting this, the Alberta economy remains very strong and the 3.7% population gain in 2022 and continued growth in 2023 is also quite beneficial. | |
| LONG TERM VALUE CREATION: On its books at least, Melcor has created significant long-term value given that 91% of its equity consists of retained earnings and the company has also paid out substantial dividends. However, the market has shaved off much of the accounting value as the shares trade at only about 29% of accounting book value whereas the vast majority of publicly traded companies trade at a higher price than book value. And it’s not clear that the ROE has been attractive at all in the long term. | |
| DESCRIPTION OF BUSINESS: Updated March 2023 based on 2022 figures. The contributions of its various segments to revenue and earnings varies significantly from year to year. In 2022, 48% of revenue was as a residential (with some commercial) land developer. The land development business appears to be mainly done with joint venture partners. Also develops, retail and industrial buildings for transfer to its rental division (5% of revenue – the contribution of this segment varies greatly year to year) . Rents out office, retail and industrial buildings including some in a 55% owned REIT structure (43% of revenue which is however before deducting the share of the REIT owned by others). Also owns and operates three golf courses and has an interest in a fourth (4% of revenue). Operates mostly in or near the major cities of Alberta. Has some U.S. residential developments (Phoenix and Denver) and rental property (6.5% of revenue – low due to no US lot sales in 2022 – and 13% of assets, included in the segments above). The rental investment property portfolio totals about 62 buildings or properties and 4.80 million square feet (of which 39 properties or 3.67 million square feet are in the REIT which is 45% owned by the public unit holders and 55% by Melcor). Tenants include the Alberta government, Canadian Tire, Canadian Western Bank, Home Depot, Rexall Drugs, Rona, Royal Bank, Save-on Foods, Sobeys, Scotia Bank, Shoppers Drug Mart, Sport Chek, Staples, TD Canada Trust, Tim Hortons, Walmart and many others. Buildings include 476 residential apartment units and about 10 parking lots. The total assets are $2167 million. Melcor is not employee intensive as it contracts out the physical work of developing properties. 13% of the assets are in the U.S. and the great majority of the Canadian assets are in Alberta. The U.S. assets appear to be mostly represented by about six office buildings purchased from 2014 to 2016 as well as over 1000 acres of largely residential development lands in Arizona and Colorado. | |
| ECONOMICS OF THE BUSINESS: The largest business is residential (and some commercial) land development. In this business they buy raw land typically on the edges of cities, mostly in Alberta but with some in Kelowna and some near Denver Colorado and other areas in the western U.S. In this business capital spending, unlike the case for most companies, goes directly into the product that is sold, so that capital is recycled although the process can easily take 10 years or more. Developing the land into residential building lots (and some multi-family and shopping areas) requires obtaining permits and installing infrastructure such as roads and utilities (which is done through contractors). Also there is substantial surveying and grading (which also is done by contractors). This business involves investing for a number of years before any lots can be sold (if ever). There is competition. The business can be highly cyclical and unpredictable. However gross margins on lots and land sales have been too low since 2015 and this has led to an inadequate overall company ROE in the 3 to 6% range. Due to long holding periods for land, a higher gross margin is required in order achieve a reasonable ROE on money invested over the years. Another portion of the business is to manage the construction (by contractors) of commercial, retail and industrial rental buildings. The economics have been such that Melcor has been able to make good profits on this business. The third major area of business is renting out the commercial and retail space. This portion of the business has generated modest but steady rental returns plus mostly increases in the market value of the rental properties as interest rates have declined – but in 2020 and since then building values declined due to higher vacancies. Overall it appears that Melcor’s business economics have been relatively poor since 2014. Unfortunately, there is not much reason to expect the ROE to reach double digits much less to be sustained at that level. | |
| RISKS: The primary risk is the state of the Alberta economy and the volatile demand for new housing (and potentially lower prices for building lots) and the demand and market rents for its office and retail space. There is some risk that demand for its office space has relatively permanently decreased due to the work from home phenomenon and due to an excess supply of office space on the market. The risk for commercial space greatly increased with the pandemic but has now substantially recovered. Another risk is the risk from higher interest rates which, all else equal, will lower the market value of its buildings and land as well as lower reported earnings. Government action to cool Canada’s hot housing market prices is a risk. There is some risk of bad debts from builders although apparently they retain title to building lots until they are paid for. See annual report for additional risks. Also, this public company has a majority controlling owner. In most cases this will benefit outside shareholders as compared to non-ownership type management. But there is a risk that the controlling shareholder will use his position to award large bonuses and stock option grants to himself and the family and not act strictly in the best interest of outsiders. The family may have little interest in the share price since they apparently have no intention of selling. The family may even prefer a lower share price to limit any capital gains tax in transferring the business to the next generation. This family control feature can tend to hold the share price down somewhat (perhaps significantly) since it seems to preclude any possibility of a take-over bid no matter how low the share price is. | |
| INSIDER TRADING / INSIDER HOLDING: Checking from January 1, 2023 to November 23, 2023. In January a number of insiders are listed as purchasing under a plan. That is likely shares received as compensation. The VP of Community Development for Edmonton (Susan Keating) bought a modest 149 shares “under a purchase plan” in January at $12.84 to hold 10,700 shares. Leah Margiotta, director of development similarly bought a scant 31 shares under a plan in January at 11.65 to hold just 513 shares. Andrew Melton bought 167 shares at $12.67 under a plan to hold 23,069 shares in this account. But he owns a total of about 229,000 shares personally. Tim Melton bought 1151 shares under a plan in January at $12.67 to hold 40,606 shares directly but he owns a total of 2.3 million shares personally. A few others bought under the plan in January also and hold modest amounts of shares. It’s notable that The V.P. of the Red Deer Region (Guy Pelletier) sold 13,689 shares in 2023 at about $12 to hold 44,597 shares. He also sold the modest 250 shares that each of three family members owned. Notably Graeme Melton SOLD 425 shares in November at $11.26 to hold 17,355. The company itself has continued to buy back a modest amount of shares as it is limited to just 1600 shares per day. However, in a new development, it has recently completed some quite significant block trades in 2022 and in 2023. Overall the insider trading signal is negative. Insiders hold substantial stock which is positive. A number of them hold significant amounts, such as $1 million, while a couple hold huge amounts well into the $ millions. However a number of executives own very modest amounts of shares which does not inspire much confidence. | |
| WARREN BUFFETT’s CRITERIA: Buffett indicates that all investments must pass four key tests: the business is simple to understand (marginal pass as the accounting is complex and the business very cyclical), has favorable long-term economics due to cost advantages or superior brand power (fail – it appears to be involved in inherently low ROE businesses – its land development business appears to be both low return and high risk), apparently able and trustworthy management (fail given the weak recent performance and apparent lack of concern for the public share owners), a sensible price – below its intrinsic value (pass – low P/E and apparently selling well below market value of assets but tempered by the low ROE), Other criteria that have been attributed to Buffett include: a low debt ratio (pass), good recent profit history (fail) little chance of permanent loss of the investors capital (pass) a low level of maintenance type capital spending required to maintain existing operations excluding growth (pass) | |
| MOST RECENT EARNINGS AND SALES TREND: This company has volatile and cyclic earnings and various accounting issues that make the adjusted earnings highly variable. Revenues per share in the past four quarters starting with the most recent (Q# 2023) were up 53%, up 34%, down 29% and down 48%. In the same four quarters, adjusted earnings per share were up 51%, up 38%, down 80%!, and down 56%. In 20022 overall, revenue per share were down 22% and adjusted earnings per share were down 15%. In 2021, revenues per share and adjusted earnings were up substantially but that is in comparison to a very weak 2020. The graph shows a negative trend in revenues and earnings per share dating back to 2014 (when oil prices fell). However, the most recent two quarters have features strong growth. | |
| INDUSTRY SPECIFIC STATISTICS: Residential lot sales in Canada over the first 9 months of 2023 were down by 33%. However. overall counting U.S. lot sales the number was about unchanged versus the first 9 months of last year. Canadian lot prices in 2023 to date were up 7% to $162,000. (This can very based on lot sizes and the percent of estate lots) Lot prices on average in 2022 were up 6% to $154,000. Lot prices on average were about flat in 2021 at $145,000 but in Q4 2021 the average was a disappointing $116,000 attributed to smaller lot sizes. In 2022 there were no lot sales in the U.S. In 2021 the number of developed lots sold in the U.S. was up 16% but the average price per lot was down to $102k from $141k Canadian dollars – the lower price was attributed to smaller average lot sizes. In addition in 2021, in the U.S., it sold 595 undeveloped lots that it had taken through the municipal approval process plus 155 acres of land. | |
| Earnings Growth Scenario and Justifiable P/E: The trailing P/E is generally not a reliable indicator for this cyclic company but at 6.3 it is certainly not pricing in much if any growth. | |
| VALUE RATIOS: Analysed at a price of $11.36. The Price to book value ratio appears extremely attractive indeed at 0.29 (29 cents on the dollar!) especially considering the “hard” and tangible nature of its assets. However note that the shares have a history of usually trading somewhat (though usually not this much) under book value. And it is possible that some of its land was purchased at higher than current market value – especially as market values will likely decline with higher interest rates. And its rental buildings could continue to suffer market value losses due to the higher interest rates. And we also have to consider the poor (adjusted earnings) ROE at 4.8% and that it has been quite poor since 2014. Under IFRS accounting, investment properties have been marked to (modeled) market value but land (other than under rental buildings) remains valued at cost (including costs of improvements and capitalised interest) unless there is an impairment which has not occurred in recent decades. The dividend yield is very attractive at 5.6%. The payout ratio is 35% and there is room to further increase the dividend. The interim adjusted P/E appears highly attractive at 6.3 but is not very meaningful given the cyclical nature of the business. Earnings will vary significantly with lot and other land sales in Alberta and the U.S. Book value per share is $39.50. Overall the value ratios (in isolation) easily support a Buy or even Strong Buy rating on the basis of buying dollar bills (the book value) for about 29 cents although the very low ROE offsets that. (It may be that the book value is stuck in an inherently poor ROE business) On an enterprise basis if the company were acquired including its debt the price appears to represent buying assets at 55 cents on the dollar of book value. P | |
| TAXATION: Nothing unusual. The dividend qualifies for the Canadian dividend tax credit. | |
| SUPPORTING RESEARCH AND ANALYSIS | |
| Symbol and Exchange: | MRD, Toronto |
| Currency: | Canadian $ |
| Contact: | ir@melcor.ca |
| Web-site: | www.melcor.ca |
| INCOME AND PRICE / EARNINGS RATIO ANALYSIS | |
| Latest four quarters annual sales $ millions: | $266.4 |
| Latest four quarters annual earnings $ millions: | $89.9 |
| P/E ratio based on latest four quarters earnings: | 4.0 |
| Latest four quarters annual earnings, adjusted, $ millions: | $56.6 |
| BASIS OR SOURCE OF ADJUSTED EARNINGS: We have removed the after tax gains (and more recently losses) on market value of buildings that the company must report under International Financial Accounting Standards. Also adjusted for the changes in the value of the REIT units which flow into earnings, and unusual income tax items. Note that earnings are cyclical and heavily dependent on economic activity. There have been some unusual gains on asset sales but we have generally not adjusted for these due to the overall cyclical nature of the company and the difficulty of obtaining a normalized view of earnings. | |
| Quality of Earnings Measurement and Persistence: Lower measurement quality and lower persistence quality. Earnings result from sales of developed residential building lots and some commercial lots at a profit, value added in developing rental buildings, rental income, and from the mark to market gains (or losses) on investment properties and occasional sale of rental property (though we adjust for the market value gains or losses). Builders often have about 1 year to pay for the lots interest-free and there is some risk of bad debt although that receivable is secured by the lots sold. Earnings are quite cyclic so they are not very predictable. However we removed the mark to market gains for adjusted earnings and so adjusted earnings are of reasonably good measurement quality but remain cyclically volatile. | |
| P/E ratio based on latest four quarters earnings, adjusted | 6.3 |
| Latest fiscal year annual earnings: | $89.4 |
| P/E ratio based on latest fiscal year earnings: | 4.0 |
| Fiscal earnings adjusted: | $54.1 |
| P/E ratio for fiscal earnings adjusted: | 6.6 |
| Latest four quarters profit as percent of sales | 21.2% |
| Dividend Yield: | 5.6% |
| Price / Sales Ratio | 1.34 |
| BALANCE SHEET ITEMS | |
| Price to (diluted) book value ratio: | 0.29 |
| Balance Sheet: (Last updated Q3 ’23). Assets are comprised as follows: 52% of the assets are investment properties which are marked to (modeled) market (and a further 3% are mostly tenant incentives and similar). 36% of the assets are represented by the land inventory (which would be land cost plus subsequent costs of developing the land and plus capitalized interest – this is not marked to market). 4% of assets is largely a large and somewhat longer term secured receivable from builders who apparently pay for lots only after one year and in some cases longer. Melcor retains title to the lots until payment is received. No interest applies until one year passes and then prime plus 2% interest applies. 3% of assets is cash. Property and equipment accounts for less than 1% of assets which illustrates the fact that this is a company that manages land development by contracting out that work. On the liability side of the balance sheet, 56% of the assets are supported by common equity, 33% by debt, 3% by a provision for land development costs, (Only) 3% by the minority interest of the REIT (the publicly traded share of the REIT) 3% by deferred income taxes and 3% by accounts payable. 91% of the common equity is retained earnings which proves that it has a history of making profits especially considering that substantial additional earnings were dividend out over the years. (However, the market is discounting the equity by 71% as if the earnings were not “real”). There is no purchased goodwill. Deferred income taxes owing can be considered a softer liability in that it may continue to grow and be deferred for years (even as deferred taxes are paid, new deferred taxes may take their place in which case there is no net cash paid out on deferred taxes). Overall, this appears to be a very strong balance sheet with hard and valuable assets financed with relatively modest debt. However, with the market discounting the book equity by 71% and the enterprise value by 45% there comes a point where we have to question if the book asset values are realistic. | |
| Quality of Net Assets and Book Value Measurement: This should be high although real estate assets are subject to possibly significant market value fluctuation. See our comments about the balance sheet. As of November 23, 2023 the shares traded at just 29% of book value. Investment properties have been marked up to (modeled) market value (and since 2020 marked down somewhat). The land inventory remains valued at cost (including development costs and capitalized interest) and it seems likely that land market values are somewhat above book value, but the actual ratio is unknown and subject to change including declines. The company attested that as of December 31, 2022 the (UNDISCOUNTED) realizable value of its land inventory was higher than its carrying value such that no provision for impairment was required. But that does not mean that the market value is higher than cost. There is also presumably value in the going concern aspect of the business beyond its asset value. Overall the quality of the assets and the book value measurement seems high. However, it may be that the land assets in particular are trapped in a low return business and that the investment properties may be over-valued on the books in light of higher interest rates. | |
| Number of Diluted common shares in millions: | 30.7 |
| Controlling Shareholder: (Updated May 2022) Tim C. Melton, the chairman of the company, together with his family, controls about 55% of the shares. A former CEO and current board member owns another 4% and other directors/officers total about 1%. It appears that about 40% of the shares are available to trade however there are some other large holders as well. | |
| Market Equity Capitalization (Value) $ millions: | $349.1 |
| Percentage of assets supported by common equity: (remainder is debt or other liabilities) | 56.5% |
| Interest-bearing debt as a percentage of common equity | 58% |
| Current assets / current liabilities: | not available |
| Liquidity and capital structure: Apparently reasonably good liquidity but they are dependent on continued access to bank credit, the company does use debt to finance their investment properties and (to a very limited degree) raw and developed land but the debt is probably not excessive and was recently 58% of the book value equity amount which is relatively low leverage. However with the equity trading at 29% of book value, debt is significantly higher than the market value of equity. It does have debt maturities coming up but these are mostly secured against individual buildings or land with no recourse to Melcor. | |
| RETURN ON EQUITY AND ON MARKET VALUE | |
| Latest four quarters adjusted (if applicable) net income return on average equity: | 4.8% |
| Latest fiscal year adjusted (if applicable) net income return on average equity: | 4.7% |
| Adjusted (if applicable) latest four quarters return on market capitalization: | 16.2% |
| GROWTH RATIOS, OUTLOOK and CALCULATED INTRINSIC VALUE PER SHARE | |
| 5 years compounded growth in sales/share | -0.8% |
| Volatility of sales growth per share: | Good long term growth with significant volatility. |
| 5 Years compounded growth in earnings/share | 18.9% |
| 5 years compounded growth in adjusted earnings per share | 0.8% |
| Volatility of earnings growth: | Highly volatile but always positive each year |
| Projected current year earnings $millions: | not available |
| Management projected price to earnings ratio: | not available |
| Over the last ten years, has this been a truly excellent company exhibiting strong and steady growth in revenues per share and in (adjusted) earnings per share? | no |
| Expected growth in EPS based on adjusted fiscal Return on equity times percent of earnings retained: | 3.1% |
| More conservative estimate of compounded growth in earnings per share over the forecast period: | 0.0% |
| More optimistic estimate of compounded growth in earnings per share over the forecast period: | 8.0% |
| GROWTH OUTLOOK AND AMBITIONS: They have a focus of harvesting their existing land position which appears to be excessive. Their ambition is more to protect investment and they are not ambitious for rapid growth that could be risky. They believe there is upward momentum in the Alberta economy. They have two new communities in the Calgary area and expect to book lot sales in Q4 of 2024. Results in its rental property buildings appear set to be stable but higher interest rates are a definite headwind to earnings . And the higher interest rates could cause further market value losses on their rental properties. | |
| LONG TERM PREDICTABILITY: While earnings are highly unpredictable in the short term, it seems safe to assume the company will continue to grow over the decades. The question is whether this will be at a good or even adequate return on equity. Currently the return on equity is unacceptably low although the return on market value of equity (the depressed share price) is quite good. In the very near-term higher interest rates may cause further market value losses on investment (rental) properties. | |
| Estimated present value per share: This company is quite cyclical is therefore difficult to value based on earnings. It seems clear that the intrinsic value is somewhat higher than the recent $11.36 share price. Consider that book value is $39.50 per share. Even if book value over-states the true intrinsic value, there would appear to be a large margin of safety here. | |
| ADDITIONAL COMMENTS | |
| INDUSTRY ATTRACTIVENESS: (These comments reflect the industry and the company’s particular incumbent position within that industry segment.) Michael Porter of Harvard argues that an attractive industry is one where firms are somewhat protected from competition. The development industry probably has limited barriers to entry – although scale, financing and industry knowledge may provide some barrier (marginal pass). There are no known issues with powerful suppliers although governments may play a restricting role and they may be dependent on key contractors though we have no information on this (pass). No issues with excessive dependence on powerful customers (pass although there may be some vulnerability to a few key home builders), No viable substitute products (pass), Probably at least some tendency to compete excessively on the basis of price (marginal pass). Overall this industry appears to be only neutral at best in attractiveness. | |
| COMPETITIVE ADVANTAGE: Established presence in the market place and knowledge. Relationships with contractors who build its buildings and do the physical development of land. Has an existing inventory of land which overall was probably purchased on average at prices somewhat below the recent market value, although we may be wrong on that as market values may have decreased. Based on the low ROE it does not appear that they truly have any competitive advantages. | |
| COMPETITIVE POSITION: Its not clear what market share Melcor Developments has but it is a fragmented market and they likely have well under a 10% share for the Province. | |
| RECENT EVENTS: In the first nine months of 2023 they sold two buildings to raise cash and they have continued to buy back shares. For Q1, 2023 the dividend was increased by 7% to 16 cents per quarter. The dividend has now been increased 5 times in the past two years after having been cut in 2016, 2017 and 2020 due to the recession in Alberta and then the pandemic. The CFO / Executive V.P. has been promoted to Chief Operating Officer. They sold 117 residential units in the U.S. in Q4 2022 for $35 million that had been purchased between 2010 and 2013 for $11.9 million. It appears that almost all of this gain was booked in Q4 (as a fair value gain) even though the building was theoretically carried at market value. A notable event is that the company has recently completed several sizeable block share repurchases that have reduced the share count by 5%. The dividend increased and the share repurchases are an indication of management’s confidence. The former CEO left the company at the end of 2021 to pursue his own projects in the real estate business and was replaced by a member of the controlling family who was formerly Chairman but who was also probably acting as CEO in many ways. The occupancy level of its investment properties increased significantly in 2022. | |
| ACCOUNTING AND DISCLOSURE ISSUES: Book value per share may over-state the true market value of its assets. Land is valued at cost but may not be worth cost if a discounted future cashflow analysis is used. Under IFRS accounting, the company (paradoxically) reports a gain when the value of the units in its separately-traded REIT decline. This is preposterous and we add it back. The company also adds it back to concentrate on Funds From Operations. Also under IFRS its gains and losses on the (modeled) market value of its rental buildings flow directly into earnings. We adjust for that. With the stock trading well below book value it is important to understand the assets and their accounting value. The capitalized interest included in its raw land costs would be a useful figure but does not appear to be disclosed. The accumulated mark-to market gains on its rental buildings would be useful but are not disclosed. The age of all its buildings would be useful but is not disclosed. Under IFRS the value of its investment properties have been written up to market (and more recently written down) but the development land inventory remains stated at cost and the market value of the land does not appear to be disclosed. The past writing up of the buildings to market value pushes up book value and pushes down the ROE. There is not much explanation of the nature of operating lease incentives or straight line rent adjustments. Overall it appears that “the market” has a difficult time understanding the accounting and economics of the company. I | |
| COMMON SHARE STRUCTURE USED: Normal, 1 vote per share | |
| MANAGEMENT QUALITY: Management quality does not appear to be good – the recent level of profitability has been inadequate and, what’s worse, management seems relatively unconcerned by the situation. The Chairman claims that most aspects of its profitability are outside of its control and that there is no point in providing more incentive for top management to increase profits. And based on their responses to questions it is not clear that they even understand that their gross margin on land sales has been too low. There are some indications that they are not good at controlling the costs of land development. And we do have some concerns that the disclosure could be improved in terms of clarity. And there is a lack of guidance on outlook. The CEOs historically have been promoted from within which is a sign of good management. Management has seemed completely unconcerned about the fact that the share price has been for several years trading at significantly less than half (and more recently less than one-third) of book value. Their role of stewards of the capital invested by public share owners seems questionable. They are protecting that capital but not earning an attractive or even reasonable return on it. | |
| Capital Allocation Skills: Based on accounting results, this is now very questionable given the poor ROE in recent years. Results about 15 years ago were far better. On occasion it has bought back shares at good prices. The creation of the REIT in 2013 appears to have been a prudent move. However the stock market for the past few years seems to disagree that the capital investments were wise given that it is valuing the equity at now just 29% of book value! It is now questionable as to whether their investments in land have in fact been a good allocation of capital. They likely invested too much in land that would not be developed for many years. | |
| EXECUTIVE COMPENSATION: Updated from the Spring 2023 circular with 2022 compensation: The CEO who is also the chair and the senior member of the controlling family was compensated was compensated at about $1.2 million similar to the prior year. The CFO/Chief Operating Officer was compensated at $1.1 million (prior year was $1.2 million) The remaining three executives were compensated at $0.4 to $0.5 million. The compensation for the top two could be considered excessive for such a low ROE company that had adjusted earnings of $54 million 2022 and FFO of 61 million. We also note that in comparing total executive compensation to performance the company focuses on asset and book value growth and dividends per share but not return on assets or return on equity or total shareholder return (They did show the share performance was below the TSX and TSC real Estate index. | |
| BOARD OF DIRECTORS: (Updated from Spring 2023 circular) A small with board with 8 members. Several key members own large stock holdings which aligns their interests with that of outside shareholders. Three members are from the controlling owner Melton family. We understand that unfortunately 4 of the other 5 can be described as friends of the family. Three of the outside directors own very few shares. Therefore this is a weak Board when it comes to the interests of the public share owners. | |
| Basis and Limitations of Analysis: The following applies to all the companies rated. Conclusions are based largely on achieved earnings, balance sheet strength, achieved earnings per share growth trend and industry attractiveness. We undertake a relatively detailed analysis of the published financial statements including growth per share trends and our general view of the industry attractiveness and the company’s growth prospects. Despite this diligence our analysis is subject to limitations including the following examples. We have not met with management or discussed the long term earnings growth prospects with management. We have not reviewed all press releases. We typically have no special expertise or knowledge of the industry. | |
| DISCLAIMER: All stock ratings presented are “generic” in nature and do not take into account the unique circumstances and risk tolerance and risk capacity of any individual. The information presented is not a recommendation for any individual to buy or sell any security. The authors are not registered investment advisors and the information presented is not to be considered investment advice to any individual. The reader should consult a registered investment advisor or registered dealer prior to making any investment decision. For ease of writing style the newsletter and articles are often written in the first person. But, legally speaking, all information and opinions are provided by InvestorsFriend Inc. and not by the authors as individuals. The author(s) of this report may have a position, as disclosed in each report. The authors’ positions may subsequently change without notice. | |
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