International Game Technology (IGT) continues trading at an appealing valuation despite rising more than 50% since last year, after the company had a bad quarter and engaged in the acquisition of Double Down Interactive, said Morley Campbell, Portfolio Manager, Analyst and Managing Director at NFJ Investment Group, LLC.
“We continue to hold International Game Technology today. The valuation is higher than it was in 2012. However, it currently trades at just 13 times forward earnings. The stock price is currently over $17 per share. But even today, on a price-to-cash flow basis, it’s just 10 times. On an enterprise value-to-EBITDA basis it’s just 7.3 times,” Campbell said.
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Campbell initiated a position in IGT in August 2012, around the time the stock dropped in price significantly due to a poor quarter and concerns over capital because of the recent acquisition, trading only at 10.2 times forward earnings.
“That compared quite favorably to both International Game Technology’s historical valuations and also International Game Technology’s peers’ valuations. The dividend yield was over 2%. For enterprise value to EBITDA, enterprise value to sales — pick your metric of choice — all of them were favorable. It was clearly screening very well,” Campbell said.
Staples, Inc. (SPLS) is solidifying its place as the second-largest online retailer behind Amazon (AMZN), beating expectations that the company would follow in the steps of Circuit City and Best Buy Co., Inc. (BBY), says Chris Welch, Co-Chief Investment Officer and Portfolio Manager for Diamond Hill Capital Management, Inc.
“The concern on Staples was that they were going to go the route of Circuit City and to some extent, Best Buy — Amazon was just going to continue taking more and more of their business. And, in fact, the office supply stores have been in a very challenging position for some time,” Welch said. “Our view was that Staples’ business was going to be stable rather than continually declining. That’s what we’ve seen since we bought them.”
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Staples has since reduced their store square footage, whereas competitors Office Max and Office Depot Inc (ODP) have announced a potential merger, which is actually favorable to Staples‘ store business, Welch says. In addition, Staples‘ online business is continuing to be very solid and the company is generating free cash flow, making this stock an attractive opportunity, Welch adds.
“They have a very large online business; over 40% of their business is online. In fact, they’re the second largest online retailer after Amazon. So our view is that at the valuation we can buy the company at, the kind of free cash flow they generate — that’s a very attractive opportunity, and we’ve had good results since we purchased it,” Welch said.
Southwest Airlines Co. (LUV) has navigated through the regulatory issues of its 2011 acquisition of AirTran and is now seeing the cost savings and synergies that have come from integrating the two airlines, says Chris Welch, Co-Chief Investment Officer and Portfolio Manager for Diamond Hill Capital Management, Inc.
“Southwest has had favorable returns this year, but we think there’s still more room for the stock to rise. It’s about $9.5 billion in market cap. They acquired AirTran, closed that acquisition in 2011, and because of all the regulatory issues involved, it’s taken a while for them to integrate that acquisition. But there’s a lot of cost savings, and there’s a lot of potential synergies between combining their routes and taking AirTran’s large position, particularly in Atlanta, and integrating that with Southwest’s systems,” Welch said.
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Welch sees further potential in Southwest due to the aligning of maintenance costs and the increased capacity discipline that the industry is experiencing, and he believes LUV is likely to generate a strong return.
“AirTran already used Boeing 737s, the same types of planes that Southwest uses, so they have a lot of synergies in their maintenance costs. So with cost cutting and revenue synergies, we think there’s a lot of potential there and don’t think that the stock is getting full valuation credit for what they can do. It’s within an industry that in past decades has long been not the best protector of capital. It’s always had overcapacity in various segments of the industry, but the past decade or so there’s been a renewed capacity discipline among domestic airlines and that continues today,” Welch said.
Microsoft Corporation (MSFT) currently has a strong competitive position in the enterprise application software space, currently holding several strong franchises that are undervalued by investors and which could unlock significant potential once investors realize the strength of their cloud and server business, says David Cassese, Portfolio Manager at BlackRock.
“As the market there, we think, has been extremely focused on the weakness in the consumer PC business, which is real and is a headwind for them. But it’s a much smaller percentage of the business than most people think, and we think the market has been ignoring how strong their competitive position is in the enterprise, how sticky that ecosystem is there,” Cassese said.
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Cassese says MSFT is trading inexpensively and has good growth opportunities, and it is just one example of a mature tech company that some refer to as old technology and which trades at a cheap valuation. He adds that many investors are currently afraid of the high valuation of the stock market, but he says a historical context provides more perspective.
“It’s important to remember that this all-time high or this high compared to the highs of March of 2000 is a very different place. And the highs of the market in March of 2000, the multiple on the S&P 500 was 30 times. Right now, it’s 14 times. So it never feels good to be buying stocks at their highs, you have to keep it in perspective and you have to think about what is the absolute valuation on the market. So we think there’s a lot of opportunity out there,” Cassese.
The Home Depot (HD) maintains sustainable competitive advantages in the home improvement retail sector through its prime location in most major cities and the insulation from Internet competition due to the nature of its products, says David Cassese, Portfolio Manager at BlackRock.
“Home Depot has the best locations in most major cities. They were there first, they were there well before Lowe’s (LOW),” Cassese said. He adds that, “If you think about what’s happened to a lot of the business models at retailers, the model has — and margins have been compressed because of online competition. Because of the nature of what Home Depot sells, they are mostly insulated from the Internet competition. So those will be the two sustainable competitive advantages they have.”
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Cassese says HD also has company-specific catalysts which made him look into the retailer. One of those, he says, is the improved in-store experience and inventory management that came as a result of logistics and store management that came with new senior executive changes years ago.
“There is a lot of pent-up demand for spending on the home, and we’ve really just started to see the housing market bottom and start to turn up. And we think, we have several years ahead of us here. We’re spending, we’ll catch up to ‘the normal,’ and perhaps even go past ‘normal,’ as people have put off projects for many years,” Cassese said.
Ventas (VTR) and Health Care REIT (HCN) have been aggressively using the RIDEA structure for their seniors housing assets, focusing on the higher end of the market where the fundamentals continue being strong, says Omotayo Okusanya, Managing Director and Senior Analyst at Jefferies & Company, Inc.
“All the RIDEA activity that they are involved in is senior housing related, so there is no reimbursement risk associated with that. That’s purely being attracted to the growth opportunities in regard to rental increases as well as occupancy increase you could see on a going forward basis,” Okusanya said.
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Okusanya says these two REITs are expected to perform better than peers, even as interest rates are on the rise and health care is expected to underperform. He has a “hold” rating on the stocks based on valuation.
“It’s very difficult for me to have a ‘buy’ rating on any of our health care names at this point, although I would say I still have a preference for the names that are going to show very strong earnings growth, primarily through the senior housing operating platforms that they have. So I am still a little bit more partial toward a name like Ventas, more partial toward a name like HCN,” Okusanya said.
National Health Investors Inc (NHI) is seeing growth in both normalized FFO and dividend per share for 2013, as the company recently updated its 2013 FFO guidance from $3.48 to $3.54 and has averaged 8% dividend growth for the past five years, says Roger R. Hopkins, Chief Accounting Officer at National Health Investors, Inc.
“With the announcement of the purchase of 17 assisted living facilities for our RIDEA structure with Bickford, we were able to update our 2013 normalized FFO guidance, and it increased it from a range of $3.48 to $3.54. To put it in perspective, last year our normalized FFO was $3.18, so we are on track for a very good year in 2013,” Hopkins said.
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Hopkins adds that growth in normalized FFO and dividend per share are very important to NHI and its shareholders, and he believes that as the company continues to make accretive investments and maintain a strong balance sheet, NHI will also continue to deliver on dividends.
“Management is incentivized to create value for the company on a per-share basis. As we look over the past five years at dividend growth from NHI we’ve been able to average 8%, and we think that is a very healthy dividend growth by any measure, and it exceeds our minimum growth thresholds that we try to achieve each year,” Hopkins said. “We’ve been able to grow the dividend each year since 2001, and by continuing to make accretive investments and trying to maintain low leverage and a strong balance sheet, we not only are able to grow our dividend, but we’re able to weather any negative winds that may appear and still grow in spite of that.”
Aviv REIT, Inc. (AVIV) enjoyed a successful IPO this year by taking advantage of high REIT multiples and the increased stability in the Medicare reimbursement outlook, which may lead to other health care REITs going public, says Dana Hambly, Analyst at Stephens Inc.
“[Aviv REIT] IPOed in March, so right at the height of where all the REIT multiples were…As long as interest rates stabilize here and with the multiples these REITs are still getting, I still think it’s a good time for an IPO of a health care REIT. You need some stability here in the interest rate environment, but overall, yes, I still think it’s probably a good time for a health care REIT to go public,” Hambly said.
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Hambly believes that Aviv REIT was more successful this time with the IPO because there has been more stability in the Medicare reimbursement outlook, which reflects a continued need for skilled-nursing-type facilities, despite the concern that skilled nursing will endure more Medicare cuts. Should the current reimbursement environment continue, Hambly says, skilled nursing could see more capital inflows.
“The Medicare cuts, we lapped those in the fourth quarter of last year. I think that if the reimbursement environment proves to be more stable than what a lot of investors might be thinking, you will see capital start flowing back into the group. I think we’re seeing that already. Aviv, I think, had tried to IPO two previous times unsuccessfully, and I think the reason it was more successful this time around is because on the financing side, those guys are seeing a little more stability in the Medicare reimbursement outlook, and there is still a need for these types of facilities, and that need will grow. And I think, again, because you can get those facilities cheaply relative to other senior housing stocks, we’re seeing the capital inflows first, and I think that will ultimately translate into the operators doing better, particularly the operators that own a fair amount of their real estate,” Hambly said.
Diversicare Healthcare Services (DVCR) operates skilled nursing facilities with ownership of about 25% of them, and the company is currently expanding through leasing agreements and fee-simple purchases as far as capital allows, said Kelly J. Gill, President, CEO and Director of Diversicare Healthcare Services Inc.
“As for growth expectations, our target is somewhere in the range of five to 10 facilities a year. And I would just add that from these growth initiatives the revenue has grown from $75.8 million to $79.3 million year over year, which is $3.5 million or 4.7% over that time, and those are quarterly numbers for the first quarter,” Gill said.
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Gill says DVCR recently purchased five nursing facilities in Kansas, a new state for the company. Gill says the transaction serves as an example of his company’s growth potential and financing capabilities, and he says the company also grew through leasing agreements in other markets.
“The single transaction increased our center count by more than 10%, and we think that in and of itself is representative of our capabilities moving forward,” Gill said. “The Kansas transaction is our largest to date. It will allow us to exercise the operating leverage we have created in our company, and moreover we believe an attractive opportunity exists for organic growth at these centers as we undertake planned renovations and implement our operating strategies.”
Kindred Healthcare, Inc. (KND) is looking to drive earnings growth as it repositions its capital structure by converting leased properties into owned properties, as well as by building new, company-owned skilled nursing centers, says Richard A. Lechleiter, Chief Financial Officer of Kindred Healthcare, Inc.
“The repositioning…is part of a larger attempt to right-size the capital structure of the company to become less lease-dependent and be a larger owner of real estate which is financed by amortizable debt and free cash flows. In simple terms, leases in our business are very expensive forms of financing compared to on-balance-sheet financings that are available to us today. So where possible, and we’ve done this over several years, we continue to look for ways to convert leased properties to owned properties,” Lechleiter said.
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KND‘s owned properties are both cash-flow-accretive and earnings-accretive, Lechleiter says, versus the leased properties that have rent escalators, which inhibit earnings growth. He also highlights KND‘s buildout of new skilled nursing centers, which will be owned properties and therefore contribute significantly to the company’s earnings.
“The new skilled nursing centers we are building today, and we have several on the drawing board in key markets, will all be owned properties, which will be more significant to our earnings growth over time. As we amortize debt, as these things depreciate, the overall contribution level to earnings becomes much more significant if we own them than if we lease them,” Lechleiter said.
