Editor's note: "Bricks and Mortar" is a mock portfolio created by reporter Nicholas Yulico that is meant to help generate real estate and gaming-related stock ideas. In keeping with TSC's editorial policy, Yulico doesn't own or short individual stocks.
The fourth quarter started off with a bang for the broader stock market on Monday, and the Bricks and Mortar mock portfolio surged on the rally.
The portfolio is now up 23.2% since its inception in late January, handily beating the
return of 8.3% in the same period.
Such outsized returns make it a nice time to examine what's working and whether there are still stocks left to buy in the real estate and casino sectors.
From a top-down sector perspective, I believe homebuilder stocks will remain a disaster and should not be bought. I've been bearish on the group for a year now and continue to flag
There's no reason to buy into a group where nearly all builders are reporting losses, and the future will get uglier because of pricing wars across the industry -- a thesis I laid out in a
recent article. I believe the two-day rally this week in the stocks will be temporary and will eventually fade once investors realize a housing recovery is more than a year away.
Real estate investment trusts, or REITs, have reported strong
fundamentals in recent months, but the stocks are off about 10% this year. Takeout premiums left the sector after the credit crunch that has shut off new
private-equity deals. Nonetheless, office owner
remains a solid bet.
There also remain a few good buys in the lodging and casino space, such as portfolio holdings
Stocks I've highlighted as overvalued dogs remain in the "flagged" camp of the portfolio. These include Ryland,
Home Solutions of America
, which have each fallen more than 28% since I said they should be sold.
Here's an update on all nine names in the Bricks and Mortar portfolio.
The strong opening of
Las Vegas Sands'
Venetian Macau in August has investors very excited about Macau, the only region of China where gambling is legal. Melco PBL, a Macau casino developer, has enjoyed some of this spillover love, with shares surging in recent weeks. This week, Melco shares have jumped 14.6% to $18.92.
Melco also recently got a small vote of confidence from JPMorgan analyst Harry Curtis, who has been one of the major bears on the stock. Curtis says Melco should be able to meet, if not beat, his 2008 earnings estimates for the company. This is mostly because Melco is reducing its focus on the mass market to concentrate on growing the VIP segment at Crown Macau, its first casino, he said.
The Crown is the only one of Melco's casinos open today. Therefore, for valuation purposes you need to look at earnings before interest, taxes, depreciation and amortization for 2010, because that is when all three of the company's three casinos will be open.
The consensus 2010 EBITDA forecast for Melco is $775 million. To value Melco, I use a 12% discount rate, and discount that 2010 EBITDA back two years, to late 2008.
Assume a multiple of 15 times EBITDA, and the stock deserves an enterprise value of $9.27 billion. Subtract the $900 million of the net debt that analysts project for 2010, and the stock is worth $21 a share today by my estimates.
Quite frankly, I don't know what multiple Melco should trade at. But 15 times EBITDA looks reasonable in comparison to fellow Macau player
, which trades at 23 times estimated 2010 EBITDA (assuming a 10% annual discount rate).
Once its three casinos are open, Melco will be a major player in the Macau market, where growth shows no signs of slowing. The stock looks quite reasonable today at around $19; however, all Macau casino stocks could pull back soon given their tremendous runs lately.
A U.S. recession, which some economists fear is looming, would no doubt be bad news for the hotel industry. Nonetheless, Starwood's strong international brand expansion opportunities remain compelling.
If the company can achieve revenue growth of 7% per year, and margins continue to expand from pricing power, then I calculate the stock is worth around $70 using a discounted cash flow model. Taking into account share buybacks or takeover premiums could lift that price target further.
agreement to acquire rival
spurred hopes of a Starwood buyout, but the takeout premium has since left the stock because of credit-market worries. But at around $62, the stock is very attractive.
Brookfield Properties (Own)
At around $26, Brookfield currently trades at 15 times next year's funds from operations per share, a proxy for commercial real estate cash flow. Analysts project the office-building owner will record FFO of $1.67 per share in 2008.
Given that analysts expect 6% annual earnings growth over the next five years, the stock is reasonably priced today and likely trades at a discount to the private market value of its real estate, much of which is located in the hot New York City market.
Office rents remain strong across the country. Absent a substantial national recession, Brookfield's portfolio should continue to perform well.
Penn National and Hilton Hotels (Own)
Penn National Gaming
and Hilton have agreed to private-equity takeout deals. Hilton's deal is expected to close later this year, at which point I'll take the stock out of the mock portfolio.
Penn National's $67-a-share deal is expected to close in about 12 months. At around $59, Penn National is trading 12% below its buyout price, making owning Penn a very attractive proposition today.
Global Real Estate ETF (Own)
Investors looking for commercial real estate exposure should head internationally, where growth remains strong. The
Global Real Estate ETF
remains the easiest way to play the market, since there are no pure-play international real estate stocks on U.S. exchanges.
I traveled to Atlantic City, where all of Trump's casinos are located, last weekend. The city had decent traffic at its casinos.
But the market remains competitive, with every casino operator working hard to bring in customers from Pennsylvania and New York, which both introduced slots facilities over the past year. Atlantic City has suffered from declining gambling revenue this year because of lost customers.
Of Trump's casinos, Trump Plaza should eventually benefit from its location near the Caesar's Pier, which is a great shopping and dining destination owned by luxury mall developer
But at the end of the day, I'm still not sure how Trump Plaza and Trump Taj Mahal can compete with the Borgata, a luxury casino owned by
that is truly the nicest destination in the city.
Until there are signs of a recovery on the horizon, Trump shares should stay stuck between $6 and $8, making it a poor investment unless you are an expert at market timing.
As I noted in a
recent article, Ryland's positive cash flow and relatively strong balance sheet mean the company is likely to survive the housing downturn. But I see no reason why investors should buy the stock right now.
To get comfortable buying the stock at today's levels, you need to believe margins and deliveries will improve by 2009. But there's no evidence of that yet, so I continue to flag Ryland as overvalued.
Home Solutions of America (Flag)
I've flagged Home Solutions because of a big lack of visibility about the future. The construction management firm did hold a conference call last week to provide updates on its projects, but it didn't include much new information.
Management said it is in the process of expanding its credit facility from $60 million to $125 million. However, the present credit line
remains in limbo, since lenders have yet to sign off on the resolution of a note payable related to Home Solutions' acquisition of Fireline Restoration last year.
Numerous question marks surround the company's future revenue growth and where margins will eventually settle, as the company switches from high-margin hurricane recovery work to lower-margin construction management jobs.
In keeping with TSC's editorial policy, Yulico doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships.