Accounting scandalARCP trades at a massive discount to its peers in the net-lease REIT space. Some degree of discount is warranted, of course; this is, after all, a company embroiled in an accounting scandal with a dividend at risk of being cut. But at current prices, ARCP trades at about half the valuation of its peer average as measured by the Price/AFFO ratio. (Standard valuation metrics such as price/earnings or price/sales are not appropriate for REITs given the distorting effects of depreciation.) Sure, those AFFO numbers have to be taken with a grain of salt given the accounting irregularities. But given the valuation gap, we have a wide margin of error here in my opinion. ARCP also trades well below any reasonable estimate of its liquidation value, meaning that at current prices the REIT is worth more dead than alive.
Valuation cushionEstimates by Shih Investments put the liquidation value at closer to $13.30 per share (Shih estimates net asset value to be $12 billion, which I divided by ARCP's 902 million shares outstanding.) Shih also notes that much of ARCP's property portfolio is likely undervalued on the books, as commercial property prices have risen 40% since ARCP went public. Even assuming sloppy buying discipline and modest overpaying by ARCP, there is substantial room for error.
Any way you slice it, the market is currently pricing ARCP at drastically below the value of its underlying properties in my opinion. And let me emphasize, ARCP's property portfolio is composed of mostly high-quality performing assets.I say "mostly" because there are a few properties—such as the Red Lobster acquisition—that are of dubious value. But ARCP's property portfolio is spread across 541 tenants and across 49 states plus Puerto Rico and the District of Columbia. It's also 99.8% occupied with an average remaining lease term of 12.2 years, according to my research. As of June 2014, no tenant made up more than 10% of annualized rental income.
Great assetsWhen you buy ARCP, you are buying it for its assets. You're certainly not buying ARCP for its management, which has been completely discredited after the accounting snafu. Do I expect the market to revalue ARCP in the next week? Probably not. Sentiment towards ARCP is about as bad as I have ever seen, and that doesn't turn on a dime. Obviously, I don't have a crystal ball, but over time I believe an investor could be looking at total returns of 50%-100% within the next 12-18 months. It will be a bumpy ride. But I expect it may be a profitable one.
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Photo Credit: Dhilung Kirat via Flickr Creative Commons DISCLAIMER: The investments discussed are held in client accounts as of October 31, 2014. These investments may or may not be currently held in client accounts. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable. Past performance is no guarantee of future results.
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