When the stock market is going up investors want a stock that can produce capital gains. When the market is moving sideways, investors want high dividend income. And when it is going down, they want safety of principal. It is hard to find a stock that will perform well in up, down, and sideways markets. On a total return basis, the Lexington Corporate Properties Trust (LXP) is the kind of stock that can produce favorable results in the three market scenarios referred to above. The stock got its comeuppance during the financial turmoil culminating in the real estate bust several years ago. But so did a large number of other stocks in all sectors of the stock market. I will render an opinion on LXP later in this article. But first I want the reader to know why it is necessary for me to do the analysis the way that I do so he/she can discount my method to whatever extent chosen. It is up to him or her to make a decision about the stock's suitability according to personal investment criteria.
A bond is a debt certificate and a stock is an equity certificate. Before an investor buys a bond at par he should ask "What can go wrong?" If everything goes right he will get back an interest rate of return while holding the bond; and, he will also get back his principal on the bond's maturity date. But if things go wrong he will be stuck with a loss; therefore he must avoid risk. With a stock it's different and when determining its suitability as an investment the investor should ask "What can go right?"
It is the successful assumption of risk that produces significant investment gains in the form of dividends and/or capital gains. (1) The dividends I receive as an investor are those declared by the company's management. Therefore, I need to know about the merits of the corporate development program that make dividend payments possible. Those merits also affect the way the investment community (aka Mr. Market) prices the stock. And (2), when things go right (or wrong) the capital gain (or loss) I achieve results from a favorable (or unfavorable) response by Mr. Market and the price at which I am able to sell it. He is the adjudicator who re-prices the stock daily and he doesn't ring a bell when the price is topping or bottoming. Therefore, (3) due diligence dictates that I rely on both fundamental and technical analysis when making investment decisions: the former tells me "what" stock to buy (or avoid) and the later tells me "when" to buy or sell it. Neither discipline can provide all of the answers for picking winners in the stock market; but the two together can be better than either alone.
The remainder of this article will be presented in two parts: the first deals with fundamental analysis and the second with technical analysis.
Fundamentally, what's going right with the company?
LXP is a real estate investment trust that acquires, owns, and manages a portfolio of office, industrial, and retail properties that are triple-net leased to corporate tenants. It also uses its expertise to provide investment advisory and asset management services to institutional investors in the net lease area.
The company was founded in 1991 and has had essentially the same stockholder friendly management team since its inception. It posted good operating results in all years except those during the real estate bust of 2008-2009. When LXP prospered the shareholders benefited via increases in the cash dividend. The stock's price hit a high of $18.00 in January of 2008 and dropped like a lead balloon with the rest of the stock market to $2.20 a year later. Since then, the stock recovered steadily reflecting the adjustments made by management to re-establish the company's position as a leading participant in its lines of business. The stock's current low price belies its importance in the real estate industry. LXP's equity base is $1.9 billion.
Insiders own about 2% of the 156 million shares outstanding at the end of October (181 million shares on diluted basis). There was only one sale by an insider of 20,000 shares during the past six months and he still retains more than 550,000 shares. Options for about 35,000 shares were awarded in Q3 to insiders at exercise prices near the stock's current price level. Since they hold sizable investment positions, it behooves the insiders to grow the company, prosper, and share the company's largess with shareholders. Institutional ownership increased in each of the last six months and now stands at about 91% of total shares outstanding. Institutional portfolio managers are privy to in-depth research reports so it is apparent that they think that LXP is an investment grade stock and not one that is a mere speculation.
The trajectory of both the company's operating results and the stock continue upward at this time. The quarterly dividend rate was cut from 33 cents in 2008 to 18 cents in 2009 and then to 10 cents in 2010. That rate was increased to 12 cents in 2011 and 13 cents in early-2012. It was increased to 15 cents in Q3. The stock is currently priced at $9.39 so the current indicated yield is 6.4%.
In Q3 LXP's adjusted funds from operations (AFFO) were 25 cents per share and the company executed well in all areas that impact its business. The comparable year ago AFFO was 23 cents per share. Seven analysts follow the company and their average estimate for 2012 is 97 cents, with the high and low being 98 cents and 94 cents, respectively. Their average estimate for 2013 is $1.02, with the high being $1.05 and the low, 99 cents. The increase is measured in pennies so the reader should bear in mind that most, if not all, of those pennies are distributed to shareholders as cash dividends. Management's comments during the conference call suggest that the analyst's estimates are valid.
Management is transparent about the way it runs the company and the conference call was quite detailed. Highlights are interpreted as follows:
Thus far in 2012 the leasing team extended 40 leases with annual rents of $33 million, a decrease of $2 million compared to the previous rent. At the end of Q3 it had 3.5 million square feet of space subject to leases that expire in 2012 and 2013, all of which were vacant. Management believes that during 2013, it can address roughly 2.3 million square feet of such expiring vacant square footage through extensions and disposition activity. Overall, it expects occupancy to stay at a high level and believes it can address some of the remaining 2013 lease rollovers during Q4. Although, its leasing results have been good, management is cautious with respect to suburban office markets where economic conditions are sluggish.
It closed on three build-to-suit projects in Q3 for $51 million and now has five build-to-suit projects underway for a total commitment of $163 million, of which $45 million has been invested thus far in 2012. The property investments underlying these projects have an attractive initial yield of 8.5% on cash basis and 9.6% on GAAP basis (the rent escalates during the term of the lease but GAAP accounting requires a straight line interpretation). Its investment pipeline of prospects now totals approximately $200 million and management believes these are attractive opportunities because they are long-term net leases with initial cap rates of 8% to 8.5%, which generally equates to 9.5% to 10% on a GAAP basis.
While addition to its portfolio of long-term leases with escalating rents continues to be the top priority for the company, extending the weighted average lease term, reducing the average age of the portfolio, and supporting dividend growth objectives are also important goals.
The company now generates about 20% of its revenue from leases of 10 years and longer compared to 15% when the year began. Furthermore, the lease rollover in 2013 through 2017 and has been reduced this year from 49% of revenue to 42%. So it is making good progress in managing down its exposure to shorter-term leases and extending its weighted average lease term.
Its asset recycling program has helped drive down its cost of capital as it produced funds for accretive acquisitions and deleveraging. Management expects to continue to recycle capital with a focus on maximizing the value of multi-tenant and retail properties and certain single tenant office properties. In Q3 it completed four dispositions for $68 million, including one sale from a portfolio of properties acquired in September. Its balance sheet increased significantly due to (1) the purchase of a joint venture portfolio and (2) deleveraging resulting from conversion of debt to equity. Some 17 million common shares were sold in Q3 causing some dilution by the common stock issuance but there was no dilution stemming from the debt conversion to 2.9 million common shares because the company's AFFO was already calculated on a fully diluted basis.
Management is looking to drive down its cost of capital via refinancing opportunities in the portfolio. In Q3 it withdrew $9 million on its seven-year secured term loan and swapped the LIBOR rate into a fixed rate of 3.36% on such borrowings for seven years. It then retired $75 million of secured debt, which had a weighted average interest rate of 6.4%. Early in Q4 it expanded the seven-year term facility by $40 million to $255 million. In 2013 it has $228 million of non-recourse debt maturing at a weighted average interest rate of 5.5%, of which some $60 million will require lender concessions for it to use any of its financial resources to support these maturities. Management believes the remaining maturities can be refinanced on attractive terms in the term loan market.
Near the end of Q3, it acquired the Net Lease Strategic Assets Fund by paying its partner in the joint venture a nominal cash sum. Management believes this was a good outcome for Lexington, as the portfolio came back on highly accretive terms that led it to increase its AFFO 2012 guidance by two cents.
Management ended up with a larger than anticipated increase in the common share dividend and in projection of 2013 cash flow income. It expects to realize a gain on the portfolio acquisition of about $168 million (that's about 80 cents per common share). It thinks it can create a lot of value in the portfolio by refinancing the underlying debt on advantageous terms, making favorable asset sales, and extending lease terms. Remaining invested in the portfolio impacted its forecasted liquidity for 2012 and so it sold the 17 million shares as referenced above. The proceeds were $156 million and they were used to reduce the company's leverage in the balance sheet.
The bottom line is that developments in Q3 were better than anticipated and the dividend was increased to 15 cents per share (which is a penny more than previously expected). The stock went ex-dividend on September 26. The next ex-dividend date will be about December 28.
Technically, what's going on with the stock?
Technical analysis is basic supply and demand analysis as taught in economics 101 and nothing more. When the propensity to buy a stock is greater than the propensity to sell it the price goes up; and when the opposite is true the price goes down. It's that simple. The difficulty is deciphering what the balance is between the two propensities and whether the balance extant will continue or reverse. An equilibrium situation requires one interpretation and a disequilibrium situation requires another.
Let's look at the chart I constructed from data in my workbook:
(1)The bold black line on top is price and the bold pink line below it is relative strength. (2) The dotted lines are moving averages and there is a set of those for price and a similar set for relative strength; they are used to define trends and reversals. (3) The five sets of gray parallel lines that frame the stock's price action are 22-day trading ranges and their progression shows how the trading range shifted during the 110 days charted. And (4) the four wavy blue lines that straddle relative strength are Bollinger Bands and they are used to detect overbought or oversold situations. Any one of the items listed as (2) to (4) is independent of the other two and could be cited as a valid technical indicator for buying or selling the stock.
Now consider this: (1) the stock's price was in a strong uptrend until 22 days ago. During the past 22 days the trend lines as defined by the moving averages have been broken. (2) The relative strength line is "neutral" so the stock is moving with the general market. The implication is that the recent weakness in the stock is due to general market weakness and not something specific to LXP. (If relative strength showed a negative reversal that would be ominous because it would indicate LXP was one of the stocks leading the market lower.) (3) The trading range, which had been moving up in textbook fashion, peaked and reversed downward (this is bearish). And (3) the relative strength action is within the Bollinger Bands so it is neutral at this time (note that any time the 2x band is approached or penetrated, that situation is quickly reversed).
I often wondered what was meant when a market pundit said that he was "cautiously optimistic" about the economy, the stock market, or an individual stock. That term is used frequently without qualification or definition of what is meant. I thought it was a lousy way to express an opinion. I didn't know what they meant and I'd be willing to bet they didn't know either. But I now find that in making a judgment about the investment merit of LXP at this time I am "cautiously optimistic" about buying the stock. And unlike others I will explain what I mean so that there is no confusion regarding my opinion.
I want to buy the stock because (1) the company's fundamental merits are stellar as they relate to its business base and its corporate development program. (2) Despite continuing problems in many sectors of the economy, the real estate sector is in a recovery mode so a company like LXP should not be unduly affected by such problems. (3) As set forth above, LXP has well defined programs underway to grow profits during the year ahead and, plausibly, beyond. (4) The dividend has growth potential and its current yield of 6.2% is attractive in today's low interest environment. And (5) the stockholder friendly management has a sizable investment in the company so it behooves the team to grow the company prudently. The last item mentioned is of paramount importance.
It is because of those five reasons that I am "optimistic" on the stock. Now how about the "cautiously" part of my "cautiously optimistic" opinion about the stock? The recent weakness in LXP's price chart cannot be ignored, to do so would be folly. The weakness, as I read the chart, is due to general stock market weakness and the vicissitudes of the market must be respected. About 70% of the time a stock moves with the general market. Given the company's fundamental merits I think the stock's weakness is short term rather than long term. Therefore, I am "optimistic" on the longer term prospects for the stock but I am "cautious" about its short term performance. I cannot vouch for other pundits but I now know what I mean when I use the term "cautiously optimistic" and I hope the reader understands what I mean.
I backed up my opinion by purchasing a few shares of the stock at $9.20 because I wanted to have some skin in the game. I will continue to follow the stock on a daily basis and when the chart action and general market conditions are favorable, I'll increase the size of my position. I never render an opinion about a target price for a stock because (1) I let Mr. Market do what he alone can do with regard to price action (and he himself doesn't know what he can do until he does it) and (2) I use technical analysis to determine my exit point just as I used it (with a big assist from fundamental analysis) to determine my entry point. I am as interested in getting high returns on my investments as anybody else and I'm willing to let Mr. Market be as bountiful as he can be. I will post progress reports as needed until the time I write a sell recommendation and close out my position.
I never tell a reader what he/she should do. I just write the article, render an opinion, and state what I am doing as an investor in the stock. I close by reminding the reader that it is up to him to make his own decision about the stock's suitability according to his personal investment criteria.
Disclosure: I am long LXP.