GenCorp - Rocketeers Or Realtors?

Feb.28.13 | About: Aerojet Rocketdyne (AJRD)

I once had a significant other who while watching TV, would ask me, "could you please get me a glass of water." Being the caring mate that I am, I would get the water and try to explain where it originated, and how it was treated and transported to the faucet. The response was always, "when I'm thirsty, I don't care about those types of details, I just want to pull a lever and get a clean, cold, glass of water."

For you thirsty alpha seekers who don't want to know how alpha originates or manifests itself in your portfolio, just buy GenCorp (GY), a small-cap aerospace company recently selling for $11.66 and hold it; possibly up to 36 months for the potential doubling of your investment, and read no more!

For those alphaers (yes---I made that term up) who like to know the details, GenCorp transformed itself in the late 1990s; getting out of the rubber and tire manufacturing business, and becoming rocketeers by purchasing a private company then known as Aerojet. Areojet was founded in 1942 by a group of scientists and became the then free world's largest rocket engine development, testing and production site, especially for the U.S military and NASA. GenCorp eventually established its headquarters at the Aerojet facilities in Eastern Sacramento County.

Anticipating massive growth, Aerojet accumulated thousands of acres of excess undeveloped real estate in Eastern Sacramento County at unbelievably low prices from the 1950s through the 1970s. Manufacturing of rocket engines was ultimately slowed by military cutbacks after the cold war ended, and more recently by reductions in NASA's budget. The company still produces rocket propulsion systems for governments and private companies worldwide, but the real alpha here is not its rocket propulsion operations; but the real estate holdings that GenCorp inherited from Aerojet, and here's why.

After hurricane Katrina devastated New Orleans, a federal government report identified Sacramento as the next most "at risk" metropolitan area in the nation for a Katrina like catastrophe because of the 125-year old deteriorating levee system that protects most of the city from the two rivers that run through it. A little more than four years ago, a building and remodel moratorium was instituted for large parts of the city. The Eastern parts of Sacramento County toward the foothills were not subject to the moratorium.

Levee reinforcements started with local tax dollars, but more than half of the improvements are awaiting Congressional budgetary appropriation and the Army Corps of Engineers to complete the remaining work. Estimates are four to six years for this to occur. What's this all mean, and what does it have to do with GenCorp?

Zillow Real Estate recently rated Sacramento as the "second hottest" real estate market in the U.S. I can tell you as a 46-year almost continuous resident, Sacramento is still by California standards, an incredibly affordable metropolitan area to live in, despite the recent run up in real estate prices. Large real estate investment companies have been taking huge positions in the Sacramento market over the last 12 months, which is a good sign of an extended recovery. Remember the building moratorium? Sacramento County Board of Supervisors just recently approved what amounts to a new city of mixed development in Eastern Sacramento County; essentially the only direction Sacramento can grow in for the next few years. Guess what company owns massive amounts of undeveloped land directly in the pathway of development? ---Yup, GenCorp!

I must be transparent about these real estate holdings in that about 40% of its 12,000 plus excess acres were designated as an EPA superfund site years ago, but those environmental hazards have since been mitigated to the EPA's satisfaction and these acres are not part of the land that is eligible for near-term development anyway.

A recent internet article by Anh Hoang, a money manager of global equities suggests that GY carries the value of its excess real estate holdings on the books at $33 million. Mr. Hoang estimates that in 2011, 99% of GenCorp's $910 million in total revenue was generated from aerospace and defense operations with the real estate sales and leasing side of the house contributing only $8 million. GenCorp recently agreed to acquire rocket motor maker Pratt & Whitney Rocketdyne from United Technologies for $550 million and issued $250 million in 7.1% senior secured notes (topic for future article) to pay for most of the purchase; so, there is a lot of debt on GY's books.

Well, a reputable commercial real estate broker recently told me that the 7000 plus acres of clean land, if sold in the current market, could conservatively fetch $700-$800 million, maybe more. I ask, how much could it sell for in the nation's 2nd-hottest real estate market three (3) years from now, after the recovery? Our conclusion was $1billion, probably more just for the undeveloped land. The real estate arm of GenCorp, the Easton Development Company, plans to participate in, if not orchestrate the entire development process, which would produce billions of dollars more. If there was ever a time for GY to unlock the value of its real estate holdings, it seems that the conditions are ripe while the building moratorium is in effect.

I don't want to hyper-focus on GY's current financial metrics, because they may scare you, and that's not the story I'm trying to tell here!

Mr. Hoang in his article estimated that GY has a minus---yes negative $393 million book value! My research suggests about negative $600 million, with much of that attributed to the debt issued to purchase Pratt & Whitney. That being said, there's a tremendous amount of value in GY's real estate holdings that if unlocked, would turn that negative number around in a hurry!

The forward PE is 33.5, which is almost twice the Russell 2000 small-cap index. Cash flow per share is steady and sufficient to maintain ongoing operations, and profit margins have improved dramatically. There should be no worry about GY continuing to pay its bills and keep the lights on!

Analyst sentiment for GY is mostly "Neutral to Hold", with two "Buy" recommendations, and price targets are upwards of $13.50 per share; however, I believe these analysts are basing their forecasts on the operations of the rocket propulsion business, not the prospect of unlocking the real estate value on the books. There has been hardly any insider selling of the stock in the last year, mostly acquisitions; and technical indicators have been flashing bullish since December.

GY may well suffer from future government expenditure reductions (the Sequester) but it will continue to produce rocket propulsion systems for the government(s) of the world. The privatization of space exploration and the purchase of Pratt & Whitney will also help it continue to chug along. The company next reports on March 21, and I suggest you listen to the conference call, or at least read the company press release following the call. GenCorp Investor Relations staff can help you with this.

The stock has had a good run from its 52-week low of $5.50 to its 52-week high of $12.14 the day this article was submitted, but I believe there is much more to come. Recently, Mario Gabelli, a well known Wall Street investment manager, told CNBC that he expects GY to double in value over the next year. While I personally did not see the interview, I would say Mr. Gabelli is spot on with his prediction with one exception. This is all tied very closely to the Sacramento real estate development landscape, and having been a near 50-year resident of this city, and knowing how slow the gears of government grind, I believe it will take three years not one for the stock to double---but hey, a potential 100% return over 36 months is not bad for any investment and is incentive enough for me to wait!

Sometimes alpha comes when one acts contrary to what most research analysts are espousing and I believe this is one of those times. So, here is the bottom line. If you are seeking serious alpha as a GenCorp Rocketeer ---oops, I mean Realtor, you could do just fine over the next 36 months. I'm in the process of accumulating GY and will continue to buy on weakness. As with any stock, there is the risk of capital loss; so, conduct your own research and speak with your investment advisor before buying GY.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in GY over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.