Ben Strubel is founder, president and portfolio manager of Strubel Investment Management, an RIA based in Lancaster, Pa.
If you could only hold one stock position in your portfolio, what would it be?
If I could hold only one stock in my portfolio it would be Tejon Ranch Company (TRC). This is an excellent company that you can buy for your portfolio and forget about for decades.
Tejon Ranch Company is a diversified real estate development and agribusiness whose primary asset is 270,000 acres of contiguous land in California. The land is located approximately 60 miles north of Los Angeles at its southern border and 15 miles east of Bakersfield at its northern border. Interstate 5 runs through the parcel and forms the approximate western border.
A majority of the land is located in Kern County. The company recently reached an agreement with five environmental groups to set aside up to 240,000 acres for conservation and to develop 30,000 acres. Planned projects include the expansion of an existing industrial park, a new mountain resort community called Tejon Mountain Village (TMV), and a new town called Centennial. Currently the company receives income from the leasing of several properties, ranch and farming operations, oil and gas exploration rights, and other miscellaneous activities.
How does your choice of Tejon Ranch reflect your (or your fund's) investment approach?
My investment approach to the equity portion of clients' portfolios is simple: I seek to buy good companies at cheap prices. First, I look for companies that have good underlying business fundamentals, usually profitable companies that generate high returns on capital. Second, I seek to pay as little as possible. To do this I take advantage of other investors' overreactions and fear. I scour out of favor industries and companies for good investments that the market has thrown away.
I am a contrarian by nature so this type of investing comes easily to me. As soon as a certain area of the economy or a certain sector takes a beating, I am there looking for bargains. Many times there is a good reason behind a significant drop in prices and good bargains are nonexistent. Other times bargains are there if you look hard enough.
Tejon Ranch meets all of my criteria for a long-term investment. It's a well-managed company that I believe is selling significantly below its intrinsic value due to the real estate sector being out of favor and because of what I believe is a misunderstanding regarding its conservation agreement.
Can you talk about the sector? How much is your selection based on the company's industry, as opposed to a pure bottom-up pick?
This selection is pretty much a pure bottom-up pick. I do keep in mind the macro view of the sector and I remain very bearish on real estate development companies and homebuilders in general, but TRC is one company that is an exception because of its unique position.
The real estate sector also depends so much on where property is located. A real estate company in the West or Southwest is going to experience a very different environment than, say, a company in certain Northeast or Midwest areas. To a large extent every company is at the mercy of the economy as a whole, but the West and Southwest still exhibit much more favorable population trends than other areas.
I think the low valuation of TRC stems from two reasons. First, there is the general distaste for real estate investment given the current economic conditions and the glut of available real estate. Second, there seems to be a misunderstanding regarding the conservation agreement. All news stories I have read report that TRC will conserve 240,000 acres of their 270,000-acre holdings. This is not the whole truth. About 178,000 acres are being set aside, essentially for free, for conservation. The remaining 62,000 acres must be purchased at market prices if they are to be conserved.
How is Tejon Ranch positioned with regard to competitors?
Tejon Ranch has a unique competitive position. The areas it plans on developing are located alongside Interstate 5 in California. TRC owns the land on both sides of the interstate, so it has essentially no competitors. Some of the activities on the land such as ranching and farming of course compete with any of the other innumerable agribusinesses in California; however, these account only for a minute amount of the value in TRC. The biggest competition would be for the planned mountain resort, which would be competing with other resort communities located within reasonable driving distance from Los Angeles or Bakersfield.
How does the stock's valuation compare to its competitors?
This is a tough one. With real estate it's all about location, location, location. In California, zoning, regulations, and the long slow entitlement and planning process figures in as well.
To understand the stock's valuation we first have to look at how the land will be used. In 2008, TRC signed a conservation agreement with five major environmental organizations led by The Sierra Club. Under this agreement 145,000 acres of land are to be set aside for conservation. A further 33,000 acres will be devoted to open spaces within TRC planned communities. Finally, the conservation groups have an option to purchase an additional 62,000 acres at the prevailing market price and set them aside to be conserved as well. Add in the 30,000 acres slated to be developed and TRC has 92,000 acres that can be monetized. So how much is that worth?
First, let's tackle the 62,000 acres that the conservation groups have the option to purchase. The land is a mixture of crop and rangeland. In the 2008 American Society of Farm Managers and Rural Appraisers Trend Report (land values in 2010 are roughly in line with the 2008 figures and the 2008 report can be accessed by readers for free), we see a wide range of value for land in Kern County. About 48,650 acres of the 62,000 is range and ranchland in the southwestern portion of Kern County.
According to the report, rangeland has a value of $200 per acre to $4,000 per acre depending on the use. I took the conservative estimate of $200 per acre and got a value of $9.73 million. The land is likely worth more, as it is used for hunting and available for movie filming, so it is not just pure rangeland. The upper end values for rangeland in Kern County are $2,000 per acre to $4,000 per acre. The remaining 13,350 acres is farmland. The low end for cropland in Kern County is $8,000 per acre giving a value of $106.8 million. So a conservative estimate for the 62,000 acres is about $116.53 million.
Now let's move on to the 30,000 acres that will be developed. The market is currently valuing Tejon Ranch at around $400 million. If we subtract the $116.53 million value of the 62,000 acres from $400 million we get $283.47 million. That means the market is valuing the remaining 30,000 acres at $283.47 million, or $9,449 per acre. It's difficult to compare that $9,449/acre figure to any comparables because so much of a piece of land's value is based on location. However, $9,449 per acre strikes me as a great deal for prime real estate in California.
Does your view differ from the consensus sentiment on Tejon Ranch?
My view is absolutely opposed to the current sentiment. I think a lot of people are saying, "Who wants to own real estate in this environment?" But this isn't a traditional real estate development company. This isn't a company that took on debt up to their eyeballs to buy up office buildings and is now looking at 50% occupancy rates. In fact, TRC has only $317,000 in debt vs. over $3 million in cash. This isn't a development company that is planning on throwing up a few hundred more McMansions in suburbia when the economy turns around.
I also think the market is not taking into account the value of the 62,000 acres. What sets the company apart is that it is not your typical real estate development company. For all major development projects TRC typically partners with other developers. Those developers are the ones who usually provide most of the financing for the projects and thus bear most of the financial risk.
And then the company has just completed an oversubscribed rights offering for $60M; is this the kind of funding that would be a help with commercial/industrial/residential entitlements - all of which I suppose could act as risks and catalysts for this stock?
I think it is a sign that they are continuing to make good progress on the development of Tejon Mountain Village and the industrial park expansion, and that the Centennial project is moving along. What I like about the rights offering was that it was a very shareholder-friendly way to raise additional capital. Existing shareholders could exercise their rights and wouldn’t see their equity stake diluted. Also, it didn’t saddle the company with a large debt load and thus divert income to interest payments. Since CEO Robert Stine exercised rights for a little under $225,000 worth of stock, I think that shows management remains confident about the company’s prospects as well. As the saying goes: “Insiders sell for many reasons, but buy for only one.”
Does the company's management play a role in your selection?
I always look at management. Specifically, I examine how focused management is on long-term shareholder return. With this investment, one of the things I really like is that Michael H. Winer, a portfolio manager with the Third Avenue Real Estate Value Fund, sits on the board of directors. The Third Avenue family of funds own over 20% of the outstanding shares. Not only do shareholders have a representative on the board, but they also have some great company as investors, with a great long-term value-oriented shareholder owning a significant chunk of shares.
What catalysts, near-term or long-term, could move TRC stock significantly?
Tejon Ranch is involved in three major projects: an expansion in their industrial park; the construction of Tejon Mountain Village (TMV), a 3,450-home resort community; and the eventual construction of Centennial, a 23,000-home master planned town 60 miles north of Los Angeles. Right now Kern County has approved the development of TMV. TRC is just waiting for the right time to begin development. An announcement of beginning development and having buyers lined up for the homes would likely cause significant stock movement. Centennial has a build-out timeline of 20 years. As each significant milestone is hit there will likely be a jump in the stock price as well.
What could go wrong with your pick?
Like any investment, the short answer is: everything. The entire development process is subject to California's very restrictive rules. While Tejon Mountain Village has been approved, the new town, Centennial, is still working its way through the entitlement and planning process. Although the Sierra Club and four other groups signed a conservation agreement with TRC, there are still some smaller groups filing lawsuits to oppose development.
One thing I like is that the traditional set of risks that face most companies don't apply here. Technological innovation and change won't make Tejon Ranch's "product" obsolete like pagers or word processors. Land is land. The power of the brand can't be eroded by poor marketing or product recalls, like Toyota (TM). Good land is good land.
Thanks, Ben, for sharing your choice with us.
Disclosure: Long TRC
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