This article will present an investment thesis for CapLease (LSE). It will accomplish this goal by giving a brief outline of the company's basic assets and liabilities, taking an in depth look at its future cash flows, and address some of the major concerns currently troubling the market. Along the way, it will note major signs that point to a discounted valuation, and finally try to come up with some catalysts that could move the stock higher.
CapLease REIT owns 64 properties valued at $1.8bn which it leases on a triple net basis (lessee responsible for all operating costs) to creditworthy tenants across the country. CapLease also has a debt portfolio consisting of fully amortizing first position mortgages on single tenant properties valued at $30mm, and a CMBS portfolio valued at $63mm. In the past few years, CapLease has moved away from holding debt securities and shifted into the real property area.
CapLease holds significantly more debt than its peers. Currently, the company holds $1.17bn in long-term debt and $121mm in preferreds, giving it an 11.7x net debt and preferred to EBITDA ratio, nearly double its peers (see pp 56-7 in 2011 10-K). CapLease has taken steps to mitigate the risk of this high debt load, by structuring 86% of its debt as non-recourse, long-term, fixed rate debt, secured by individual assets. Additionally, the debt amortizes, which gives the company additional advantages as we will discuss a bit later.
The upshot of this being that CapLease has a book value of nearly $600mm, but as of the writing of this article trades at only $340mm, a 53% discount. Most of its peers trade either at, or at a premium to book value, making CapLease much more attractive relative to its peers.
Future Cash Flows
Besides, for the stock's significant discount to book value, it almost trades at par with future cash flows. According to the data given by the company in its most recent 10-K and press releases, CapLease has lease commitments for a total of $892mm, a $30mm loan portfolio, and a $63mm MBS portfolio, all scheduled to come into the company's coffers by 2030. The company's WACC stands at 7.06%, and after deducting for all expenses, the discounted cash flow stands at $305mm or at a 10% premium to the companies market cap (see here for detailed spreadsheet). Amazingly, the current share price seems to assume that the company will return all of its assets to the bank, and might sign one or two large leases for the balance of the company's history.
In short, that won't happen. The company will increase cash flow both by renewing the leases on many of its larger properties and by continuing to deploy capital from its low cost revolver, thereby significantly adding to future cash flows at no cost to investors.
The two main points made above -- that CapLease trades at a huge discount to book value, and almost at par with cash flows -- forces us to ask the obvious question, why? Obviously, we cannot say with certainty why the market has discounted CapLease so heavily, but three reasons come to mind.
- Heavy debt load
- Impending major lease expirations
- Low dividend relative to peers
I will now go through each of these concerns, and try to show why investors shouldn't worry.
Heavy Debt Load
As mentioned above, CapLease holds about double the amount of leverage as its peer group. Again, I don't see it as a problem. Even if CapLease defaults on some of its loans and has to return property to lenders, the debt is nonrecourse and will not affect the other properties in the portfolio. To make the point more emphatically, even if CapLease loses half of its properties to lenders, considering the company trades almost at cash flow, you still get the other half for free. In short, a default does not affect the company on the REIT level, and the other properties remain safe.
Impending Major Lease Expirations
Between now and 2017, CapLease has a slew of major lease expirations coming due. The harshest of this wave will come in 2016 and 2017 when CapLease faces 12% and 13% of the leases, respectively, coming due. Additionally, in the immediate future, the company has two major leases still up in the air, one with the US Government in Bethesda, MD, and a Nestle Holdings lease in Indiana. Not to belabor the point, but even if it cannot renew any of these leases, so what? The company trades at cash flow. But even beyond that, to assume it won't release any of these spaces, at least partially, smacks a little bit of naiveté. Current management has been in this business for 17 years, and I think they have the knowledge and experience to guide the company through this tough time. Additionally, management owns 4.75% of the stock, high compared to its peers, as such they have their interests in the right place. Again, even if the company cannot renew or re-tenant any of these spaces, which will not happen, investors can find safety in future cash flow, and assuming management can act effectively the spaces should get filled up.
I think this represents the single biggest reason CapLease trades at such a discount. Despite the fact that it pays a dividend in line, or even above its peers -- 5.31% -- it only pays out 43% of FFO as dividends compared to the industry standard of 85%. I have yet to see a clear reason for this -- the company could raise the dividend without violating any of its debt covenants.
However, bottom line, if anything this should prove a major upside for the stock. The company only pays out 43% of FFO, giving it a lot of upside if it decides to raise the dividend, which the company has a lot of room to do.
This stock has two main catalysts:
- Lease renewals -- if the company can announce significant lease renewals especially before it hits its big wave of lease rollovers in 2016-7, or release its major vacancy in Indiana, then the stock could see a significant move up.
I would like to emphasize that I believe this will catalyze the stock, and not the buying of new assets. Investors expect management to deploy existing capital into those deals, and investor's real questions center on their ability to do the unexpected and either renew tenants or release their major vacancy.
- Increased Dividend -- In the company's presentations, it constantly emphasizes its ability to raise the dividend and the company ties it to its ability to amortize debt. Namely, the company pays down interest and principal on its loans, thereby reducing total debt on its properties, and allowing it to raise the dividend it pays to investors. In fact, the company followed through on this promise, recently raising the dividend 8%.
Presumably, it will continue to increase the dividend, but slowly. I don't see a major movement in the stock from small increases like the one just announced, but as mentioned above, it has the room to put into place a major dividend increase. Additionally, incremental increases in the dividend similar to the one just announced should at the very least give the price support, and once the dividend gets high enough, income seeking investors could buy up the stock sending the price higher.