Here is the second volume of our newsletter, where I provide a detailed analysis of a stock I believe is valuable. In the first volume, published November 16, 2016, I chose
Acuity Ads. At the time of writing (February 6, 2017) the share price is up over 60 percent from the date of the newsletter release. I will continue to update you with newsletters from time-to-time using plain language to clearly convey the opportunity that investing in the selected stock represents. Further, you will receive newsletters only when I believe there are near-term catalysts of benefit to the stock.
The stock I am discussing today is Terra Firma Capital Corp (TII.V/TSX), a real estate finance company that offers customized debt and equity solutions to developers in both Canada and the U.S.
Here is the Executive Summary of the investment thesis for Terra Firma (TII.V):
- They are trading at a discount to Book Value Per Share (BVPS).
- Given the discount to BVPS and assuming a 1.5x multiple, there is exceptional upside in the share price.
The actual BVPS is closer to 87.5 cents rather than the reported 79 cents.
They can more than double their loan book from this point without the need for additional equity.
- This will drive increased revenues and earnings per share.
They will receive all the payments owed to them by Urbancorp, including interest.
- Urbancorp is coming out of bankruptcy with approximately $31 million in profit, an unusual situation.
They are expanding their loan book down into the U.S.
- They will receive higher yields on first mortgages (in Canada they provide second mortgages).
- This means higher yields and better security.
- They are positioned to become the dominant player in the U.S.
With greater security they will be able to reduce their cost of debt capital and increase their ROE, and this will further increase their earnings by reducing costs.
Management are large shareholders and continue to buy in the open market.
There is an NCIB (Normal Course Issuer Bid) in place to provide share price support.
Terra Firma – Management and the Business
One of the reasons why it is so important to invest in companies with good management is that all companies face stormy times at some point. And just like a ship in rough seas, if there isn’t a good captain at the helm it could well be in be trouble. In the case of Terra Firma, the storm that hit was the bankruptcy of Urbancorp, a developer in Toronto. It is telling that Terra Firma has had other projects go bankrupt before which they provided with development loans secured by land, and still had positive outcomes (to the tune of 27 percent IRR).
However, in the case of Urbancorp, it was one large company that Terra Firma had provided mortgages to for development, which then went bankrupt. Because of the concentration of projects and Toronto’s high property values, Terra Firma’s prospects looked quite dire for a time. However, if you took a moment to look at the projects, the properties, and the actions that the company’s management took, it was clear to see that the temporary drop in share price was an excellent opportunity to acquire shares.
What I find most fascinating about investing is the widespread belief that the market is efficient; I wholeheartedly disagree. Several market observers have written articles illustrating that Urbancorp is coming out of bankruptcy with a profit, a highly unusual situation. Such an outcome means all secured creditors will be paid in full, and there was money left over. This further means that any monies owed to Terra Firma will be paid back with accrued interest.
It is also important to note the actions Terra Firma’s management made just before Urbancorp filed for bankruptcy. Terra Firma took possession of one of Urbancorp’s projects in Etobicoke (Alderidge) and became a joint venture partner with Mattamy Homes. The project is now 100% sold as of this past weekend.
By taking this action they not only prevented the whole mortgage from being tied up in the bankruptcy but also ensured that shareholders were able to participate in the upside of the project. This loan was $7 million, which represented about 11 cents of book value per share (BVPS). Given that the value of this land has appreciated since the mortgage was first advanced, and the project has been almost entirely sold, I would guess that the value has increased to at least $10.5 million, and possibly quite a bit more.
This means that the BVPS for Terra Firma is not 79 cents, but rather 85 cents. When you also include interest payments Urbancorp previously missed that they will soon pay back, this adds another 2.5 cents, which means that the BVPS is
at least 87.5 cents. As the stock is currently trading at .74, the return from the current share price to BVPS of 87.5 cents is 18 percent. An 18 percent gain just to get back to book value is what I call a solid cushion, also known as downside protection.
Now these types of companies trade at a premium to their book value. Why? Well, consider this: If you were lending out money as a business, and one company made 10 percent on their money while another company made 18 percent, you would consider the revenues, or EPS (earnings per share) in your calculations, and pay a higher price for the company that makes 18 percent on their money rather than the company that makes 10 percent (all else being equal).
A good company to compare Terra Firma (TII.V) to is Tricon Capital (TCN.T). This company typically trades at between 1.15x to 1.35x of BV. Using Terra Firma’s 87.5 cents of BVPS and a multiple to the BVPS midpoint of 1.25x, this means that TII.V would be trading at $1.09/share. This is now a 47 percent upside to the current share price of .74 cents/share. The normalized ROE of TCN is closer to 12 percent, whereas the normalized ROE of TII.V is closer to 16 percent, and going higher. Therefore I believe that TII.V deserves a premium multiple to BVPS over TCN. Given the higher ROE and better growth profile, I ascribe a multiple of 1.5x, which gives you a share price of $1.31, a 77 percent premium to a $0.74 share price.
This is best understood as a simple EPS – TII.V will have higher EPS than TCN, and therefore will command a higher share price.
Trading on EPS
Eventually, the shares of the company will begin to trade at a multiple of EPS, meaning that the share price will be higher than the BVPS multiple I am currently using. But for the purposes of this initial analysis, BVPS and a simple multiple is the best first step for analyzing the shares of TII.V.
So the catalysts for the appreciation of the BVPS and multiple normalizations are already out in public, but the market is not efficient; most people are momentum investors who don’t actually conduct any real analysis of what they own.
What will drive Terra Firma’s valuation once the multiples normalize? The continued deployment of first lien mortgages down in the U.S., where they gain a greater yield
and they are first lien mortgages. This provides more security than the second lien mortgages in Canada, along with a higher yield – a great combination.
Additionally, the mortgages will typically be much larger in the U.S. than they are here in Canada, allowing TII.V to grow at a much faster pace than they have been.
Summary of near-term and mid-term catalysts for Terra Firma (TII.V):
- Ability to double their loan book with faster growth at higher yields with better security in the U.S.
- The true BVPS is closer to 87.5 cents rather than 79 cents.
- Using a multiple of 1.5x to BVPS, the share price should be closer to $1.31, a share appreciation of 77 percent.
Additional Catalysts:
- There should be additional deals done in the U.S. These deals are done at a higher yield than in Canada, and they are first lien mortgages, giving them higher security.
- This drives ROE higher.
- I believe the growth from new mortgages will be over 50 percent in the coming year.
Seeing increasing revenues, ROE and EPS – with additional growth of the loan book.
Maximizing syndication of the current loan book.
Reduction of the cost of debt, further increasing ROE and EPS.
I hope you found this newsletter interesting and helpful. To stay in the loop, please follow us on Twitter
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Best regards,
Colin Fisher, President and Portfolio Manager
StableView Asset Management
Disclosures
StableView’s clients, funds, and pools own shares in Terra Firma. We may sell or buy more at any time without updating the reader of this note. We may or may not do advisory work for Terra Firma in the future – currently, there is nothing contemplated. This is not intended as a solicitation or offer of securities. StableView Asset Management makes no representations or warranty, express or implied, in respect thereof, takes no responsibility for any errors and omissions contained herein and accepts no liability whatsoever for any loss arising from any use of, or reliance on, this report or its contents. Information may be available to StableView Asset Management that is not reflected in this report. This report is not to be construed as an offer or solicitation to buy or sell any security. The reader should not rely solely on this report in evaluating whether or not to buy or sell securities of the subject company. We may change our recommendation on this stock and are under no obligation to notify you the reader of any change. StableView Asset Management may buy more securities of the Subject Company, or sell securities, at any time without notifying the readers of this newsletter.