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Items of Interest
Repurposing of Retail properties, uranium and $3 trillion+ of dry powder.
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I called this newsletter Value Situations as I see its purpose as highlighting specific equity ideas or situations where I see significant value upside (with limited downside) today, or where I see routes to potential value upside in the not-too-distant future.
With that in mind, in this week’s newsletter rather than cover a specific situation or theme I thought I’d highlight some news and other items of interest that I’ve come across over the past week that I believe are worth tracking and which may lead to some interesting opportunities over time.
The Repurposing of Retail Properties
Retail is among the most hated of sectors, and was already bombed out before COVID hit, with the “Retail Apocalypse” sweeping the US mall sector and the “Death of the High Street” in the UK being two of the more prominent narratives around this theme.
A Bloomberg story last week highlighted some recent examples of retail space repurposing which I think is worth considering in the context of REITs and other listed property vehicles that trade at steep discounts to NAV, on the perception that they are melting ice cubes as portfolio vacancies continue to rise and underlying rents and valuations deteriorate further.
The article highlighted some recent examples of how defunct retail properties have been converted into colleges, libraries and offices and draws a parallel with the dead industrial areas of cities in the UK during the 1980s and 1990s.
In the US, it’s been pretty well reported how Amazon has been buying up distressed or defunct shopping malls and converting them into fulfillment centres and warehouses to support its online retail operations, with Amazon having acquired 25 malls between 2016-2019. Perhaps more interestingly, Amazon is even looking at rolling out its own department stores in the US, which could perhaps breathe new life into the strip mall properties it is reported to be targeting with these new stores.
With AA-rated Amazon corporate bonds of 15 – 20 year maturities currently yielding ~2.4% - 2.7% , it’s fair to assume its lease covenant would price at a reasonably tight yield and create significant value for a landlord owning repurposed real estate leased to Amazon on a solid 15-20 year lease term.
Beyond Amazon, there are other notable examples of this repurposing theme gaining traction. Brookfield Asset Management, which took its listed property investment arm Brookfield Property Partners private in July sees the future of its retail assets evolving into a mixed use format including retail, dining, residential, fitness, co-working and health care facilities. Similarly, British office and retail REIT British Land is evolving its model, and recently acquired a car park in central London to redevelop it into a last-mile logistics hub to diversify away from traditional retail and build exposure to e-commerce.
With stocks like Hammerson Plc (HMSO) in the UK priced at sub-0.5x NAV after massive write-downs to its portfolio, plus COVID inflicting further damage to its prospects, one might think that much of the bad news for its assets is already priced in, as it embarks on its own repurposing strategy to convert empty retail space into hotels, offices and for residential use. Of the 17 analysts covering Hammerson, the consensus view is Hold-to-Sell (8 holds, 7 sells), suggesting a turnaround and re-imagining of its portfolio is some way off.
I’m not saying that Hammerson is a name worth considering right now, but I do think it and its peers represent a situation worth monitoring over time. With retail landlords trading at distressed values and facing a choice to adapt or die, they are sitting on millions of square feet of land that could be used for other purposes. With the likes of Amazon entering the physical retail space and demand for alternative uses in residential and logistics continuing to grow, there may be hidden value within these names to be unlocked in time.
After an 11 year bear market following the Fukushima nuclear disaster, uranium has started to attract real institutional interest in recent months.
Last week, Harris Kupperman of Praetorian Capital wrote an excellent summary of the uranium market situation on his Adventures in Capitalism blog. I recommend reading it, as it sets out the uranium bull thesis clearly and succinctly.
Following on from this, Andrew Walker of the always interesting Yet Another Value Blog recorded a great podcast with Brian Laks, a portfolio manager at Old West Investment Management, who is a significant investor in uranium. On the podcast, they discussed the uranium thesis in further detail – I recommend anyone interested in to watch/listen to it:
The new uranium bull market story has been proposed for some time, with a very active and knowledgeable community of uranium investors on Fintwit, but its really in the last 6 months or so that it has started to gain real traction as the spot price of uranium has started to move and utilities approach the point at which they’ll need to start contracting with producers for new uranium supplies to fuel their reactors.
If I were to try and boil the thesis down to a few bullet, I’d offer the following:
Uranium is an essential input for nuclear reactors with no substitute
Following Fukushima, there was a massive supply glut as reactors were taken offline due to safety concerns and an aversion to pursuing nuclear power for fears of future disasters; this excess supply is now reversing as nuclear demand is increasing again at the same time as uranium supply is tightening
A supply crunch is looming with annual demand (and growing) of ~180m lbs per annum vs. annual production of ~120m lbs plus secondary supply of ~20m lbs implying a current market deficit of ~40m lbs. This supply shortfall is attributable to the 11 year bear market and lack of uranium mine investment with many mines shut or idled due to the depressed price being below the level needed to incentivise producers to produce and bring new supply online. The current uranium commodity spot price is ~$35/lb where as the price needed for producers to mine and produce profitably is estimated to be at least $60+ per lb (70%+ higher).
Energy utilities typically contract several years out before their inventories run down to ensure no supply disruption, and negotiate multiyear supply contracts with uranium producers. However, due to the oversupply coming out of the previous cycle and the depressed prices in the spot market in recent years, utilities have been happy to purchase any additional supply needed in the spot market; however this supply is declining rapidly and utilities will need to contract again with producers (at much higher prices) to ensure continuing supply
Utilities’ coverage rates (contracted lbs of uranium supply / lbs of uranium required) are beginning to trend below 100%, indicating utilities have less locked-in supply than they need to keep running their reactors, at a time when spot market supply is tightening (note utilities typically look to maintain coverage ratios well above 100% to ensure no unforeseen shortfalls)
Global demand for uranium is also increasing as the global nuclear reactor fleet is increasing, partly as a consequence of a move away from coal and fossil-fuel power generation, with ~56 new reactors under construction an a further 99 in planning currently (World Nuclear Association, July 2021). These new reactors will further increase the demand from current levels.
On the macro level, global electricity use is rising with increased urbanisation and population growth; nuclear power currently generates ~10% of the world’s electricity but with the closure of coal and fossil fuel power plants due to ESG considerations, nuclear as a clean and reliable power source is starting to be seen as the only viable way to place this lost generation capacity, given that renewables such as wind and solar are too unreliable. As such uranium is starting to benefit from ESG tailwinds, with policy and attitudes towards nuclear power improving as it gains acceptance as being part of the overall energy solution post-fossil fuels.
Putting all of this together, a fundamental supply/demand imbalance for an essential commodity with price insensitive buyers and ESG tailwinds makes the bull case picture look pretty compelling.
But a picture is worth a thousand words, so some historic charts probably best provide a sense of the future upside expected in the next cycle. At the peak of the previous uranium bull market in 2007 (when there was no supply deficit) the uranium spot price reached ~$136/lb after a run up from ~$15/share at the start of 2004 (~9x increase). Today the current price is ~$35/lb with the view that the price will reach new highs in this coming cycle:
Source: Cameco Corporation
Many uranium investors focus on the miners rather than the commodity as being the way to play the new uranium bull market, as these are more levered to price increases in the underlying commodity. The share price for Canadian-based Cameco Corporation (CCO / CCJ, the second largest uranium producer in the world) increased from USD $3/share to $55/share ( ~18x bagger) during the previous bull market from ~2004 – 2007:
While Cameco’s performance was impressive, it was not the biggest winner during the previous uranium bull market however; Australian miner Paladin Energy (PDN) went from AUD $0.01 to AUD $10.70 (~1000x! ) between late 2003 and the market peak in Q1 2007:
Such multibagger returns for uranium stocks are again expected if a new bull market in uranium materialises in the coming 2-3 years when utilities’ supply coverage will fall to inoperable levels if they do not start to contract for new supply.
Paladin in particular is expected to be big winner in any new bull market, as it operates one of the lowest cost uranium mines in the world, the Langer Heinrich mine in Namibia, which was a fully producing mine before being idled in the last bear market. As such, it is a ready-to-go miner rather than a speculative prospect, and so is in a position to immediately capitalise on an uptick in uranium prices and a new contracting cycle with utilities.
Given the extent of the structural supply/demand imbalance (which again wasn’t present during the previous bull market) combined with utilities likely becoming forced purchasers of uranium at almost any price, market commentators are forecasting the uranium spot price to reach highs of up to $150/lb, thus enabling the producers to contract at price levels 3x+ the current spot price, driving a massive increase in profitability and cash flows.
London AIM-listed small-cap Yellow Cake Plc (YCA) is an interesting name in the sector. YCA is a specialist company that buys and holds uranium, thereby offering investors exposure to the commodity theme without any exploration, development, mining or processing risk. As such it is a lower risk play on the thesis compared with miners, but still may offer asymmetric, multibagger returns if the bull thesis plays out for the spot price which underpins YCA’s NAV.
YCA currently trades at £3.05/share or ~1.1x NAV, reflecting a uranium commodity price of ~$35/lb. If the uranium commodity price (more accurately called uranium oxide in concentrate, or U308) increases to $60/lb (the level needed to incentivise producers to start producing for utilities again) the NAV increases to £4.29, indicating a forward discount to NAV of ~30% at the current share price. If the U308 spot price rises to say $100/lb (still ~26% below the previous peak), this would imply a forward discount to NAV of ~56% at YCA’s current share price.
The table below shows a simple, crude analysis of the potential upside scenarios all the way up to a U308 price of $150/lb, and assumes the YCA market price equates to 1x NAV as the U308 price rises:
Source: Value Situations analysis
Most recently, the entry of the Sprott Physical Uranium Trust is seen as the catalyst previously missing to push utilities into contracting at higher prices to trigger the new bull market. The Sprott trust is an ETF (U.U) that only launched in July but has been aggressively buying up spot supply, and is expected to squeeze the market and force utilities into buying uranium as their inventories continue to run down while spot supply is taken off the market.
With some very interesting dynamics and a possible catalyst now in place, I think the uranium market is one worth watching, with the potential to offer some pretty unique and asymmetric value opportunities over the next 2 years as utilities will have to start contracting for new supply.
Dry Powder & Take Privates
A favourite topic of mine is the record levels of private equity dry powder and what I call the Forced Purchaser theme as a catalyst for public equities, which continues to play out in the UK equity market.
Two further news items last week reconfirmed my thinking on this. Firstly, in reading about yet another US PE take-private of a UK listed company, this time UK robotics business Blue Prism in discussions with TPG and Vista Equity Partners, I came across Bain & Co.’s mid-year private equity report, which reported on the sheer scale of the industry’s mountain of dry powder – there is now ~$3.3 trillion of dry powder controlled by PE funds, ~2.75x the previous peak level of 2007/2008. Furthermore and not surprisingly, with $539 billion of deals completed in H1 of this year, (in line with the full-year average since 2016 of $543 billion) Bain forecasts the industry will hit a record of $1 trillion of completed deals for the year, breaking the previous record of $804 billion set in 2006.
Source: Bain & Co, Private Equity’s Wild First-Half Ride, July 2021.
With $3.3 trillion of capital to be deployed, of which ~$1 trillion sits in LBO funds according to Bain, I would expect a lot more take private bids to materialise in H2 this year.
Bloomberg also ran another interesting article on “bargain” UK takeover targets, highlighting the findings of a Bloomberg survey of 15 risk-arbitrage desks, fund managers, traders and analysts across the U.K. and Europe. The poll found that UK-listed sports-betting firm Entain Plc (owner of Ladbrokes) is the top takeover target among the investors surveyed. Entain was previously the subject of an unsuccessful bid by MGM Resorts earlier this year, but the view is clearly that it will come into play again.
Aside from Entain, the poll highlighted a diverse range of takeover targets across sectors including publishing, healthcare, energy and engineering, with the common theme across each being the perceived cheapness of UK listed companies compared to other markets. Based on market-wide (index) EBITDA multiples, the UK market (as represented by the MSCI UK Index) is trading at less than 8x compared with 10x for European companies and 15x for US companies:
Against this backdrop and the mountain of dry powder that needs to be deployed, UK Plc is now itself in play it seems.
With regard to my own ideas on this theme, assisted by Ireland’s proximity to the UK I continue to see Irish names Hibernia REIT Plc and Dalata Hotel Group Plc as obvious candidates for take-privates by real estate-focused PE acquirers if their share prices remain depressed at current levels, due to the combination of their low valuations, quality investment attributes and limited downside from asset backing.
That concludes my round up of what I found most interesting last week. Hopefully this has been of interest, and please get in touch if you've any thoughts on the themes or names mentioned above.