TCN - 2 Of My Favorite Stocks For 2024

2023-12-26 08:05:00 ET

Summary

• I don't invest just in REITs.
• I also invest in non-REIT stocks to diversify my portfolio.
• Here are 2 of my favorite stocks for 2024.

Most of you here on Seeking Alpha know me as a REIT analyst ( VNQ ).

That's my main circle of competence and it is also where most of my capital is going.

But I also invest in other sectors of the market.

Diversification is the only "free lunch" that the market has to offer and I don't want to miss out on it.

My non-REIT investments are typically companies that are still somehow related to real estate since that's what I know best.

Below, I highlight two of my favorite non-REIT stock investments for 2024:

Tricon Residential ( TCN )

Tricon may look like a REIT, but it isn't one.

Instead, it is an asset manager that specializes in single-family rental investments, and it earns fees for managing capital for others. It typically also invests heavily alongside other investors so it also participates in the returns of its various funds.

The interesting thing here is that the company is priced at a steep discount to its net asset value.

The company's latest NAV estimate is $14.09 per share, but it trades at just $9. As such, Tricon is offering an opportunity for investors to buy an interest in a diversified portfolio of single-family rentals and its asset management business at just 65 cents on the dollar.

Just recently, Land & Buildings announced that they had initiated a position in Tricon and released a presentation highlighting the opportunity.

You can study their presentation by clicking here.

In case you are not familiar with Land & Buildings , they are the biggest activist investment firm that specializes in listed real estate securities. We don't always agree with all of their calls, especially on the short side, but generally speaking, they have a good track record at identifying undervalued real estate companies and then pushing their management to unlock this value.

To give you an example: we were invested alongside them in American Campus Communities (ACC) and they pushed the management to sell the company, which tripled our money since our first purchase just two years earlier. This is still one of our best performers of all time:

Today, their new target is Tricon and the interesting thing is that it has many similarities with American Campus Communities.

• Both focus on residential properties.
• Both own assets that are in high demand by private equity players.
• Both have significant value-add potential that private players could unlock.
• Both are priced at huge discounts relative to their net asset value.
• Both are/were targeted by activists who were/are pushing for a sale.
• And most importantly, they both attracted the interest of Blackstone ( BX ), which is the biggest private equity player in the world.

Blackstone is the company that eventually bought out American Campus Communities, and today, they already have a $300+ million investment in Tricon, representing about 12% of the company's market cap. They even have a seat on the board.

Blackstone has aggressively grown its portfolio of single-family rentals in the past years. It bought a $6 billion portfolio in 2021 at a ~3.5% cap rate.

Today, Tricon is priced at a 6.5% implied cap rate and that's despite its rents being materially below market according to a study by Land & Buildings:

So the normalized forward cap rate is closer to 7%.

You would never get even close to that in the private market if you tried to buy middle-income single-family rentals in TCN's sunbelt markets.

Recent single-family rental transactions have been reported at 4.5-5%. Green Street Advisor has previously used a 4.7% cap rate to value Tricon's portfolio.

By using a more conservative 5.5% cap rate, Land & Buildings estimates that Tricon has 65% upside potential and it has a clear plan to unlock this value.

They believe that simply raising rents to market levels could unlock 20% earnings growth. Beyond that, earnings could be increased by another 30% by reducing excessive overhead. Tricon's G&A is high today because they were aggressively expanding their portfolio in recent years, but this has changed and costs could be reduced. Finally, if that's not enough to push the share price closer to fair value, then buybacks and/or a full sale of the company could unlock value.

This is what happened with American Campus Communities and Tricon could be a remake of that.

RCI Hospitality ( RICK )

RCI Hospitality ( RICK ) is the only listed company that specializes in adult nightclubs. In case you are not familiar with the company, you can start by reading our investment thesis by clicking here.

In short, they have been able to grow their FCF per share by 20% annually over the past many years by acquiring clubs from retiring owners. This is a fragmented sector with few sellers due to the stigma attached to these assets, but many sellers as most owners approach retirement, and this provides RICK a unique opportunity to buy these assets at low multiples, earning large spreads over its cost of capital:

Over the past year, the company has kept earning significant free cash flow, growing its cash pile, but its share price has dropped significantly, in part because they haven't identified a new acquisition opportunity in a little while.

But on a recent conference call, the management made it clear that they are back on the negotiating table and ready to make new deals.

Here is an interesting section from a recent Q&A:

Joseph Gomes (Analyst)

Hey. So, you guys kind of answered most of mine, but I just kind of want to see how just the overall environment is just looking like for any just new potential club acquisitions, how are owners being obviously in this kind of cautionary environment?

Eric Langan (RICK's CEO)

Yes, I mean, we haven’t pursued, so I don’t really know. I’ve told almost everyone that has called me in the last 2 months that we’ve got to get this other acquisition under our belt (Jussi's addition: RICK has made major acquisitions recently and been working on integrating those, which kept them busy) . We’re working on it. Let’s talk at EXPO (Jussi's addition: this is a major club conference) . Let’s talk at EXPO. Seeing the hotel room count full already, means there’s going to be lots of people there. So I’m very optimistic that – and I’ve got some meetings set up, and some people that I’m going to make sure we talk to, while we’re out there. And people that want to talk to us while we’re out there.

So I think we’ll get a kind of a list put together and we’ll talk multiples and locations and try to figure out what’s the quickest and easiest for us in timing and what the best deal is . And, cherry pick the best clubs like we’ve been doing for the last 10, 15 years. But EXPO – every year at EXPO, we always make someone and we always start the process. So, the reality is just how quickly we can do it. We’re ready now, so we could close something pretty quick quickly.

I think we have, if I’m correct, approximately $45 million or $46 million worth of unencumbered real estate or under encumbered real estate we could roll in to a loan. At 70% loan to value that would pull about $28 million. With the under encumbered parts probably $4 million, $5 million we’d have to pay off. So we could easily pull a $20 million down payment out from our bank right now if we need it.

I’m not counting our line of credit, so we could hit – we paid down our line of credit a little bit so we could probably hit that line of credit again if we needed to. So we’re in good shape. And we still have $25 million cash on the books. So we’re in great shape to make an acquisition. Obviously, we’re not using equity at these prices. So it would be a debt, in cash acquisition right now.

I don’t – unless, of course, the stock [indiscernible] runs back up over $80 over the next few weeks, which, the market where it’s at, some of the uncertainty out there. I think that’s probably unlikely. So I would love that it did, because it would give us even more ammunition, as we go to EXPO in a few weeks.

But, if it stays under, then we’ll just continue to buy back a little bit every week with some of our cash and , just keep following our capital allocation strategy. We’ve proven from 2015 on, it works. And there’s no there’s no flaw on it so far at this point. So I think we’ll just keep doing what we do."

So they are essentially telling us that their team is now ready for new acquisitions, which wasn't the case for most of 2023 because they were too busy integrating their latest acquisitions.

This is very good news.

Moreover, they now have about $20 million of cash today and they expect to soon pull another $20 million from banks by refinancing some properties.

That's $40 million.

Then RICK typically also gets seller financing when buying clubs so overall, its buying power is likely near $100 million right now and it is ready to make new deals.

That's very significant considering that they target 25-33% annual cash-on-cash returns on their new acquisitions, and their current cash flow is just around $80 million annually. This is just to say that they could create significant value in the near term if and when they announce some new club acquisitions.

These acquisitions are the number #1 reason behind RICK's huge returns these past years and so I remain very optimistic:

While we wait for acquisitions, RICK is also buying back $100,000 of shares each day, creating value for patient long-term-oriented investors.

Priced at 7x FCF and offering 20% annual growth prospects, we continue to think that RICK will likely be one of our biggest winners over the next 10 years.

For further details see: