CHCI - Comstock Holding: Q3 2023 Update And Recent News

2024-01-15 03:22:07 ET

Summary

• Comstock reported solid results in Q3 2023. As expected, the incentive fee added a large bump to revenue and earnings leading to $0.49 GAAP EPS.
• Besides the incentive fee, recurring revenue grew 12.6% year-over-year led by 37% revenue growth in parking management revenue.
• In late December, CHCI announced that it fully acquired a plot of land in Rockville, MD adjacent to residential properties that it partially owns through a JV.
• In this article, I’ll discuss Q3 2023 results in more detail, discuss the Rockville land acquisition in more detail, and provide an update on the stock’s valuation.

After earnings results that were below my expectations in Q2 2023, Comstock Holding Companies, Inc. (CHCI) surpassed my expectations in Q3 2023. I discussed Q2 results in my last update on the stock but in brief, while revenue grew year-over-year in Q2, it fell more than 10% sequentially and COGS was about flat sequentially. This led to low earnings and margins. I wrote that these negative results did not change the big picture of the investment thesis as lease rates on both the Rockville residential properties and the assets in the anchor portfolio remained high which continued to demonstrate that these assets are high quality and will continue to benefit from demand tailwinds.

Q3 continued to validate the thesis but also provided investors with more comfort in the economics of the business. The lease rate in the residential portfolio grew year-over-year and remained flat sequentially at 97% and the lease rate in the commercial portfolio grew both year-over-year and sequentially to 92%. The company also recently announced that it fully acquired land in Rockville. This is a deviation from the asset-light business model that the company touts, but I am optimistic that this may prove to be a smart purchase.

Outside of some of this business-specific news, general real estate news and news specific to the DC-Maryland-Virginia area also provide reasons for investors to be excited about the prospects of Comstock's portfolio of managed and owned assets.

I am maintaining a buy rating and assigning the stock with a price target of $8. I have concerns relating to dilution, taxes and the incentive fee which I will discuss in more detail, but I believe the stock is worth $8 even with these concerns in mind.

Q3 Earnings Results

The solid Q3 2023 financial results were largely driven by the $4.8mm incentive fee that the company booked in the quarter and by growth in the parking management revenue. This led to GAAP EPS of $0.49 for the quarter.

These results were offset slightly by a decline in leasing, acquisitions, and development fees due to higher transaction volume in 2022, and were also offset by booked losses in real estate ventures but not by enough to prevent record quarterly gross and operating margins of 40% and 36% respectively. Of course, these margins are not sustainable over the course of a year due to the incentive fee but recurring revenue grew 12% year-over-year.

Further, details in the 10-Q indicate that Comstock's portfolio of managed assets at full build out has grown since the last quarter. Assets under management at full build out grew from 63 in the last quarter to 65 this quarter.

Rockville Land Acquisition

Comstock recently announced that it acquired a plot of land in Rockville, MD for $1.5mm in cash. This plot of land is adjacent to its residential buildings partially owned via a JV with Comstock Partners (a separate entity owned by the CEO of Comstock Holding, Christopher Clemente). This is a deviation from the asset-light business model that the company touts but it seems like a smart acquisition based on the details provided in the press release.

The land currently houses a parking lot but it has entitlements for 117 residential units and 11,000 square feet of retail space. The seller was not disclosed in the press release but I imagine that restrictive construction costs led to a lower selling price for the land. Vacant lots are rare near the Rockville metro station and Comstock clearly knows the area well. Given the high lease rates at the two residential buildings it owns nearby, the odds are high that a residential building on this site would have few issues leasing units.

The company has ample liquidity to pay for this land and hold onto it for some time. Even if Comstock doesn't develop the land and if construction prices drop and interest rates decline, they should be able to sell the land for a good price.

I like this acquisition due to the optionality it provides; there are a few ways in which Comstock can make money from it and it won't affect the company's capital structure in a big way due to its large net cash position.

Relevant News

Monumental Sports and Entertainment, the owner of the Washington Capitals, Washington Wizards, and Washington Mystics, recently announced plans to move the teams to an arena and practice facility located in Potomac Yard, a neighborhood in Alexandra, VA, away from its current arena in Washington D.C.

Alexandria is just south of Washington D.C. and is accessible via the blue line on the D.C. metro. Comstock's assets in its anchor portfolio are located North of D.C. in Reston, VA and Loudon County in VA. These areas are not very close together but it further supports the idea that demand is moving away from Washington D.C. and into Virginia.

The assets in Comstock's anchor portfolio will continue to benefit from these demand tailwinds.

Valuation

The stock is clearly cheap based on yearly earnings with the incentive fee as the stock trades around 10x EPS of the quarter with the fee alone. However, the company's most recent annual report indicates that the planned incentive fees go through 2024, meaning next year's may be the last. The section says "For the year ended December 31, 2022, we recognized revenue from Incentive Fees of $3.9 million, stemming from an operating asset triggering event on October 1, 2022, that is the first in a series of annual operating asset triggering events that are scheduled each October 1 through 2024". What does it mean for the value of the business if next year's is truly the last one?

In the model below, I am assuming that revenue in 2024 grows 10% over 2023 revenue and in 2025, the incentive is dropped and revenue and operating income decline by $5mm because of it. From there, I assume that revenue will grow 5% through 2033 and the company's operating margin remains constant at 10%. I am using a 25% tax rate starting in 2028 when the company's net operating losses begin to expire (this tax asset may be the topic of a future article). With a 10% cost of capital and a 0% terminal growth rate, the value of the stock in this scenario is about $7.86.

Even when assuming the incentive fee ends in 2024, the company begins paying taxes within the next 10 years, and with what I think are conservative growth assumptions, I believe the stock is undervalued by about 65%.

Risks

Dilution is one of my main concerns with the stock. Since 2021, shares outstanding have increased 5-6% each year. If the company is able to grow earnings faster than this, it is not too big of an issue. This is something to keep an eye on especially with very small companies that are largely owned by insiders as is the case with Comstock Holding. There is little to no ability for activist shareholders to create change as 70-75% of the business is owned by insiders. If growth slows and dilution continues, minority shareholders will suffer.

Additionally, this is a very illiquid stock with about $40,000 worth of shares traded daily on average. Along with the lack of liquidity, the bid/ask spread on the stock is often as large as 5%. This makes it difficult to not only buy a position but also to exit without being forced to sell at a low price. If an investor needs to sell their shares quickly anytime soon, then they should not invest in the business at all.

Final Thoughts

Comstock reported solid Q3 results after a relatively disappointing Q2. I remain positive on the stock due to this recent momentum along with recent company-specific news, such as the purchase of a plot of land in Rockville, MD at what seems to be an attractive price, and demand tailwinds continuing with more investment moving out of D.C. towards VA (as demonstrated by Monumental Sports planning to move its facilities to Alexandria, VA and out of D.C.).

While dilution and illiquidity must be monitored, I am maintaining a buy rating and assigning a $8 price target. This price target takes into account concerns about the incentive fee which may end after 2024 and future tax payments after the tax shield asset runs out.

For further details see: