HHC - The Howard Hughes Corporation: Location Location Location

2023-03-09 08:31:21 ET

Summary

• Howard Hughes Corp owns large chunks of land, much of which are under long-term development, in a variety of desirable, high-growth markets nationwide.
• Rising interest rates may hamper results, although the inflationary environment could potentially support land sale values, which provide cash flows for development of its master-planned communities.
• Pershing Square's recent tender and current ~36% stake should provide at least some encouragement to long-term holders.
• The stock has had a tremendous run. I think it makes sense to step back and let the thesis unfold a bit more before considering a purchase.

I'm recommending a Hold rating on the shares of The Howard Hughes Corporation (HHC), with a price target of $90 per share, approximately equal to 55% of the company's view of NAV and roughly 20 times forecast adjusted 2023 earnings per share.

Teravalis potential

The company's newest and arguably highest potential MPC, Teravalis, is comprised of 37,000 acres of land outside of Phoenix, AZ. HHC estimates it will contain 100,000 homes and it is currently estimating that it will sell the first 1,000 lots for $80-85k per lot, or $325-350k per acre. Management stated in its third-quarter earnings call that sell out is expected over 40 to 50 years. While that is obviously an extremely long timeline, based on the current selling prices and potential escalation, and using a 10% discount rate, the value of Teravalis's land is in the $1.5 - $2.5 billion range.

That's a wide range, which is unsurprising given the time horizon. However, the lower end of the range puts particularly little weight on management's ability to increase values through its MPC development efforts. It also does not factor the potential transition from more starter homes to more customized (and lucrative) residential properties, as well as the commercial assets that HHC can build into this MPC.

Share buybacks

The company has picked up the pace of share buybacks in recent quarters and for the full year 2022 they repurchased over 4 million shares for $390 million, representing nearly 8% of total shares outstanding. While there is certainly much investment to be done in continuing to develop its MPCs and condo facilities, if management believes the difference between the company's share price and NAV is as great as they say, they should continue to aggressively repurchase stock.

Limited near-term debt refinancing

The company has successfully mitigated its ongoing risk to higher interest rates. It completed over $1 billion in incremental debt raises, and only has $155 million of maturities in 2023 and 2024, with a weighted average tenor of 7.5 years. In addition, the company's cost of its fixed-rate and variable-rate debt (excluding condominium financing) is only 4.4% and 5.2% respectively, both competitive levels compared to where treasuries are currently trading.

Risks to investment thesis

Significant office space exposure

Uncertainty in the macroeconomic backdrop is higher than normal given the central bank tightening cycle currently underway, and companies are still evaluating how to operate in the post-COVID "new normal", whatever that may end up being. Approximately 50% of HHC's stabilized NOI is projected to be derived from offices. Given the trends in remote work, it is not too difficult to see a situation in which this eventually weighs on cash flows of these properties, and therefore HHC's earnings. Many of HHC's office buildings are located within its MPCs, which may potentially shelter it to some degree from these changes, but this is something which should be monitored closely.

Interest rates and increasing cap rates

The company's efforts to reduce near-term interest rate exposure in its capital structure are noteworthy. However, the rise in Treasuries and mortgage rates has at least started to have an impact on HHC's guidance, with results having weakened somewhat from their highs during the pandemic. Management's previously communicated view on NAV was assuming the following cap rates:

Source: HHC 2022 Investor Day Presentation, 4/7/22

Unfortunately, the rise in interest rates have rendered these cap rates irrelevant in the current environment. Higher cap rates equals lower property values. While higher inflation might also translate to higher land values, it is hard to look at the above, and look at the affordability impact of significantly higher mortgage rates, and wonder how significant the impact on HHC shares will be.

Conclusion

Shares are relatively cheap compared to management's view on net asset value, and their strong repurchase activity could be seen as an endorsement of the disconnect between share price and NAV. However, this is a very long-term story with a wide range of potential outcomes to the extent that NAV/NOI become compressed for one or more of the above reasons. Therefore, notwithstanding some of the positives and Pershing Square's significant ownership position, I would steer clear of shares for now. To the extent there was a significant pullback, I might reconsider taking a position in the stock.

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