KW - The St. Joe Company Looks Awfully Pricey Right Now (Rating Downgrade)

2023-06-20 03:06:00 ET

Summary

• The St. Joe Company's recent financial performance has been mixed, with declines in average revenue per homesite sold and overall profits.
• Shares of the company are expensive on an absolute basis and relative to similar firms, making it a less attractive prospect for investors.
• The author has downgraded the business from a 'hold' to a 'sell' until either fundamentals improve drastically or shares drop materially.

I pride myself in a solid track record when it comes to investments. In general, the calls that I make turn out quite well. But every so often, I will misjudge an opportunity. Sometimes this involves me becoming too bearish. In other cases, I become the exact opposite. One company that I feel now that I misjudged in the past is The St. Joe Company ( JOE ). Over a year ago, I wrote a rather neutral article about the company. But in retrospect, even that was too optimistic based on the fundamental condition of the company and how things have changed since then. Given how things have gone, and with the benefit of hindsight, I do now believe that the company is a rather risky prospect for investors to consider at this time. As such, I have decided to downgrade the business from a ‘hold’ to a ‘sell’ until either fundamentals improve drastically or shares drop materially from where they are.

A look at recent pain

Back in late February of 2022, I found myself analyzing The St. Joe Company. For those who do not know, the company engages in a number of activities. At its core, it is a diversified developer of real estate. This means that it develops land and sells it. It also builds apartment buildings, senior living facilities, hotels, commercial space, industrial space, and more. Conceptually, this is a rather interesting area to invest in. But even at that time, I acknowledged that shares of the company were expensive. At the end of the day, however, the business model trumped the pricing of the company in my eyes. And that led me to take a rather neutral stance on the firm. Since then, shares have taken a beating, generating a loss for investors of 16.2% at a time when the S&P 500 has declined by a much more modest 0.6%.

From a purely operational perspective, results achieved by The St. Joe Company have been mixed recently. Consider how the company performed during the 2022 fiscal year . Revenue during that time came in at $252.3 million. That's down from the $267 million reported one year earlier. Interestingly, there were some parts of the business that performed remarkably well during this time. As an example, hospitality revenue for the business expanded from $75.3 million in 2021 to $97.2 million the same time in 2022. This increase, according to management, was primarily related to a rise in club members from 2,255 to 2,604, and higher lodging revenue, the latter of which was thanks in large part to the Hilton Garden Inn Panama City Airport that opened in July 2021 and the Homewood Suites by Hilton Panama City Beach that opened in March of last year. The new WaterColor Inn suites that opened in June of last year helped the company as well.

Another part of the company that did well was its leasing business. Revenue under that unit spiked from $27.1 million to $39.2 million. That increase, according to management, was driven largely by additional multifamily and senior living leases. But not every portion of the company fared well during this time. The one that was really hit was the real estate portion of the firm. Revenue plunged from $158.6 million to $109.2 million. This decrease, according to management, can really be chalked up to a couple of things. For starters, the company did see a decrease in the number of home sites that it sold. This number declined from 804 in 2021 to 752 last year. In 2021, the company also sold two homes. No homes were sold in 2022. However, these declines were offset slightly by a $1 million increase in unimproved residential land sales. In addition to the number of homesites dropping, the average revenue per homesite sold, excluding home site residuals, plunged from $157,000 to only $98,000. Management attributed this decline to a change in the mix of sales from different communities. I have no doubt that this played a role in the picture. But I would also imagine that a significant contributor would be the fact that the housing market is experiencing significant weakness, as evidenced by the backlog of many of the largest homebuilders.

With the decline in revenue for the company also came a decline in profits. Net income declined from $74.6 million in 2021 to $70.9 million last year. Operating cash flow was cut by more than half from $111.8 million to $48.2 million. If we adjust for changes in working capital, the decline was even more significant, from $110.7 million to $30.6 million. It's important to keep in mind that not every company is the same. When it comes to its cash flow data, I believe that The St. Joe Company deserves some special attention. I say this because the company books, in its operating cash flow, both the cost of real estate sold as an add-back to cash flow and expenditures for an acquisition of real estate to be sold as a reduction. I am not saying that this is inappropriate by any means. But while these assets are not strictly inventory, in my mind, they behave in a way that's similar to that or that would be similar to an investing activity instead of an operating one. So I made an extra category here that further adjusts operating cash flow to remove these particular cash flow items from the picture. This does narrow the decline in operating cash flow quite a bit, but it doesn't bridge the gap. On this basis, the metric would have fallen from $102.1 million to $81.7 million. Over the same window of time, EBITDA for the company fell from $112 million to $84.4 million.

Mixed financial results continued for the company into the 2023 fiscal year . Both hospitality revenue and leasing revenue increased year over year, with hospitality revenue spiking from $16.3 million to $24.5 million. This increase, management asserts, was driven by a further rise in club members from 2,271 in the first quarter of last year to 2,653 the same time this year. It also helps that real estate revenue for the company showed signs of stabilizing, dipping modestly from $36.8 million to $35 million. This actually came as the number of homesites sold spiked from 181 to 327. But once again, the company experienced a significant decline in revenue per homesite sold. The metric ultimately fell from $150,000 last year to $62,000 this year. As you can see in the chart above, profits for the company continued to fall, with cash flows following suit.

Those who are bullish about the company will point out that the business has a lot of potential in the long run. This very well could be the case. For instance, as of the end of the most recent quarter, The St. Joe Company operated 616 rooms from the seven hotels that it has in its hotel portfolio. It has another five hotels under development that will collectively have 682 additional rooms. The company also has 23,127 additional residential home sites in its pipeline spread across 21 different communities. Of these, only 2,556 are platted or under development. And another 3,530 are in the engineering or permitting phase. For its multifamily and senior living community operations, the company also has another 431 units to be completed and only 91% of the units that have been completed have been leased, so that leaves additional upside if the company can find occupants.

This is all very true. But in my mind, it's not enough, particularly in this uncertain economic environment, to make the company worth what it's trading for. Using data from both 2021 and 2022, I was able to create the chart above. In it, you can see how shares are priced on a price-to-earnings basis, a price-to-adjusted operating cash flow basis, and an EV-to-EBITDA basis. Even if we assume that financial performance reverts to what it was in 2021, shares of the enterprise look rather pricey. Normally, I would also like to compare the business to similar firms. But over the past year or so, I have gotten far stricter with the comparables that I utilize. And truth be told, it is difficult to find a business that makes for a good comparison. However, I did find four companies that I think are similar enough from an operational standpoint to compare the enterprise to. In the table below, you can see that, on both the price-to-earnings approach and the EV-to-EBITDA approach, The St. Joe Company ended up being the most expensive of the group. But when it comes to the price-to-operating cash flow approach, two of the four companies ended up being cheaper than our prospect.

Takeaway

All things considered, I suspect that the long term trajectory for The St. Joe Company will be just fine. Having said that, I don't believe that the company is a terribly attractive prospect at this time. Shares are expensive on an absolute basis and relative to similar firms. Recent financial performance has been mixed. The decline in average revenue per home site sold has been particularly problematic, though this has been offset to some degree by the strong hospitality operations of the firm. Given how expensive the stock is, however, I do believe that some downside is likely from here. As such, I've decided to rate the business a soft ‘sell’ at this time.

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