2023-06-05 05:16:53 ET
Summary
- Ares Commercial Real Estate missed estimates for Q1 2023 earnings, which led to a significant decline in the share price.
- A high dividend yield of 14.6% is stable, given the company's significant liquidity position.
- Shares are substantially undervalued at a close to 30% discount.
Introduction
Regular readers of my articles will know that I have covered Ares Commercial Real Estate Corporation (ACRE) several times previously. My most recent article on the company came a few months back in February 2023, after the company announced its FY 2022 earnings. Since my last article, the company has released its Q1 2023 earnings. In this article, I will re-evaluate the company to determine if my investment thesis holds true.
Q1 2023 Earnings
The company released its earnings report for the first quarter of the year early last month. The company reported distributable earnings of $0.27/share and revenue of $26.5 million, both of which missed analyst estimates.
Not surprisingly, the stock, which had already been experiencing a downward trend in recent months due to rising interest rates, declined even further. At its lowest point on just over a month ago on 4 May 2023, the company's share price was at $7.76. Since then, the company's share price has recovered somewhat, rising by over 23% during this period, though it is still down from when I last covered the company.
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Loan Portfolio
As at Q1 2023, the company's loan portfolio stood at $2.2 billion, down slightly from the $2.3 billion at the end of 2022. This was due to no new loan commitments being made during the quarter, as part of a conscious decision by the company in order to build its liquidity position. The company was able to reduce its office exposure, from 37% at the end of 2022 to the current 31%. This reflects the company's decision to gradually shift towards the multifamily, industrial and self-storage markets, though the company remains on the lookout for opportunistic investments. The portfolio is also well-diversified geographically, reducing any risks associated with economic fluctuations or disruptions in any single area.
While the company did not make any new loan commitments during Q1 2023, the company has a loan capacity of $475 million (highlighted by the 18% in white in the below pie charts). When asked about this during the earnings call , the CEO mentioned that the company expects to be more active during the rest of the year though they will continue to be selective with the loans they originate given the current macro-economic environment.
ACRE May 2023 Investor Presentation
Balance Sheet
The company has taken steps to shore up its balance sheet. With approximately $1.7 billion in outstanding borrowings, the company has a net debt to equity ratio of 1.9x. It has also increased its liquidity position, with more than $225 million available in liquidity including over $150 million in cash.
ACRE May 2023 Investor Presentation
It should be noted that the net debt to equity ratio of 1.9x excludes the current expected credit losses ((CECL)) of approximately $92 million. Even after including its CECL losses, the company has a net debt to equity ratio of only 2.1x, which compares very favourably against its peers.
ACRE May 2023 Investor Presentation
Dividends
During the earnings call, the company maintained its dividends, paying out a quarterly dividend of $0.33/share and a supplemental dividend of $0.02/share, taking the total payments for the quarter to $0.35/share. The company has maintained its quarterly dividend at $0.33/share for several years now, since 2019 while its supplemental dividend was introduced in 2021 and has been there ever since. Annualized, this gives the company a dividend of $1.40/share and a forward dividend yield of 14.6% based on the latest share price of $9.59.
Of course, the key question is whether the company will be able to maintain its dividends. As mentioned above, the company has built up its balance sheet and liquidity position, which should give investors comfort that its dividends are secure. Crucially, during the earnings call, the CEO reiterated the company's commitment to maintain the current level of dividends:
Historically on our first quarter calls, we've provided a dividend outlook for the remainder of the year. Based on what we see today, and despite the near-term industry headwinds and credit challenges, we expect to be in a position with our run rate earnings power to continue our current level of regular and supplemental quarterly cash dividends for the remainder of the year.
Valuation
In terms of valuation, the company has a book value of around $13.15/share, as mentioned during the earnings call. Given the share price of $9.59, this gives the company a price-to-book (P/B) ratio of approximately 0.73. Depending on which website you use - Yahoo Finance , Macrotrends , YCharts , Morningstar or even some other website, the figures might differ slightly but they are all around that range. Regardless, it is clear that the company's shares are substantially undervalued.
Risks
Of course, as with any potential investment, there are undoubtedly risks. The current macro-economic environment is a challenging one, and the company still has a rather high exposure to offices at 31% of its portfolio. There is no way to know for certain whether the company will be able to successfully overcome all challenges. That being said, management has recognised these challenges and has been taking efforts to improve its liquidity position. This will ensure the company is better prepared to face these challenges.
Conclusion
I have owned Ares Commercial Real Estate Corporation for several years now. Excluding the sharp decline during the start of the pandemic, the shares are currently trading at one of the lowest valuations I have seen. While there is certainly no guarantee that the company will be a successful investment, there are a couple of factors which lead me to favour a "buy" rating for the company.
First, the company is substantially undervalued at a P/B ratio of 0.73. With close to a 30% margin of safety, it seems to me that most of the downside has been priced into the stock - even if it isn't, it still provides an added layer of safety compared to if the stock were trading at its book value. Next, the management. The team was able to successfully navigate the challenges brought on by the pandemic (and that was with a higher exposure to office properties too!), and I see no reason to indicate they are not capable of navigating the current macro-economic environment as well. That they have actively reduced originations and chosen instead to strengthen their liquidity position gives me confidence as well. Finally, the company's stable dividend. The current dividend is a stable one, and the company has also indicated that they expect to be able to maintain their dividends in the near future. Thus, even if the share price continues to fluctuate, I will continue to collect my 14.6% in dividends each quarter.
For further details see:
Ares Commercial Real Estate: Substantially Undervalued; High And Stable Dividends