2023-04-06 17:11:44 ET
Summary
- Tejon Ranch owns a large amount of land outside of Los Angeles.
- Shares rally periodically on hopes of development but these have always fizzled. Over the past 35 years, Tejon Ranch shares have produced virtually no return.
- With interest rates soaring and the California housing market looking vulnerable, this is not the time to own Tejon Ranch.
I've always found the so-called "land bank" companies to be interesting investing candidates. These are the firms that own a big chunk of land and earn some sort of income from it due to agriculture, oil and mineral rights, forestry, or whatnot.
Over time, the value of the land should appreciate due to inflation. And, if things go really well, shareholders can earn a windfall if and when the land changes uses and becomes houses, offices, or some much more valuable asset.
Not too long ago, I wrote up Maui Land & Pineapple ( MLP ) as one such example of an intriguing land bank that was trading near 5-year lows . Shares have since popped 30% on excitement around new management and the potential for a faster development schedule going forward. There are opportunities for investors that watch these sorts of assets and notice when they get to unusual valuations.
Unfortunately, the topic of today's article, Tejon Ranch ( TRC ), is not in such a favorable position. While the stock has rallied 20% since its lows last October, there is little fundamental reason for such a move. In fact, with soaring interest rates, sagging property prices in California, and the prospect of a prolonged downturn in the housing market, TRC stock seems set to revisit its 52-week lows.
Tejon Ranch: A Long History Of Underperformance
Tejon Ranch is a large piece of property north of Los Angeles. At times, there has been speculation around imminent plans to develop the property. However, it has seemingly been too far away from L.A. to generate all that much traction as far as development goes.
And indeed, dating back to 1985, Tejon Ranch shares have produced essentially no return whatsoever:
The company is not a dividend payer, so there's been no income while waiting for more than 35 years for something to happen with the property.
Shares had three notable run-ups. Two of these occurred in the 1980s, as property investors bid up Sunbelt housing and associated land. This all fizzled out in the early 1990s as the savings and loans (S&Ls) collapsed and speculative housing went into a downturn.
In 2005, things revved back up again. California's housing market went to previously unthinkable heights, and TRC stock climbed to its peak. But we all know what happened next. California was an epicenter of the 2008 housing bust and great financial crisis. More remote cities like Bakersfield were key players in the housing bust and builders wisely shelved plans to develop housing far outside of California's major urban areas. Tejon Ranch's land -- well outside of Los Angeles proper -- lost its appeal and shares slumped.
By 2020, shares were back to near 40-year lows. And, surprisingly enough, even the 2020-21 housing surge failed to do much of anything for Tejon Ranch stock. That's in stark contrast to other land development plays, such as Florida's St. Joe ( JOE ) which appreciated sharply during the recent housing boom.
Wrong Kind Of Asset To Own In A Recession
Any large-scale monetization effort at Tejon Ranch would be based on significant development. While the company brings in some revenues from things such as agriculture, ranching, and mineral rights, they are not of a scale that would move the needle monetarily.
Unfortunately, the outlook for development now looks cloudy. Higher interest rates are causing a major slowdown in housing market conditions. New mortgage applications have slumped. Homebuilding is likely to slow down. And California appears to be at the leading edge of the housing slowdown as prices are already down 7% year-over-year while California home sales by volume have dropped a third. Furthermore, median days on the housing market has doubled, indicating that inventory levels are rising.
All that to say that these are not the sort of market conditions that would cause anyone to fast-track residential development in the far outskirts of Los Angeles.
And, even before the current headwinds, it's not like things were booming. Santa Clarita, the nearest city in-between Tejon Ranch and LA, saw its population growth tail off significantly in the late 2010s. Meanwhile, Bakersfield, which had been a massive growth story between 1980 and 2007, saw its population growth rate plummet since that point.
The appeal of building huge suburban projects far outside of major Californian cities seems to have diminished. And banks are more wary about funding large houses in the desert after their devastating losses in 2008. The conditions for Tejon Ranch were already less promising heading into the 2020s, and now the sharp rise in interest rates only further complicates things. This is even before getting to the local opposition to the project.
Perhaps there will be some additional demand for logistics or industrial buildings at Tejon Ranch. Warehouses are still in demand, even if that market has cooled a bit since 2021. However, I doubt you can make the numbers pencil out on Tejon Ranch simply from industrial buildings. Retail and housing were supposed to be core tenets of the bull thesis, and both seem to be on shaky ground for at least the next few years.
Don't Expect Any Big Developments In 2023
When a stock is prone to long periods of sideways trading, such as this one, it can help to look for a catalyst to reinvigorate trading. However, I doubt 2023 will be that year for Tejon Ranch.
The company said as much in its November 2022 earnings press release with this blunt message:
California is one of the most highly regulated states in which to engage in real estate development and, as such, natural delays, including those resulting from litigation, can be reasonably anticipated. Accordingly, throughout the next few years, the Company expects net income to fluctuate from year-to-year based on commodity prices, production within its farming segment and mineral resources segment, and the timing of sales of land and the leasing of land within its industrial developments.
The Company is experiencing higher costs in fuel, fertilizer, pest control, and labor costs during 2022. These price increases are magnified in the almond market as higher inventory levels and a stronger dollar have had an adverse effect on the price of almonds during 2022 and can continue into 2023.
This does not read like a firm that is at an inflection point toward more favorable market conditions.
Time Is Not Your Friend
A big issue with this sort of business is how it funds itself. If the company can make enough money off its other operations, such as agriculture, then it can be self-funding and not need to raise capital.
In the case of Tejon Ranch, however, existing operations have not been particularly profitable for long stretches of the past few decades. In any case, management has doubled the outstanding share count since 2000:
What have the company's loyal long-term shareholders gotten for all that dilution? There's still not much tangible to show for it, either in current operations or near-term development plans at the company's master planned communities.
If we assume the S&P 500 gains 8% per year compounded, the value of the stock market doubles approximately every nine years. That is a reasonable baseline discount rate that Tejon Ranch has to compete with. If buying an S&P 500 index fund makes 8%/year, Tejon Ranch has to keep up with that to be a worthwhile investment.
It's unlikely that land values alone will appreciate 8%/year, especially when the land in question is closer to Bakersfield than downtown Los Angeles. But it gets worse. Once you add in all the shareholder dilution, now investors only own half as much land (per share) as they did 20 years ago.
It's easy to think about owning this sort of thing as a long-term holding with the belief that one day they'll figure out how to monetize the asset. But don't forget opportunity cost. Every year that passes where Tejon Ranch sits largely undeveloped is another year where shareholders funded an inert hunk of land instead of investing in strong cash flow and profit-generative assets.
TRC Stock Verdict
Needless to say, I'm not a fan of Tejon Ranch shares at this time.
If you do want to revisit the asset, I'd consider it once interest rates drop sharply and the California housing market starts to turn back up. That would be the point where you might see investor interest in the asset return. Any positive developments in terms of permitting for development or favorable court rulings would also potentially reshape the narrative. For now, though, there's little reason to own this especially with the macroeconomic headwinds.
The stock hasn't created shareholder value over the past 35 years, and there's little reason to expect much change in the near future either.
For further details see:
It's A Bad Time To Own Tejon Ranch