2023-11-07 07:05:04 ET
Summary
- Safehold's Q3 2023 results had some more pain for long suffering shareholders.
- Even excluding one-off items, the earnings contraction was quite strong.
- We look at the positive developments including the credit upgrade and tell you why we would look for an Austrian security for direction.
As we came into 2023, we had a clear message for Safehold ( SAFE ) shareholders.
Hence we would stick the bonds for now and look for long opportunities on the common later in the year.
Source: If You Liked 2022, You Will Love 2023
The bonds have a flattish total return with the interest income being offset by a price decline. But they did win out versus the stock and by a massive margin.
Seeking Alpha
We look at the Q3-2023 and tell you why we may get more of a bounce from here and why bears should press their luck till later in 2024.
Q3-2023
There was not a lot of cheer for investors with the Q3-2023 press release. The GAAP numbers looked awful with a large goodwill write down. This was associated with market conditions and management commented on the numbers upfront.
The goodwill asset was created when we closed the merger and was recorded on our balance sheet, with the value at the end of last quarter sitting at $145.4 million. Goodwill primarily represented future savings and synergies associated with completing the merger and replacing our prior external management structure.
Goodwill assets are recorded under GAAP to be tested for impairment annually. However, we also are required on an ongoing basis to determine if there are indicators of impairment, and if so, test for impairment at such time.
We determined that the precipitous and sustained decline in SAFE stock price during the quarter was an indicator of impairment and that a full impairment of the asset was required. This is entirely an accounting-driven and non-cash impairment and does not speak to the value or durability of our asset base and Safehold certainly still benefits from being an internally managed company.
Source: Q3-2023 SAFE Conference Call Transcript
Our take is between the GAAP numbers and what management said. While the loss is not real in the sense no actual cash flow is lost, the low SAFE stock price is indeed a sign of how broken things are. There is going to be a very different dynamic in play if SAFE is issuing stock at 12X GAAP earnings vs the 42X GAAP earnings it issued stock at in 2021.
Looking at the actual numbers it is clear that there are more problems here than just the goodwill losses. Earnings scrubbed six ways to Sunday still showed a year over year decline of 18%. We are referring to the $0.33 shown below which removes out goodwill write down, merger costs and Caret costs. You can see that this decline has accelerated versus the year to date number of just 8%.
Taking a more detailed look at the costs and expenses, we can see that total General and administrative expenses are running at $17.86 million per quarter. This works to over 20% of revenues.
Interest expenses continue to rise briskly and now are at 54.4% of revenues. Last year, we were a shade under 50% and SAFE's all-in bet on the floating rate credit line is chewing away at the earnings.
Outlook
If you look at what SAFE traded at in 2021, you are now doubt going to find this little timeframe as a beacon of cheapness.
Even this quarter's earnings annualized means that that SAFE is just at 13X earnings. Bulls touted this as a great play way into 50X and 60X earnings, so at 13X you can at least count yourself as being fortunate enough to see the obvious bubble. Also at 13X your odds of making money are far higher. And there is this.
SAFE Q3-2023 Presentation
Moody's has actually upgraded SAFE to an A3. This has to be one of the strangest upgrades in the history of the rating system that we have seen. SAFE's interest coverage is well under 2.0X. Debt to EBITDA is in excess of 15X. We are not aware of any REIT entity in the ballpark of these numbers having an A3 rating. Mid-America Apartment Communities, Inc. ( MAA ) which has an A3 rating as well, has an interest coverage ratio of 10X and a debt to EBITDA of 3.4X. We are not even penalizing SAFE for having cash flow far lower than its GAAP earnings thanks to how these long term leases work. You can see that non-cash interest earned subtracts $62 million earned while non-cash interest paid only add $10 million to cash flow . Operating cash flow excluding changes in working capital (our favorite measure) shows just $5.0 million generated year to date for 2023.
10-Q
Even using the GAAP earnings at face value, it is hard to see this as A3 rated. But rating agencies in their infinite wisdom feel otherwise, so we will run with it. That rating applies to this giant debt structure below. The weighted average maturity, which excludes the floating credit line, is pretty decent at 22.5 years. SAFE does explain how some of its hedges are mitigating the pain on that floating rate exposure.
SAFE Q3-2023 Presentation
While that may be true, there is no doubt that the company remains a complete bet on lower rates. We say that because the company's earnings are now contracting and cash flow does not even cover the dividend. If it has to regain some of its lost multiple, earnings have to grow once again at the minimum and that will require lower interest rates.
Verdict
To make a call on SAFE stock you have to keep in mind where it has been. The stock was high as $91.00 at one point and post 80% plus drop (at its low), one cannot have the same bearish enthusiasm. It has underperformed Vanguard Real Estate ETF ( VNQ ) by a whopper of a margin and delivered one of the most painful swan dives we have seen in the REIT sector.
SAFE also now trades almost 30% below its 200 day moving average.
Even management decided that it was not going to wait for higher prices and issued stock at rock-bottom prices in August. So sentiment looks ripe for a bounce. If we had to guess here, we would think SAFE makes it over $20 at some point soon. The catalyst likely could be lower interest rates as that has been one of the most one-sided boats we have seen. Austria's 100 year bond (down 82% from its peak) chart looks like a picture match of the SAFE bubble.
So lower rates likely adds some fire beneath the SAFE wings.
Longer term, SAFE will have to contend with about half of its exposure coming from single tenant office buildings.
The Daily Shot On X
Yes the ground lease structure provides a large buffer but it is not impenetrable. We are seeing many single tenant office buildings being abandoned or sold for 70%-80% off the pre-pandemic price. We are even seeing multi-tenant office buildings sell at those kind of discounts. So a buy here means that you have to be comfortable with the long term setup. We definitely are not in that camp. We think a bounce materializes here and then we might see another leg lower later in 2024. For the bullish investors, we would suggest considering the bonds once again as they offer a nice 7% yield to maturity. If you believe in that A3 Credit rating, then the bonds are well priced.
Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.
For further details see:
Safehold: The Ultimate Swan Dive