Ryanair Stock Analysis – Not a Buy Yet, But a Stock to Watch

I’ve been marginally following Ryanair for a few years now. When a CEO states:

“If someone wanted to pay £5 to go to the toilet, I’d carry them myself. I would wipe their bums for a fiver.”

ryanair ceo

It means that he is dedicated to the business. Nevertheless, I always look at risk versus reward and Ryanair was always a bit too expensive for me in the past. Over the past months however, the stock is down significantly and it is time to do a deep research into the business, to see whether it is undervalued and a good investment, or the business model is not strong enough to mark it a long-term investment opportunity. We know airlines are not renowned for being the best businesses in the world but you never know, Buffett bought 4 of them a few years ago.

1 Ryanair stock price

To value Ryanair, we have to look at:

  • The current situation full of issues
  • How those issues affect the short- and long-term outlook
  • Whether Ryanair has a moat, a competitive advantage
  • Where we are in the business cycle for airlines in Europe
  • Ryanair’s stock price compared to a long-term earnings model
  • General and specific risks

The recent news on Ryanair has been mostly negative

The news has been bad over the last two years for Ryanair:

  • Unionization and strikes that led to huge staff cost increases – 28%.
  • Higher oil prices have influenced their hedging, they are 90% hedged for FY 2020 but still forecast an increase of 400 million in costs.
  • The competition has been constantly increasing and has created overcapacity in Europe, despite the bankruptcies. Germany has large overcapacity as Lufthansa is initiating a price war by selling tickets below cost with its Eurowings subsidiary.
  • Air Traffic Control is also an issue with new regulations coming up and probably higher costs due to understaffing and more traffic.
  • The recently acquired Lauda Motion subsidiary suffered losses of 140 million in the first year where the situation is still chaotic, according to the CEO.
  • The Boeing Max aircraft issue has delayed delivery of 5 aircrafts ordered.
  • There will be more airline failures this winter, thus book your trips only with good companies. On the other hand, for Ryanair, this indicates there will be a stable supply of pilots and staff.
  • Guidance is flat for profits, between 750 million and 950 million on lower prices, 8% passenger growth and strong ancillaries. If there is no Brexit. Long-term guidance says investors should expect a few down years.

All of the above shows how the airline industry is tough, something we’ll discuss in a moment.

The same issues forced Ryanair to lower prices as the average ticket sold fell from EUR 39 to 37 and consequently net income fell to 1 billion. However, the sky isn’t that dark.

Ryanair’s short term and long-term outlook

Ryanair’s CEO clearly states that the fare environment will be weak going ahead. But things are not all bad. There have been some bankruptcies in Europe over the last years which allows Ryanair to grow and get more slots. It is expected that there will be more divestments and perhaps other opportunities for Ryanair to scale as it recently did by acquiring Lauda for 50 million EUR and further investments. Now that the company is unionized and both a Boing and Airbus operator, it can participate in consolidations.

Another positive will be the delivery of newer Boing 737Max planes with 4% more seats and 16% better fuel efficiency. Over the coming years, Ryanair plans to sell its older aircrafts, 10 of the oldest will be sold for 170 million as soon as they get the new aircrafts.

From listening to the conference call, I must say the management is very opportunistic. Something you don’t hear much when listening to calls. They recently took 750 million of unsecured debt at very low rates and they prefer to lease 7 to 9-year-old planes for less than $200k per month rather than to acquire new planes. On new aircraft prices, the CEO says how the pricing is high and order books are full and how they’d rather wait for the pricing cycle to weaken. This is a very important thing to hear for Boeing or Airbus investors.

It is interesting how Ryanair switched from dividends to buybacks, perhaps again opportunistically, and how they have a new 700 million share buyback plan. That is important and we can see how the number of shares outstanding has significantly declined over the past years. Pabrai would call this an uber cannibal stock.

15 buybacks and dividends ryanari

Source: Ryanair investor relations

They know the price environment is weak, but they think share prices are low and their cost advantage is the key for the long-term. Thus, long-term, a good investment in a currently bad environment.

My question is: can somebody compete with Ryanair? For that we have to analyze the competition, their fare prices, profitability etc.

Ryanair’s competitive advantage

In whatever business you are, if you are the lowest cost operator, you will probably survive all downturns, grow market share and be a good investment.

8 ryanair cost advantage

Source: Ryanair IR

Ryanair has to be compared to EasyJet as Wizz is not really a long-term competitor as it will hardly survive as an independent airline. Therefore, Ryanair’s advantage is large when it comes to cost.

Ryanair’s business model is different as it is the only company that has significant scale to operate as it does by using remote, small, ex-military airports across Europe.

9 ryanair costs competition

Source: Ryanair IR

Ryanair’s scale is incredible and they are further planning to expand in Ukraine, Israel, Bosnia & Herzegovina etc. Plus, they might take advantage of bankruptcies in the future but they are not interested in expanding in Scandinavia due to high government taxes.

10 ryanair airport coverage

Source: Ryanair IR

Given Ryanair’s business model, it actually doesn’t have much competition among customers that look for low prices.

11 market share

Source: Ryanair IR

Good market share, in a growing market as more and more people fly. Further, Ryanair’s share is even higher with cost aware customers. All smaller airports want to get Ryanair into their hub and the others are not that of an interest as unstable.

When it comes to business analysis, the best thing to do is to go to Peter Barklin from Niche Masters Fund. He has been kind to share his Global airline industry presentation with me and I’ll use some slides to better explain what Ryanair could be. If we take a look at the demand curve for the industry, Ryanair covers a huge part of the market and given its low cost, it might really have a moat.

14 ryanair cost curve

Source: Niche Masters Fund

As Ryanair has a kind of advantage due to low costs, let’s see what is going on within the European market.

What does it mean low-cost? These guys print their logo and put it on an old laptop. As long as it is functional. Got to love such managers. Source: 2019 FY Ryanair conference call.

ryanair

The European market

Consolidation will continue as many will fail. Ryanair actually hopes oil prices stay high so that they have lower competition in the future due to bankruptcies.

On fares, according to the CEO, fares in Europe are 25% when compared to North America and therefore have to rise at some point in time given that those are artificially low now.

If there is a price war, Ryanair will win due to the lowest cost. Profits might suffer for a year or two, and that is what shareholders should expect according to the CEO, but Ryanair should win.

The story is that there will be 4 to 5 big carriers in Europe and that is it, like in the US. Ryanair as the lowest cost, Lufthansa, BA AIG, Air France- KLM, with a question mark whether EasyJet will survive as an independent carrier – probably they will.

What did Buffett do when the industry consolidated and stocks were cheap? He bought them all, all four of them.

Ryanair stock price analysis, valuation and investment thesis

The market cap is currently at 11 billion EUR. Profits over the last 5 years, that have been good, were around 1 billion on average.

15 ryanari financials

Source: Morningstar Ryanair

Management has guide for profits between 700 and 900 million, let’s take 700 million over the next two years. After two years, we can assume profits to grow back to 1 billion and above, as the market consolidates. Or, we could see profits go to zero, especially if we have a recession.

However, what is a given, is that Ryanair will reach 200 million passengers per year by 2024.

16 growth

This implies growth of 25% in revenues from traffic and probably higher growth from ancillary businesses. If fares  in Europe increase by then, I would assume a 50% increase in revenues, add an acquisition and we are beyond 12 billion in revenues, perhaps even 15, depending on what is acquired. On 15 billion in revenue, with an average historic gross margin of 25%, net income could be 2 billion. If they continue with buybacks, earnings per share could be at 3 EUR and the stock price at 30, at some point in the next 5 to 7 years. That is a 16% return over the next 7 years. If it happens over 10 years, it is an 11.6% return.

If I look at earnings, it is impossible to make a model as airline earnings will always be volatile. However, I can estimate 2 years at 500 million, 2 years at 2 billion, 2 years at 1 billion and I would even add a year at zero and one at 3 billion. Thus, Ryanair will make a billion per year over the next 10 years, probably 1.5 billion. Thus, a fair price for a 15% return should be 10 EUR.

IMPORTANT STOCK PRICE NOTICE: If profits suffer for another year or two, the market will see only that. If there is a slowdown in Europe, this could get ugly. It is time to look at the sector and then be ready to strike when the situation looks like it was in the US a few years ago, when Buffett bought everything. However, there are always risks.

Ryanair investing risks

A plane crash – that would be a huge blow. Then the EU commission might get involved due to too much power the company might have. There is the Brexit, a probable EU recession over the next few years, EURO risks as the currency and the continent are fragile, from an economic, demographic and political side. So, plenty of risks there and the company doesn’t really have a margin of safety. Therefore, I would look at this only at business returns above 20%. At 1 billion, the stock price should be around 5 and around 7.5 EUR for 1.5 billion in earnings.

To keep on the watch list, it will also be a good indication for the European economy.

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How To Invest With Coming Debt Crisis – Don’t Be The Turkey

Three extremely important pieces of information released over the last weeks for investors are:

  • The increase in US budged spending and consequently deficits.
  • The ECB’s public stance that they are going to print money, buy assets and do whatever it takes to prevent a recession.
  • The FED is ready to lower rates to keep economic growth stable.

My main concern is that we are in a Thanksgiving turkey situation and have a real turkey problem. What is the turkey problem?

The turkey is born, and fed more and more each day. The turkey thinks everything is perfect, food is coming in larger and larger quantities and there is absolutely no risk. As the days go by, the turkey’s wellbeing constantly increases. You can read more about Black Swans and turkeys in my Nassim Taleb articles.

1 turkey problem

Similarly, governments think they can spend money and not care about deficits. The central bank heads will do whatever it takes to keep things going well by printing more money and we, governments, corporations etc. all feel like turkeys. Think about it, aren’t you feeling good like a well-fed turkey and your wellbeing is constantly increasing?

There is only one minor issue, at some point in time, the butcher feeding the turkey, decides to prepare it for Thanksgiving. Similarly, the money printing game will end, it has happened a thousand times in history and currencies always debase, i.e. lose their value.

2 turkey problem

The key here for investors is not to be the turkey. Let’s start by explaining the economic fundamentals, the financial engineering provided by central banks and then conclude with how to invest so that your portfolio doesn’t end up like a Thanksgiving turkey.

Content:

Economy and monetary policy:

  • US budged deficits
  • Lower interest rates, money printing

How to invest:

  • Be like a government – have debt, but smart, good debt
  • S&P 500 to 5,000 points in 2030 but index fund investors will not be happy
  • Buy value like Buffett did in the last 50 years

US Budged Deficits

For me, one of the most important pieces of information over the last weeks was the ballooning of the US budged deficit.

3 us budged deficit

Source: Bloomberg

If we look at what the Congressional Budget Office has to say, The Budget and Economic Outlook publication shows how the US budged deficit will be larger than $1 trillion per year very soon.

4 budged defitic

Source: CBO

This means that the US total public debt will continue to grow at extremely fast rates.

5 total public debt

Source: FRED

The public debt is now 22 times higher than what it was in 1981. From my point of view, spending more than what you make can only last for a while, but sooner or later the butcher will come. Now, I know interest rates are lower and the debt cost servicing isn’t high, but interest rates can change if central banks lose control and history teaches us; sooner or later, central banks always lose control.

  • Lower rates, monetary easing and stimulus

Given what is going on with governments debt levels, corporate debt levels and even household debt levels, central banks have no other option to keep interest rates low, practically at zero, and promise to print as much money as necessary when necessary.

So, we have the FED saying how it will cut rates to sustain economic growth.

6 fed rate cuts

Source: WSJ

And we have Mario Draghi practically saying how the ECB will do whatever it takes to stimulate the economy.

7 draghi

Source: Bloomberg

My conclusion is that over the longer term, money will be printed and currencies debased or better to say sacrificed. Economies and businesses will be stimulated but sooner or later this too will pass. We have to be very careful, not to be the turkey.

How to invest to not end up like a turkey before Thanksgiving

If everybody has a lot of debt, especially governments, it means all policies will help the majority, i.e. those with debt. So, let’s say you have a 30-year mortgage with a fixed interest rate of 3.5% like I have and let’s say currencies lose 50% of their value over the next decade due to inflation. This would mean that the value of your house would go up 50%, your salary too, while your mortgage payment would remain the same.

8 inflation

You are practically playing the same game as governments.

Secondly, the ECB and the FED say they will buy assets, which means the value of financial assets will continue to go up as it did in the last ten years. I would not be surprised to see the S&P 500 at 5,000 points with index fund investors not happy about it.

If we see inflation, which is very likely to escalate somewhere in the future because it is never linear and the FED and ECB will lose control, especially the ECB that doesn’t have any kind of coherence within. Everybody is happy to get free money from money printing, but when things get ugly, we will see for how long will Europe last.

In 1961 it looked like there will be no inflation to worry about given that inflation was at 1.2%. However, over the following two decades, inflation was often above 5% and peaked at 13.5% in 1980.

9 inflation us

Source: FRED

My point is that by focusing on value investing, like Warren Buffett did over the last 50 years that have had significant inflation, you can do better than what the S&P 500 offers even if it doubles in the next decade.

The S&P 500 did go up 28 times since 1981, but Berkshire did just a bit better.

12 berkshire

The difference comes from the focus on businesses, that have moats, have pricing power and can consequently adapt to inflation. Therefore, when investing, and you have to be invested because currencies will be worthless, focus on buying value, businesses that will do good no matter what. Thus focus on risk and reward, exactly what value investing is.

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How To Invest $1000 – 6 Rules For Investing Your First 1000 Dollars

Before discussing the 7 rules to follow when investing $1000 and an example of where I am investing my $1000s, I first want to ask you a question that is extremely important when it comes to making the first steps in the stock market, a question that many stock market beginners overlook.

Do you just want to make a little money on stocks or do you want to create long lasting wealth, become rich?

Let me explain the difference. Making a little money on stocks means buying Tesla’s stock (TSLA) at $178 and selling it a month later at $215.

1 tesla stock

That would give you $200 on your $1000 investment which is a 20% return. Not bad, but that’s not investing, that’s betting. Many did the same in December of 2018 hoping to make 20% on TSLA.

2 tesla stock price

Their loss, as I am writing this, is 43%. If you want to make money trading stocks, I can’t help you as I don’t have a crystal ball. Trading can make you some money, but it is unlikely it will make you rich in the long term.

If you want to invest your first $1000, in a way to develop an investing mindset that is going to create long lasting wealth for you, then I can help as there are some simple rules to follow.

A great book about how to become wealthy, financially independent, live where you want to live and how you wish to live, is the Millionaire next door. The book describes how the real millionaires are not those with flashy cars, expensive clothes, living in Belair etc. The millionaires are those that save their money, let it work for them over time, invest their time and energy to make what they know, own or manage, more efficient, avoid crazy risks and build their wealth over a lifetime.

3 millionaire next door

Source: Millionaire next door

Similar rules can be applied to investing and I am going to share 7 rules that are going to help you create a long-term, wealth-building investing mindset.

7 Rules To Become A Stock Market Millionaire Starting With $1000

These 7 rules will help you on how to invest your first $1000 to develop a long-term wealth building mindset.

  • Make your $1000 work for you

When investing, the key question to ask is what do I get as a return on my investment? Investing is not about buying a stock that goes up and down in value. Investing is about owning a business that creates some kind of value. Over the last 20 years, investors putting their money into Amazon (AMZN), have in return received the best e-commerce ecosystem in the world. Some other businesses pay large dividends like Coca-Cola (KO) has been doing for Buffett over the past 30 years. His dividend now is above 60% per year on what he invested in 1988.

Focus on what are you getting back on your $1000, it could be dividends, buybacks or it could be some new value that is being created. Then, when you know what is the return, you let it compound.

  • Let it compound

When you find something that creates value, you have to let it compound over time. The key when it comes to investing for the long-term to become rich is compound interest.

4 compound interest

Compound interest is extremely powerful, you just need the patience and right mindset to take advantage of it.

$1,000 invested at 15% per year over 40-years becomes $267,863. That is the power of compounding. Now you are going to say that it is hard to get 15% per year and I agree with you. But you will hopefully invest $1000 many times over in your lifetime and some of those $1000 investments might even hit 20% per year, some will hit 5%, but some will definitely do amazingly. Just 4 investments that compound at 20% per year, something Buffett did over 50 years, thus $4,000, would become $5,879,086 in 40 years. And let’s say you invest $1000 one hundred times in a period, 4 of those 100 investments might give you 20% per year or even more. I invest 1000 per month and I must say how I really enjoy the compounding created over time in the form of business development, higher dividends, reinvested dividends.

This is just to show the power of compounding. And I’ll also tell you the only thing that is certain, if you don’t invest you will surely not take advantage of any kind of compounding. Therefore, invest and let compounding interest do the work for you.

  • Even more important than investing is saving, so add up

5 saving money

Source: AZ Quotes

Charlie Munges is a person that says it clearly. Save, thus spend less than you make, invest it and you have nothing to worry. Invest the money in something offering a return, possibly exponential over the long term and that is it. How to find such investments? This is a bit controversial, but I’ll say go into depth.

  • Go in depth versus width

Most financial advisers and talking heads tell you to diversify. They tell you that so that they can make you listen to that talk show for longer as there is more to talk about. However, too much diversification is actually diworsification.

If you understand the risks of an investment, i.e. what can go wrong where the best thing is to think about worst case scenarios, and understand the rewards you will likely get. The rewards in the form of dividends, growth, reinvested earnings, a business model that will compound over time, then it is better to go in depth rather than width.

The key is to specialize in a few areas, I am currently researching REITs (Real Estate Investment Trusts) and if I find something interesting to follow, I’ll start learning more about the specifics of the business over the next few years. I might invest only once in 10 years in a REIT stock, but I’ll probably know it very well before investing. Knowing something very well allows you to understand the risks and rewards of an investment. This makes it much easier to invest the $1000 you have.

Give yourself time and learn about 5 or 10 things to invest in over the next decade. This is mastering only one thing, sector or investment vehicle per year. I can guarantee that when you become an expert, you will be able to find those 15% investments that others might overlook. This can be in real estate, stocks, commodities, businesses…

Over time I have built my specialism in emerging markets, commodities as from time to time Wall Street doesn’t like commodities nor emerging markets. When Wall Street doesn’t like something, prices are usually cheap. For example, something that is going to be developed over the next 3 years is usually extremely under-priced. Most investors are so focused on stock prices that they omit long-term business developments, something we can take advantage of.

  • Buy businesses, not stocks – a quick example from my portfolio, a stock to buy

The key when it comes to investing is to be a business owner. Let’s say you own a nice hotel in Paris.

6 paris hotel

As an owner, would you constantly watch real estate prices to see whether you made something? Or, as a real owner investors do, you would not have any intention of selling such a property and the only thing you would care about is how to increase prices or occupancy rates and manage costs.

The downside to buying stocks is that there is a price that changes every second. However, what you are buying is a business that develops and grows over time.

Let me give you an example. I am a happy owner of a company called Lundin Mining (TSX: LUN, OTC: LUNMF) because of the following reasons:

  • I am bullish on copper as I see demand for it rising due to all the electrification that awaits us, due to all the Teslas, a growing global population, especially in emerging markets.
  • The company is family owned and the owners are conservative. This means that debt levels are carefully assessed and the goal is to create a vehicle that will grow and increase dividends over time. The current yield is low at 1.78% but a buyback has been announced and they are investing in growth.
  • Large investments in the future is what Wall Street rarely focuses on until those investments start to produce cash. They have invested a lot in 2018 and will invest another $745 million in 2019.

7 2019 investments

Source: Lundin Mining

Plus, they have recently invested another billion into a newly acquired mine.

8 chapada

Source: Lundin Mining

All of the investments will likely significantly increase production over the next few years, increase cash flows and probably lead to higher dividends.

9 production profile

Source: Lundin Mining

Given the 30% expected increase in production over the next few years, I expect a similar increase in the value of the investment, be it through higher dividends or through a higher stock price. Their cash dedicated to investments will significantly decline and therefore there could be much more for dividends or more acquisitions.

I like the management and their style and therefore I am happy holding this for the very long term. My expectations on current prices is for a 12% yearly long-term investing return. I am happy with that and over the past year I have invested $1000 in Lundin twice in my portfolio where I add $1000 on a monthly basis. That is also my plan, I’ll keep buying businesses that I like

  • Invest for the long-term

Lundin Mining, the company discussed above had a market capitalization of $14.5 million in the early 2000s and now has one of $3.7 billion. Both Amazon’s and Apple’s market capitalizations were below $100 billion in 2009 with AMZN’s being below $25 billion.

10 market capitalization

Source: MarketWatch

Their current market capitalizations are around $900 billion and might surpass the trillion for good in the future. This is a perfect example of how Wall Street focuses on what will happen in the next quarter, the longest term analysts might look a few quarters or a year ahead, but few think about how will the business they own look in 10 or more years.

By thinking about how will your investment look like in 10 years, investing becomes easy. You don’t waste time on noise like the current trade war discussions that were about tax breaks a year ago or about going to war with North Korea two years ago. You focus on what is important, the acquisition the management just made, the small but constant increases in dividends, the new facility that is being build etc or you see big structural risks like declining demographics in some countries, piling government debt or trends that take of market share like e-commerce is doing for retail.

By using a long-term common sense perspective, you can eliminate the short term bets from your portfolio and concentrate it on long-term businesses with positive tailwinds. Just think about what will the worlds and the business you own look like in 10 years.

  • Compare the investments you own with the rest of your finances

Do you have credit card debt of 11% or student debt of 8%? Pay that because it is an immediate return of 8% risk free. Investing in stocks, be it just $1000 requires a clean personal balance sheet. By clean personal balance sheet, I mean:

  • You don’t need the money, ever. If you need the money in a few years or something, you might behave irrationally and sell at the wrong moment in time. Unfortunately, most investors sell in fear of seeing their investments decline further. If you know you don’t need the money and you can weather storms, you can let the investments compound over the long term for you.
  • If you have any kind of debt with a high interest rate, pay that first and invest the monthly costs you save in stocks. This gives you an immediate return and gives you also piece of mind.
  • You know your life, income etc. doesn’t depend on your investments. If it does, you are again not able to make rational decisions when investing as there are outside, or better to say personal influences that unable you to buy when others are selling for example.

Summary

If you wish to develop a long-term wealth building investing mindset please subscribe to my channel. In this article I have given you the 7 key mindset tools to use long term and an example of how I do it.

The key is to have a long-term orientation even if investing just $1000 because your long-term financial success depends on the mindset you have. A correct mindset means focusing on investing in various good businesses of which I have given you an example of a business I am invested in and finally, the key is to have your stock market investments detached from your personal finances. Sounds easy when written like this but very few adhere to that. The result of not following such simple rules are terrible investment returns.

The average investor did 1.9% per year over the last 10 years even if all other classes did much better. If you have $1000 to invest, start building a vehicle that will make you rich in the long term by having the correct mindset.

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How To Invest In REITs – Pros, Cons And Simon Property Group Example Analysis

Content:

How To Invest In REITs – Pros, Cons And What Are REITs
Introduction – REITs have been the best investment over the last two decades
What impacts REITs as investments – dividends and capital appreciation
Pros and cons of investing in REITs
The pros of REITs
The cons of investing in REITs
Simon Property Group REIT analysis (NYSE: SPG)
SPG company overview
Densely populated areas and high demand lead to positive lease spreads
Dividend is just 65% of funds from operations but still yielding 5%
Self-funded growth and investments
SPG’s debt
The retail environment in the coming years

This article is about the general pros and cons of investing in REITs and about Simon Property Group (NYSE: SPG), used as an example to show what to look at when investing in REITs.

Introduction – REITs have been the best investment over the last two decades

REITs (Real Estate Investment Trusts) have been the best performing asset class in the last 20 years with an average return of 9.9%. This much better than the 5.6% return of the S&P 500 and even better than gold or oil.

investment returns.PNG

Source: Raymond James

The most important point to note is that despite the S&P 500 returned 5.6% per year, the average investor got a return of 1.9%. This really emphasizes Graham’s statement:

“The investor’s chief problem — and even his worst enemy — is likely to be himself.”

Buffett always suggests to read chapter 1, chapter 8 and chapter 20 of Benjamin Graham’s book The Intelligent Investor (full summaries in the links) to avoid making the mistakes average investors usually make, which is to buy high during exuberant times and sell low in panicky times. I know some that sold in March of 2009 and bought back only in 2015. Nevertheless, this is not a story about investment mindset on which you already have the links to Graham’s book above, this is a report on whether it is smart to invest in REITs now and whether we can expect a similar performance in the next decade or two. In this article we will discuss:

  • Why did REITs do that good
  • What impacts REITs as investments – dividends and capital appreciation
  • Pros and cons of investing in REITs
  • Put all into perspective by analysing Simon Property Group (NYSE: SPG)

The goal of this article is to check whether it is smart to invest in REITs now, compare the possible rewards to the risks and avoid being the average investor, as average investors will again underperform almost anything else over the long term.

Why did REITs do that good over the past 20 years?

The main reason REITs did good are interest rates. In 1999, from when the previous chart measured performance, interest rates have gone mostly down.

interest rates REIT.PNG

Source: Raymond James

In 1999, you would get $6,000 on $100,000 in a normal savings account while during the last years, you would get less than $1,000.

However now, some cash investments accounts do generate around 2% as interest rates increased. Consequently, REITs did extremely well up to 2016, then as interest rates started going up, then there was a bit of a pause due to the FED making a few hikes, but since Powel capitulated on higher interest rates, REITs resumed their growth.

reit investment returns

Source: iShares Core U.S. REIT ETF

The above clearly indicates that REITs are interest rate plays. If you can get a 6% return on government guaranteed savings, you are going to expect a much higher yield from various real estate investments that are always risky.

However, real estate investments, unlike bonds, offer inflation protection as the value of the properties might go up in the future and you can increase rents, thus some REITs should even deserve a premium. Additionally, REITs usually borrow money to acquire real estate or mortgage backed securities and thus interest rates play two roles. One comparative for investors that we just explained and the second for their margins as the higher the interest rate spread, the higher the profits of the REIT. The interest rate spread is the difference between the interest the REIT is paying on the loan and the yield on the mortgage backed security it bought, for example.

The iShares Core U.S. REIT ETF has a yield of 3.5%. If investors would suddenly expect a yield of 7% because of a higher interest rates environment, the value of REITs would probably half.

4 reit yield.PNG

Source: iShares Core U.S. REIT ETF

One might look at the above 3.5% yield and say no way because it is too low, but we don’t invest in markets or indexes, we invest in individual businesses and therefore we must look at individual opportunities. Plus, REITs are not only about dividends.

What impacts REITs as investments – dividends and capital appreciation

Many focus on dividends as the only return metric for REITs. However, investors can expect returns in the form of capital appreciation too. If you can increase rents, the value of the underlying real estate will probably go up in the future. Plus, as the targeted inflation rate is above 2%, we can add a minimal 2% yearly dividend return that we can expect from capital appreciation.

This is also what I am going to focus on while researching REITs:

  • First, we have the dividend that is paid out of the REIT’s funds from operations (FFO).
  • Second, if the dividend is smaller than the FFO, it means that the REIT has space to self-fund its growth, that should add too to the investment picture.
  • Third, given the huge money printing over the past decade and likely increase in the future, I think there is a high chance of high single digit inflation where owning good real estate comes in handy.

Let’s summarize the pros and cons of investing in REITs and start this REIT overview by looking at the largest position of the USRT REIT, Simon Property Group (NYSE: SPG). The stock is close to its 52-week lows, offers a 5% yield, so it looks like a good start to understand the sector better.

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Pros and cons of investing in REITs

The pros of REITs:

  • You can own real estate without the hustle of repairing toilets

Real estate investment trusts are internally self-managed or externally managed vehicles that take care of real estate for you; collect rent from tenants, pay expenses and give you what is left in the form of dividends. There two main types of REITs; equity and mortgage REITs. Mortgage REITs invest in mortgage backed securities while equity REITs invest directly in real estate.

Further, you have many various specialized REIT like land REITs, apartment, senior housing, single family, hotels, retail, commercial, offices, healthcare, storage, data centres, industrial, timberland and many other specializations. There is a REIT for practically anything related to real estate and those that do more are called diversified REITs.

  • REITs have to pay out at least 90% of income through dividends and pay no income tax

REITs are especially attractive to income seeking investors as more than 90% of income has to be paid out in the form of dividends. If not, a REIT might lose its REIT status which also brings the benefit of no corporate income taxes. Therefore, payments to shareholders can be substantial, especially over time.

Finding the REIT that manages to grow, have a higher yield from the invested properties than the cost of capital and thus the capacity to increase dividends, is the holy grail of investing in REITs. We are going to do out best to find REITs that have the potential.

  • Real estate usually appreciates in value and offers inflation protection

Apart from the above-mentioned dividend and income, REITs can offer huge returns from capital appreciation. If there is inflation and you own real estate while you have long term debt with fixed interest rates, you would be in REIT heaven. (we already used the holy grail anecdote so heaven is better here). REITs can simply increase rents or hotel room prices if there is inflation. Of course, if the property offers quality.

The key is to hold those REITs that will continue to see the value of their real estate appreciate. Empty malls, ghost cities or abandoned factories are definitely not a good sign for capital appreciation.

  • Liquidity

Even if liquidity should not be a concern for long term investors, you can sell your REIT by on click on your mouse. Something you can’t do when you own real estate.

The cons of investing in REITs:

  • Interest rate risk

We already mentioned how REITs depend on interest rates as lower interest rates have been a key factor in their boom. However, if a REIT is a great business, has great properties and a good business model, you shouldn’t worry much about interest rates as lower REIT stock prices would allow you to increase your yield on the reinvested dividends and consequently your long-term returns.

  • REITs use a lot of leverage

As REITs have to pay out more than 90% on their income there isn’t much left for growth. As ‘no growth’ is practically the most hated situation on Wall Street, managements tend to do whatever it takes to keep growing which includes risky acquisitions or mergers, overinvesting in new properties even if the market is saturated and not having a margin of safety within the interest rate spread.

  • There is high competition

Investing in real estate is like investing in stocks. As would Peter Lynch say, the more stones (stocks) you turn, the number of great investments you find will be larger. You can check my video on How to invest in real estate here if you wish to hear my views on what makes the difference when it comes to investing in real estate.

However, REITs usually invest in large properties, there are usually many bidders for such projects and, especially if the property is of high quality, initial investment prices can be sky high. Therefore, by investing in REITs you miss on the opportunity to really find the best bargain in the neighbourhood or a fix-up that doesn’t really need that much work but others don’t see it. Such laser focused real estate investing allows you to make money immediately when you buy as you pay less than what the property is actually worth.

Some REITs trade below net asset value but there is usually a reason for that, it can be the management, trends, new competition etc.

  • Most people already own a home

By owning your home, you are already exposed to many of the real estate benefits mentioned, especially if you have a low interest rate 30-year fixed mortgage. Therefore, having a heavily weighted REIT portfolio alongside owning a home and maybe a rental unit, might make you too exposed to the real estate market that, as we have seen from 2009 to 2013, doesn’t always go up.

  • The dividends are taxed as income

Taxes are always personal but you have to check how will the dividends you receive from REITs be taxed or you might want to hold REITs in non-taxable accounts. This is an even bigger mess for non-U.S. investors.

  • Some real estate sectors are being hit hard, think of retail

Given the boom in e-commerce, retail is hit hard and consequently REITs owning retail stores suffer. On the other hand, REITs owning distribution centres do well, so be careful when buying REITs and either buy absolute bargains or REITs that have strong sector tailwinds.

  • REITs were created in the 1960s and boomed only in the last 30 years

The first REITs were created in the 1960 while REIT investing became really popular only in the last few decades. Therefore, you might be buying in exuberance as average investors usually flock into buying exuberantly priced assets after the low risk/high return gains have already been made.

  • The risk of a recession

When discussing almost any business, you will hear how it would be impacted by a recession. REITs would be no exception but perhaps investors still have a bit too much of 2009 in their memories. Further, as we can’t anticipate a recession, perhaps it is best to simply know your portfolio will suffer, at least temporarily, reinvest the dividends and enjoy the ride up when the recession is over. Therefore, yes, earnings might fall and dividends might get cut, but that is with every business and many didn’t invest in 2010 fearing a recession. No need to mention how they feel now.

Let’s now put all the above into perspective by analysing a very large REIT, Simon Property Group.

Simon Property Group REIT analysis (NYSE: SPG)

I want to start this REIT analysis series by analysing one of the best REITs out there, Simon Property Group (NYSE: SPG). I’ll also use it to explain what you need to know when investing in REITs:

  • The dividend yield, buyback, growth and capital appreciation return
  • The interest/lease spread
  • Funds from operations (FFO or AFFO – adjusted)
  • Focus on debt
  • Sector trends

SPG company overview

SPG owns malls and outlets in the US, Europe and Asia.

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Source: SPG – The Shops at Crystals, Las Vegas NV

I am going to focus on the key aspects of investing in SPG and avoid a purely descriptive chapter as you can learn much more about the business from their Investor Presentation. Just shortly, 79.5% of net operating income comes from U.S. malls and outlets, 11.7% from the Mills, a REIT they acquired in 2007, and 8.7% is international.

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Source: SPG

The key factors for SPG are the following:

Densely populated areas and high demand lead to positive lease spreads

Despite the turmoil in the retail sector, SPG keeps increasing rents and keeps occupancy at high levels. Average leases per square foot increased from $51.59 in 2016 to $54.18 in 2018. If a company can increase rents and keep a high occupancy rate, it means their customers aren’t really in that much trouble.

The lease spread is the difference between the new lease in comparison to the lease of the previous tenant.

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Source: 2018 Annual Report

SPG is considered a high-quality REIT, with great assets and therefore it can increase leases.

Dividend is just 65% of funds from operations but still yielding 5%

Funds for operations (FFO) is a crucial metric when it comes to analysing REITs. FFO describe what is left after all the expenses are paid. The management has to distribute more than 90% of net income as dividends but don’t forget that a non-cash expense when owning real-estate is depreciation. Thus, the cash flows are usually higher than net income. Therefore, SPG can self-finance its growth as it is practically distributing only 65% of what it could distribute. This leaves room for buybacks and investments on top of the 5% dividend yield.

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Source: 2018 Annual Report

In February 2019 SPG announced a new $2 billion dollar buyback program for 2019 and 2020. If they spend all the available $2 billion on buybacks, that would add a 1.7% yearly buyback return to the dividend as the market cap is currently $57 billion. This would put the expected investment return to 6.7% already. But that is not all, there is still room for growth.

Self-funded growth and investments

The company is building new developments and refurbishing existing malls.

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Net operating income growth was 3.2% in 2018 and 4.2% on average over the last 4 years (this includes inflation). Even if we put a conservative 3% growth rate on net operating income, the growth should increase income by 80% over the next 20 years that should consequently add another 3% to the return from SPG.

Summing up the 5% dividend, 1.7% buybacks and 3% growth, the expected yearly return from SPG could be 9.7% over the next decade or two.

SPG’s debt

When it comes to debt, SPG is as good as it gets with A credit ratings. This means that whatever hits the economy, SPG should not have trouble to service its debt payments.

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Source: Investor Presentation Q1 2019

The only thing that is concerning a bit but it might also be a management decision, is the shorter debt maturity. This is necessary to keep the same interest rates as the cost of debt went up over the past years, but longer fixed interest rates are always nicer.

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Source: Investor Presentation Q1 2019

Logically, SPG has most of its debt on fixed interest rates.

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Source: Investor Presentation Q1 2019

What is really interesting are the interest rates in Europe. The Noventa di Piave designer outlet close to Venice, where I have been once when returning from a visit to Venice and Padova, has a fixed interest rate of 1.95% maturing only in 2025. This implies SPG might easily grow in Europe as interest rates are ridiculously low.

11 europe.PNG

Perhaps there will be other acquisitions. As long as the net operating income is higher than the cost of capital needed to service the acquisition debt, it pays to growth via acquisitions. This might add another percentage point to the returns over the long term.

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However, there is always a catch.

The retail environment in the coming years

This is the main question to answer when it comes to retail REITs, are these outlet centres going to still be interesting to consumers in 5 to 10 years? Or, will we be so entangled into virtual reality that a visit to an outlet or mall will be considered a waste of time?

The answer to the above questions is unknown, some may be more or less convinced but the reality is nobody knows what the future brings. As investors we have to think about what can happen and then put it into an investing perspective.

Things could continue as those are now, thus SPG should continue to pay a 5% yield that should probably grow between 3% and 5% per year, the company should continue to do buybacks and the expected return should be close to 10% per year.

E-commerce might even boost SPG’s growth as omnichannel might lead online sellers to open stocks in high-end locations.

However, if there is less interest for malls and outlets, revenues might stagnate and consequently eliminate the additional 3% yearly return coming from growth. SPG owns class A malls and outlets while market specialists predict closures for class C and D malls. Mall bankruptcies might even increase the number of visitors for SPG.

Another risk is always interest rates, if interest rates go up, SPG’s spreads might decline.

I think the above described uncertainty is what the market is pricing in because if not, you wouldn’t find a high-quality REIT like SPG offering a 10% total yearly long-term return.

I am going to continue to look at REITs and at the end of the sector analysis we are going to compare what is out there and perhaps find something to watch or even invest in. The fact that one of the largest REITs in the U.S. possibly offers 10% is encouraging for further REIT research.

reit comparison dividend.PNG

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Tesla Stock Crash – My Message To Tesla Investors 

I’ve been a Tesla stock bear over the last years and I would always receive a lot of hate when I would do a video on Tesla and also lose hundreds of subscribers. However, now that the risks are materializing and the stock is down, I think I can actually add value to Tesla investors because I know a thing or two about buying or holding a stock that is crashing.

I want to discuss 3 things that should help:

  • Forget about market noise
  • Growth stocks strategy
  • Buy or sell solution

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Source: CNN Money

The reason for the above decline is simply psychological, I don’t think the risk reward ratio when it comes to Tesla has changed much over the last 5 months. Tesla has always been a risky play but now the sentiment has turned negative and it is all doom and gloom.

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So, in just 5 months, the stock went from being a market darling with $3,000 price targets to being the most hated with $10 price targets.

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In such a crazy environment you have to focus on 3 things:

  1. The reason you bought the stock in the first place – forget about the noise

If you know why you bought in the first place and nothing spectacular has happened with the business, short term stock market fluctuations don’t matter at all. The key is that you understand the risk and rewards well, the likelihood of the positive and negative scenarios unravelling. Focus on that and forget about the news and the market’s noise.

If we take a look at what institutional investors think, we see that such jumps in yields are normal and related to the market’s sentiment.

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Source: Borse Berlin

  1. Tesla is a risky growth stock – have a strategy

I assume many of the Tesla investors have always had a strategy and I hope it was always part of a plan. Tesla is a growth stock, which means there will always be fluctuations in the stock price.

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Such fluctuations have to be accepted as given. The key is what are you going to do about them. Having a set portfolio allocation helps, having a set portfolio allocation to growth stocks helps even more.

Portfolio – 100%

Value Investing – 40% (5 stocks)

Growth/Tech Investing – 40% (10 stocks)

Cash balance – 20%

The above is just an indication and is something I wish every investor should have in relation to one’s preferences. The key message is that growth investing should be part of a strategy, a long term strategy where I would go to Peter Lynch as the best guide.

Lynch’s strategy was to hold many growth stocks for a very long time, this would allow him to find the 10 baggers. If you own 10 such stocks and only 2 don’t go bust and actually become 10 baggers, you will double your money.

Plus, you might buy such stocks when those are cheap, because it is part of your strategy. Interesting enough, Tesla is still a 10 bagger for the early growth investors. 

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If growth is part of your strategy, the likelihood of finding growth stocks early increases significantly. Don’t chase market darlings.

  1. Buy more or sell

This is the hardest question to answer but if you can leave emotions aside, it is possible to answer it. If you are looking at your Tesla stock and you feel bad, it means that you are under the influence of emotions. Being under the influence of emotions is not good when investing in stocks. 

Try to rationally estimate what can happen. You probably know more about Tesla than I do, therefore also understand the value of it better. So, try to create scenarios, from the worst case one, to the best case one, attach probabilities to those and see how would such scenarios affect your portfolio, personal finances etc. Understanding the risk and reward in relation to your personal situation and portfolio will give you the answer to whether buy more, hold or sell.

If you need help with a worst case scenario for Tesla, you can always watch one of my old videos.

So, to conclude, I am not happy to see what is going on with Tesla because it is people’s hard earned money there and it is never nice, plus it can be painful. I keep having the picture of my former students that have been playing with Tesla’s stock. My message is pretty simple: Have a strategy so that whatever happens you are ok. Be objective in assessing the situation. Try to really see how this fits your portfolio and forget about the noise.

Further, if this doesn’t work well, don’t be pushed away from investing, just keep in mind the risk and reward next time and allocate your money adequately.

Tomorrow I’ll discuss my general stock market crash strategy so you might want to consider subscribing as I think it will be very valuable. 

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Turquoise Hill (TRQ) stock analysis – copper and gold stock

Contents

  • TRQ stock down 70% – a bargain?
  • TRQ company overview
  • The current issues – 4 big unknowns
  • Financial situation
  • Valuation
  • Copper conclusion – Many copper miners are in the same situation
  • TRQ stock down 70% – a bargain?

TRQ Stock and huge 100 year asset down 70%

Turquoise Hill owns an amazing asset, the Oyu Tolgoi mine in Mongolia that is expected to produce copper, gold and silver for the next 100 years. Thus, we have a very important metal for the future, copper, a hedge for inflation, gold and low-cost production. But the stock price is down 70%, so let’s see what is going on and whether this is an investment, speculation and what are the risks and rewards.

The last time I made a proper analysis of Turquoise hill was in 2016 and my conclusion wasn’t positive.

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Source: Seeking Alpha

At 2016 copper prices there was too much uncertainty which made the whole project extremely risky as the investment wasn’t justified by the future expected cash flows. Since then the stock did well for a while as copper prices rebounded, but now it is more than 50% below the 2016 price and more than 70% below the 5-year high of $4.4. Plus, copper prices are 30% higher that should have been a huge positive.

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However, when you have an asset like TRQ has, namely the Oyu Tolgoi mine in Mongolia, expected to produce copper and gold for the next century and to be one of the top 3 copper mines in the world, it is always good to check whether temporary issues have made the stock a bargain. Let’s first describe TRQ to show what it is and then compare the estimated value of the assets to the current market capitalization.

TRQ company overview

By 2025 Oyu Tolgoi should be the 3rd largest copper mine in the world with extremely low cash costs of around $0.5 per pound. If in 2025 copper prices end up above $3, the yearly production of 1.3 billion equivalent pounds of copper should result in EBTIDA of $3 billion. Not bad when compared to the current market cap of $2.5 billion. Even if we take only 66% of the EBITDA, it is still a great number as Oyu Tolgoi is jointly owned by the Government of Mongolia (34 per cent) and Turquoise Hill Resources (66 per cent, of which Rio Tinto owns 51 per cent). Since 2010, Rio Tinto has also been the manager of the Oyu Tolgoi project.

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Source: Turquoise Hill Investor Relations

For those that don’t know, Oyu Tolgoi is a mine with a huge expansion plan in Mongolia.