Care Investment Trust

Care Investment Trust owns senior housing facilities and senior housing-related debt assets. The company operates as a REIT. The company trades (quote) at a 7.8% yield and has significant excess capital.

Originally formed to invest in healthcare-related mortgages issued by CIT Group (before CIT’s 2009 bankruptcy) the company ran into trouble in the turbulent credit markets of 2008. After weighing various alternatives, including liquidation, the company ultimately sold a majority stake to Tiptree Financial Partners. Tiptree is managed by Tricadia Capital, a New York-based hedge fund. Care Investment Trust used the cash proceeds of the transaction to make a tender offer for all shares outstanding,  ultimately resulting in a 92.2% ownership stake for Tiptree. Insiders own 93.2% as of the most recent proxy statement. Because of its extremely low public float, the company was involuntarily relieved of its NYSE listing.

Since its restructuring, Care Investment Trust has undertaken multiple transactions, both purchasing and divesting interests in senior housing properties. As of March 31, 2012, the company’s balance sheet looks like this:

Note: the balance sheet has been adjusted for the Key Bank mortgage note refinancing that occurred on April 24, 2012. Total liabilities and equity are estimates and may differ slightly from actual figures.

A brief consideration of the balance sheet reveals a few notable observations.

1. The company is under-leveraged. Loan-to-Book value on the owned properties is 78.8%, but only 37.7% when the company’s cash is taken into account. Investing this excess cash in additional senior housing assets could substantially increase funds from operations.

2. The company’s debt maturity profile is a concern. The weighted average maturity of the company’s outstanding mortgage debt is just 4.30 years. Extending the average maturity of the company’s mortgage notes by several years would greatly reduce the company’s financing risk.

3. At a recent trading price of around $6.95, the company trades at only 75% of book value, nearly all of which is tangible. Many companies might try to build shareholder value by repurchasing shares below book value, but Care Investment Trust is limited by the fact that so few shares (fewer than 700,000) are held by non-Tiptree investors. Care Investment Trust will have to rely on the whims of the market to realize a higher valuation.

Care Investment Trust resumed quarterly dividend payments after the third quarter of 2011, paying shareholders 13.5 cents per share. The company’s adjusted funds from operation were 7 cents per share last quarter, so current cash flows don’t quite support the dividend. Fortunately, the company’s excess cash creates significant investment opportunities that could increase distributable cash flow greatly.

Care Investment Trust has nearly $50 million in cash on hand against minimal current liabilities, so I think it’s safe to assume the company can devote $40 million or so into new senior housing investments. The company executed its 2008 Bickford purchase and lease at an initial lease yield of 8.21%. The lease is triple-net, meaning the client is solely responsible for expenses like repairs, taxes, utilities and others. Assuming the company can execute similar 8.20% yield leases, the chart below illustrates net cash flow to the company under various leverage and interest rate scenarios.

If the company maintains loan-to-value ratios and mortgage rates similar to its previous transactions, investing $40 million could yield $5.32 million in additional funds from operations.

However, how do we account for depreciation on these owned properties? There is often a wide gulf between the amount of depreciation expense shown on REIT income statements and the actual amount of capital expenditure by the company, year after year. The upshot is that much of the depreciation expense shown on the income statement is accounting depreciation only, not actual economic depreciation representing the deterioration of assets. Long-lived assets such as real estate often maintain significant value long after being depreciated to $0 on corporate balance sheets. Additionally, real estate prices tend to rise in the long run (emphasis on long run) which helps offset real economic depreciation. For the sake of conservatism, I will assume that all the depreciation indicated in Care Investment Trust’s financial statements is a real loss of economic value. In 2011, depreciation on the company’s Bickford assets was 2.90%. I think a conservative and defensible assumption on the long-term appreciation of real estate properties is 2.0% annually. Using a 2.90% depreciation figure and a long-term real estate appreciation figure of 2.00% indicates an annual real depreciation cost of 0.90% of property value. The chart below incorporates this net depreciation to estimate economic cash flow to the company after investing $40 million.

Assuming leverage and financing costs comparable to previous transactions, the company may be capable generating another $3.88 million in economic cash flow per year, or 38 cents per diluted share.

Adding 38 cents per share in yearly adjusted funds from operations to the existing 28 cents per share would yield 66 cents per share, a yield of 9.5% at the current trading price. In order to maintain the present yield of 7.8%, the company’s price would have to appreciate by 22% to $8.46 per share.

Larger health care-focused REITS currently trade at yields of around 5.5%. Care Investment Trust does not deserve to trade at those levels due to its illiquidity and small size, but even trading down to a 6.5% yield after investing $40 million would result in a trading price of $10.15, a gain of 46.4%.

Of course, Care Investment Trust’s management might make a terrible acquisition and waste its firepower. The funding environment might lock up and make new investments all but impossible. Economic uncertainty and budget pressures might make senior housing less tenable for the elderly. Still, Tiptree owns over 90% of the company and will be extremely motivated to grow its value. The company’s significant excess cash provides stability for now, and the ability to make a transformational investment at an opportune time. Until then, investors will be rewarded with an attractive yield on current prices. Care Investment Trust is a conservative real estate investment with significant potential for increased dividends and capital gains.

 

No position.

 

 

 

 

 

Abatix Corp.

Abatix Corp. (ticker: ABIX) manufactures safety, disaster recovery and construction supplies. The company operates branches in the Southeast and West Coast, as well as Texas, but also sells internationally. The company was founded in 1983 and deregistered its stock in 2007.

Abatix’s revenues are strongly tied to natural disasters and other catastrophes. The terrible tragedy and human suffering of these events is not to be diminished or ignored, but somebody still has to provide products to help mitigate damage and rebuild afflicted areas. In 2010, the Japan tsunami and Haiti earthquake combined with other disasters to inflate Abatix’s revenues by more than 40%. Hurricane Katrina affected revenues similarly in 2005. In some ways, Abatix’s business model is the mirror image of that of a property & casualty insurer. Rather than suffering occasional, unpredictable losses due to hurricanes and miscellaneous calamities, Abatix experiences occasional, unpredictable and exceptional profits from the same events.

Abatix has been consistently profitable for the past decade and carries no debt. Still, the company trades at a 20% discount to net current asset value. Here’s a look at historical earnings. The company has not provided cash flow data in recent years.

Abatix is a slow grower, compounding revenues at just 2.2% over the past decade. Earnings growth has been a little better at 3.2%, compounded. Neither of these figures account for exceptional environments like 2010 and 2005. The company’s operating leverage is significant, evidenced by years such as 2010, when a 51.5% increase in revenues propelled operating earnings higher by nearly 1,100%.

Like a lot of small manufacturers I look at, Abatix has used its recent cash flow to pay down debt and accumulate significant excess assets. I don’t know whether it’s simply laziness in capital allocation, or the secure feeling that comes of holding excess cash in an uncertain economy, but the trend is clear.

Abatix has succeeded admirably in putting itself on firm financial footing. Unfortunately, the deleveraging process has also resulted in anemic returns on equity.

DuPont analysis is a useful tool for examining the drivers of return on equity. In its basic form, the DuPont analysis formula incorporates three terms: asset turnover, equity multiplier and profit margin.

Asset turnover is defined as revenues divided by assets. Higher asset turnover means a company is using its assets more efficiently and generating more dollars in revenue for each dollar of company assets.

Equity multiplier is defined as assets divided by equity. A higher equity multiplier indicates higher leverage. Using leverage can improve return on equity greatly, but also puts the firm at a higher risk of bankruptcy.

Profit margin is simply net income divided by revenues and measures a company’s success in managing costs and selling profitably.

The reason for Abatix’s gradually declining returns on equity is clear. The company has failed to grow revenues as fast as it has grown assets, so the asset turnover ratio has declined from 3.59 in 2001 to 2.29 in the twelve trailing months. Over the same period, the company’s continual deleveraging has reduced the equity multiplier from 2.11 to 1.20. Profit margin has held steady.

It seems evident that Abatix’s poor returns on equity are largely responsible for its low market valuation. On the positive side of things, the company has begun to take action to reduce its large cash balance in a shareholder-friendly way. In July 2011, the company announced a $2 million share repurchase plan. Since then, the company has repurchased 7.4% of shares outstanding at prices far below book value. Assuming that shares were purchased around the current price, the company has around $700,000 remaining under the share repurchase authorization.

While shares outstanding have declined moderately, the size of the company’s float has been reduced dramatically. As of May 9, only 240,331 are freely trading, just 14.3% of shares outstanding. These shares have a market value of just $2.8 million, less than the cash on the company’s balance sheet. I have to wonder if the company won’t someday make a tender offer for this small number of shares and be free of the hassle of public ownership entirely.

With a current market cap of $19.5 million and trailing income of $1.66 million, Abatix has an earnings yield of 8.5%. That may not seem outstanding, but keep in mind that disasters will occasionally cause the company’s earnings to rocket. Average annual earnings for the past five years were $2.82 million, a 14.5% yield on current market cap. Abatix Corp. is not the next Facebook, but investors interested in purchasing a steady company at a strong earnings yield and at a discount to net current assets may do well with Abatix.

 

No position.

 

 

 

 

Computer Services, Inc.

This post is a slight departure from my usual habit of profiling a highly-obscure, minutely-sized and modestly-valued company residing on the bulletin board or pink sheets. While there are many such companies to be found, Computer Services, Inc. is not one. In fact, Computer Services is a strongly profitable and rapidly-growing company with one of the highest market capitalizations to be found off the major exchanges.

Computer Services, Inc. (Quote here) provides back office, transaction processing and internet banking software platforms to financial institutions, especially community banks. These software systems are under-appreciated but absolutely essential pieces of modern bank operations. Many banks, community banks in particular, lack the in-house expertise to develop and manage complex software, so outsourcing these functions to Computer Services, Inc. makes perfect sense. Effective and reliable web banking services are a critical part of any bank’s value proposition for clients, a trend which will only strengthen.

Founded in Paducah, Kentucky in 1965, Computer Services has expanded from 45 clients and $1 million in revenue in 1971 to over 5,000 clients and $178 million in revenue in fiscal 2012. As if compounding revenues at an amazing 13.5% for 41 years were not enough, the company has raised dividends for 22 consecutive years.

A large portion of the company’s growth has come from small, focused acquisitions made year after year. These smart acquisitions have helped increase revenues and profits without diluting shareholders; Computer Services, Inc.’s diluted shares outstanding have actually decreased by 11.9% over the last decade.

Here is a look at Computer Services’ historical results:

Perhaps the company’s most impressive data point is its massive improvement in margins over the past decade. Since 2002, the company has steadily improve operating and net margins by 39.2% and 52.1%, respectively. Clearly, the company has found itself enjoying economies of scale and has expanded into lucrative, higher margin lines of business. The company makes significant capital expenditures on software development and hardware to support growth, but total free cash flow has still exceeded total net income over the last decade.

Computer Services maintains a pristine balance sheet with nearly no debt, which assists greatly in providing flexibility for making strategic acquisitions.

While the company has had an outstanding history of growth and profitability, a lot of runway remains for takeoff. Computer Services’ revenue was only 3.1% of what competitor Fidelity Information Services brought in in its most recent four quarters. The technological needs of local banks will only grow more complex with time, and Computer Services, Inc. looks to be there to meet those needs.

With such a track record of growth, high quality earnings and fiscal conservatism, my only wish is that it had all gone unnoticed by investors. Truth is, Computer Services’ results have caught the eye of many and the company’s shares trade at a healthy valuation.

At a trailing P/E ratio of 19.22, Computer Services has a trailing earnings yield of 5.20%. Conservatively estimating future revenues and earnings growth of 5.00% (roughly two-thirds of five-year historical revenue growth of 7.42% annually) gives an estimated annual rate of return to investors of 10.20%. This assumes the company’s valuation remains stable and that management avoids major mis-steps. I require a minimum rate of return of 12% for high quality, stable companies like Computer Services, so I would pass on the stock at the moment.

I will, however, keep the company on my watchlist and wait for an opportunity to buy in at a more attractive valuation. In late 2008, for example, the company traded all the way down to $11 per share, representing a P/E ratio of only 10.2 on TTM earnings known to investors at that point. Investors buying in at that point locked in a 9.80% current earnings yield and got all the growth essentially for free. When the market eventually turned and re-rated Computer Services back to a realistic valuation level, these investors realized a 200% return to date, plus dividends. It could happen again, and I plan to be there if it does.

 

No position, though I may add on a significant decline.