In our most recent Portfolio Review, we explain that certain segments of the financial markets have become increasingly polarized with the large and popular companies trading at expensive valuations and the smaller, lesser-known companies being deeply discounted.
This is particularly true in yield-driven sectors such as REITs, MLPs, Utilities, and Financials where recent disparities in performance have resulted in historically large valuation gaps between small and large companies.
Therefore, we are today buying mainly smaller companies at High Yield Landlord. Despite their higher volatility, we think that they currently offer better risk-to-reward, and are set to outperform as they grow in size and their valuation multiples expand.
Below we highlight two such companies that we bought lately, starting with a foreign asset manager, and finishing with an apartment REIT.
DIC Asset (OTCPK:DDCCF)
Asset managers are in the business of finding and managing investments for you, in exchange for diverse fees that typically include a management fee which is a percentage of total assets under management, as well as an incentive fee that's earned if the performance exceeds a certain threshold.
Naturally, this can be a very lucrative business if you are a good investor and manage large sums of capital. This is especially true for asset managers who specialize in alternative asset classes that aren't in direct competition with low-cost ETFs. They are commonly able to charge higher fees and enjoy a lower turnover in their investor base due to the illiquid nature of their investments.
Real asset-focused asset managers are a good example of that.
Most of them have performed phenomenally well over the recent past as investors poured money into real asset investments in order to diversify in a volatile marketplace, earn income in a yieldless environment, and protect themselves from inflation in a money printing world.
Popular names in this space include Brookfield (BAM), Blackstone (BX), and KKR (KKR). They manage $100s of billions and trade at new all-time highs after rising substantially over the past year.
But at the same time, some smaller and lesser-known asset managers have missed out on the recent surge. DIC Asset is a good example of that:
Unlike its peers, DIC Asset has not yet even recovered from the covid crash and still trades at a 10% discount to pre-covid levels.
Based on this large performance disparity, you would assume that something is wrong with DIC's business model, but in reality, its business is growing even faster than its peers. Ignoring its wholly owned assets (colored in green in the below chart), its assets under management have more than quadrupled over the past few years and grew by another 45% in 2020 alone:
That's much faster growth than what its larger peers are experiencing. It results in rapidly growing fee income, which has allowed DIC to nearly double its dividend over the past few years:
Yet, these big achievements have been overshadowed by the company's small size and lack of following.
DIC is an asset manager that specializes in real estate investments in Germany. On one hand, most US-based investors have never heard of it, and on the other hand, a lot of German investors don't feel comfortable investing in stocks due to their volatility.
As a result, DIC is today priced at a 40% discount to NAV and just 12x cash flow. That compares very favorably to its larger international peers. We expect up to 50% upside as DIC continues to grow and eventually earns a higher valuation multiple. While you wait, you earn a rapidly growing 5% dividend yield.
Clipper Realty (CLPR)
The REIT market currently presents similar opportunities. Large REITs have performed very well lately and are now priced at relatively expensive valuations, whereas smaller REITs are still discounted:
Source
This is especially flagrant in the apartment REIT sector.
Over the past three months, most large apartment REITs such as Camden (CPT) and Mid-America (MAA) rose by ~25%, but one outlier called Clipper Realty dropped by 11%.
That's nearly 40% in disparity!
This must be because CLPR is heavily invested in New York City, right?
Wrong.
SL Green (SLG), the biggest NYC-office REIT, rose by 10% over the same time period, and 81% since last November due to positive news affecting the NYC market:
If anything, CLPR should be outperforming SLG in the recovery because apartment communities in Brooklyn are more defensive investments than office buildings in Manhattan.
According to Bloomberg (via Business Insider), more Manhattanites moved to Brooklyn during the pandemic than to Florida. That's where most of CLPR's assets are located, and since their rents are well below market, it offers good margin of safety and growth prospects, despite the current challenges.
CLPR just uploaded a new investor presentation on their website, and the following table is particularly interesting:
It shows that most of their assets have clear upside catalysts to drive rent and value growth over the coming years.
As you may know from our previous articles, we are not particularly bullish on NYC, but these property-specific catalysts should mitigate the damage in the short run, and help sustain and grow value in the long run. Moreover, our macro analyst, CashFlow Capitalist, has recently found good reasons to be optimistic about NYC's eventual recovery and we are currently preparing an article on this topic.
Time to Buy?
We have been looking for more residential exposure and this is our opportunity. When it dropped to $7.25 per share we initiated a position. Today, it has already risen to nearly $8, but it remains a great deal, trading at just of its NAV (consensus estimate of analysts in 2020), and while you wait for the recovery, you earn a near 5% dividend yield.
In comparison, most large apartment REITs are today priced at a premium to NAV and only pay a 2-3% dividend yield.
Bottom Line
There are better and worse times to invest in large-caps and likewise for small-caps.
Today, we find a lot better value in smaller and lesser known companies like DIC and CLPR.
They fall out-of-the-radar of most investors and may at times trade at materially lower valuations despite enjoying stronger fundamentals.
The downside is that they are typically more volatile in the short run. But if you are long-term oriented, this higher volatility should be seen as a gift because it allows you to build positions at lower prices, while you wait for stronger long-term appreciation.
We currently own DIC and CLPR in our Core Portfolio at High Yield Landlord, along with 22 other similar opportunities.
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