For value investors, it’s a tough market.
With the exception of the energy sector, North American stock markets are in pretty good shape. Stocks are bumping up against all-time highs, and investors are generally pretty bullish. Certain macro issues are making some investors nervous, but the economy in North America looks to be pretty strong.
This kind of market is tough for value investors, who look to buy beaten-up companies. There just isn’t much distress out there. For the least disciplined, it means stretching the definition of a margin of safety, buying stocks that are just a little cheap. For the most disciplined value investors, it means sitting on cash and not doing a whole bunch.
Even in frothy markets, there are still value investing opportunities. Let me tell you a little more about Hudson’s Bay Co (TSX:HBC), which I think is an undervalued gem hiding in plain sight.
The skinny
Hudson’s Bay Company has come a long way since 1680, the year it was granted exclusive access to Canada’s great wilderness. The company essentially invented the current department store format in Canada, building huge locations in cities like Calgary, Vancouver, and Winnipeg. It eventually acquired locations in Ottawa, Toronto, and Montreal, as well as a bunch of real estate it eventually sold off to Target when it expanded into Canada in 2011.
The company has settled into a niche of being a high-end retailer. It acquired Lord and Taylor in 2006, eventually following that up with Saks Inc. in 2013. Between the three brands and its Home Outfitters banner in Canada, the company has 325 stores across North America. Plans are also in place to expand the Saks brand to Canada, where it’s relatively well known by consumers.
Although full results aren’t yet out for 2014, Hudson’s Bay is doing pretty well. The company is expected to do $8 billion in revenue for the full year, with an EBITDA of more than $600 million. That puts the company’s enterprise value to EBITDA ratio at just a little more than 11x, with is reasonable.
If the thesis on Hudson’s Bay just included the operating business, I’d agree it’s pretty weak. But there’s a huge hidden asset on the balance sheet, along with a plan to monetize that asset.
The real estate
Remember all that real estate Hudson’s Bay accumulated throughout the years? It’s likely worth more than the company itself.
To fully understand the real estate, we have to look at the record of Richard Baker, Hudson’s Bay’s ex-CEO (and current chairman). Under his leadership, the company has been quietly accumulating high quality pieces of real estate.
After buying the company for just $1.1 billion, Baker flipped the company’s Zellers locations to Target for $1.8 billion. He then sold the company’s flagship Toronto location for $650 million.
Baker then acquired many pieces of world-class real estate in the Saks acquisition. The Saks Building itself in New York City is worth $4.1 billion, which is $1.2 billion more than what HBC paid for the whole company just a year earlier.
Depending on who you ask, the remaining real estate is worth anywhere from $7 billion to $8 billion, which works out to more than $40 per share. Shares currently trade at $23 each.
The company plans to extract the value from the real estate by forming a REIT, a strategy already successfully implemented by other Canadian retailers. It even went as far as hiring the man responsible for the creation of Empire Company’s REIT to be its new CFO. Baker has repeatedly hinted at the possibility of this during interviews with the financial media.
The main risk of the story is management doing something silly with the cash, since the company is obviously raising capital for something. It took out a $1.25 billion mortgage against the Saks building in New York City, and just announced a private placement of nearly 5 million shares to the Ontario Teacher’s Pension Plan. It could easily raise $2-4 billion from a REIT spinoff. The risk is the company announces a big, debt-laden acquisition with the proceeds.
Still, in a market with few value ideas, Hudson’s Bay offers an interesting opportunity. If you add up the value of the business and the real estate, this stock could easily double once a catalyst appears to unlock value.
