Feature interview

Robert Ruggirello, CFA is the Managing Director of Brave Eagle Wealth Management, a NY-based Registered Investment Advisor. We emailed with Robert about when to adjust FFO/AFFO figures, what factors receive too much investor attention and overcoming behavioral biases.

Seeking Alpha: How do you determine from a qualitative and quantitative standpoint what the market is missing in a stock, as you did this very successfully for Gramercy Property Trust (NYSE:GPT), which was acquired by Blackstone?

Robert Ruggirello, CFA: We start with the basic assumption that the stock is priced right. From a quantitative perspective, we try to extract what’s priced in, i.e., we solve for the expected growth rate given the current market price. Then we can compare our expectations vs. what we think market expectations are and this informs us to potential mispricings. Qualitatively we try to identify the driver of the mispricing. With regard to Gramercy, we estimated a very low growth rate priced in by the market and thought the company would grow at a higher rate.

After a tremendous amount of due diligence, we identified a very high-quality asset portfolio, in a sector with powerful tailwinds, and a strong management team, trading at a discount to NAV with a low implied growth rate. We couldn’t identify any logical reason for the stock to trade at such a discount. The fast pace of acquisitions and dispositions to reposition to an industrial REIT, along with the firm’s JVs, and non-relevant historical financial statements made the analysis complex. We were able to benefit from this complexity.

SA: Are there any industries or companies that stand out as likely targets for consolidation in the REIT space?

RR: I think we could see another acquisition in the Industrial sector. Industrial is in high demand given what appears to be a long-term secular runway of growth for e-commerce. At this point in the cycle, most of the public REITS are focusing on primary markets, recently illustrated by the announced Prologis (NYSE:PLD) acquisition of DCT. In my opinion Terreno (NYSE:TRNO) and Rexford (NYSE:REXR) are the most likely acquisition targets for public or private investors looking to tilt their exposure towards high demand last-mile locations. Both firms have asset portfolios surrounded by strong demographics (see my most recent article on Terreno) in infill locations.

We may also see a mall or shopping center acquisition if an acquirer sees a deep value opportunity. It will be interesting to see if Brookfield’s offer for General Growth Properties (NYSE:GGP) is accepted by shareholders.

SA: Can you walk us through the different ways you value REITs, including the advantages and disadvantages of each approach?

RR: We use cash flow valuation to estimate intrinsic value for any business including REITS. The advantage to cash flow valuation is that any stock is worth the present value of the cash flow to equity owners. The disadvantage is the difficulty in estimating the inputs, we address this by creating a valuation range using scenario analysis.

We also use a net asset value (NAV) analysis that estimates balance sheet items at market value. The advantage of this is that we can estimate the value of real estate using private market comps. The disadvantage is that the cap rate estimates that are required are just a rough estimate.

It is impossible to visit every building and assign an appropriate cap rate to it, even if we could, it would still be an estimate. Further, a cap rate contains discount rate and growth estimates, so in using cap rates, investors are indirectly making the same estimates necessary for a cash flow valuation. We prefer to create a range here as well, using best and worst-case cap rate estimates.

In the case of the Gramercy, the cash flow and NAV valuations were extraordinarily close. This gave us confidence in the valuation.

SA: FFO/AFFO are key metrics for evaluating REITs but you note instances where investors should disregard them – can you explain?

RR: There are several adjustments made to FFO, but by far, the most important is the add-back of depreciation. This is a huge assumption and only works if the properties aren’t depreciating. For example, investors using FFO to measure earnings for mall REITS need to revisit if this is a valid assumption. If malls have been depreciating in value, which the market is implying in stock prices, then investors and analysts have been vastly overstating earnings (FFO).

AFFO is mostly used as a cash flow metric. The problem is that it is not standardized, and company management has discretion to include or exclude certain items. Some companies go further and calculate Cash Available for Distribution or Funds Available for Distribution, CAD and FAD, respectively. If AFFO is cash flow then what is CAD and FAD and why are they necessary? If CAD or FAD is cash flow, then what is AFFO?

Investors using FFO should consider the depreciation assumption. Investors using AFFO should understand what is included and excluded to analyze if it is really free cash flow.

SA: For REITs, what factors do you think receive too much – and too little – attention by investors?

RR: There is far too much focus on yield. Companies declare dividends, but the market assigns the yield. High yields usually result from high risk, low growth, or a combination of the two. We believe a total return approach that is cognizant of yield is a superior approach.

SA: In your article on Tanger Factory Outlet (NYSE:SKT), you noted various behavioral biases – how can investors recognize and correct their own bias and improve investment decisions?

RR: When a stock declines in value, investors often use heuristics like “back up the truck” and “double down.” This is quite dangerous and assumes that the market is always wrong. This could be a demonstration of overconfidence bias. Investors should always revisit their investment thesis to see if it is still valid and consider if they were wrong before investing more capital. This type of non-biased framework is a way for investors to avoid behavioral biases.

We like to have a target allocation on a stock, we buy back to the allocation and trim back to the allocation depending on market movements. Academics theorize that this type of “constant rebalancing approach” may earn a premium for providing liquidity. We also have individual position maximums and sector caps. This helps to remove emotion from portfolio construction.

SA: What’s one of your highest conviction ideas right now?

RR: We recently became interested in American Homes 4 Rent (NYSE:AMH) and published on Seeking Alpha to alert investors to a serious insider buy from Wayne Hughes. After the article was published, Tamara Gustavson, the daughter of Wayne Hughes, made an even bigger purchase, and we made a small purchase a few days later. This insider buying is occurring with the stock trading at about 80% of sell-side analyst consensus NAV.

Based on our estimates, initial research indicates that given the current price, the market only expects cash flow growth between 2.5% and 3.3% using conservative equity discount rates in a range of 7.5%-8.25%, respectively. This appears to us to be a low hurdle rate given the lack of new supply and the high cost of home ownership relative to renting. Since the IPO general and administrative expenses and net property expenses as a percentage of revenue have decreased to levels in-line with multi-family REITS, driving margins higher. The capital structure is appropriate, and the management team has a strong pedigree.

To summarize, you have strong insider ownership with buying at current prices, low short interest of approximately 2.2%, a low implied growth hurdle rate, and margin expansion in a sector with favorable supply and demand dynamics. We plan on writing a Seeking Alpha-dedicated article on AMH.


Thanks to Robert for the interview. If you’d like to check out or follow his work, you can find the profile here.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Check with individual articles or authors mentioned for their positions. Robert Ruggirello, CFA is long TRNO, GGP, AMH.


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Gold Declines as U.S. Dollar Strengthened in May

Gold remained resilient in May, as the U.S. dollar strengthened considerably. The U.S. Dollar Index (DXY)1 gained 2.4% and closed the month at its highs for the year, driven by new fears of an Italian debt default and EU breakup. Populist parties from the left and right are attempting to form a coalition government that would likely drive Italy further into debt and to promote initiatives that would enable Italy to exit the euro. Italian President Sergio Mattarella blocked the coalition, which effectively suspended its plans. We expect to see the coalition make further attempts to gain power, which should keep the markets on edge for the foreseeable future.

As the DXY gained, the gold price fell to its low for the year of $1,282 per ounce on May 21. Gold subsequently advanced into month-end as the Italian situation rose to a boil, ending at $1,298.52 per ounce for a monthly decline of $16.83 (1.3%).

Gold Responds to Systemic Risks, Not Headlines

It seems that every time new, scary headlines emerge, press articles declare that gold no longer serves as a safe haven.2 The Italian political crisis is the latest case in point. The evolving situation in Italy is supportive of gold, as shown by its resilience against a strong move in the U.S. dollar. However, anyone expecting a big move from gold fails to understand the fundamentals of the gold market. Gold responds to genuine global systemic risks. These are risks that can have a negative financial impact on just about everyone personally and/or professionally, i.e., risks that bring excessive inflation or deflation, currency, debt, banking crises, or geopolitical events that impact trade and commerce. Localized risks that are the subject of most headlines do not elicit a strong response from gold.

Stock, bond, and currency markets reacted violently to the Italian news. However, the gold market remained calm, which tells us that, so far, this is not the systemic event that the headlines are implying. The chances of an EU breakup are still very small. The euro has survived Greece and Brexit. Gold price action indicates the EU will survive Italy as well. If the situation reaches global systemic proportions, we are sure there will be a strong response from the gold market. Until then, investors should be wary of the implications of the seemingly endless stream of scary headlines.

Gold can also have a different response locally that many American reporters ignore. In euro terms, gold gained €25.62 (2.4%) in May, making a new yearly high. Italians holding gold have a safe haven hedge.

Like gold, gold stocks saw little net movement in May, as the NYSE Arca Gold Miners Index (GDMNTR)3 advanced 0.2% and the MVIS Global Junior Gold Miners Index (MVGDXJTR)4 gained 0.3%.

Indications of Late-Cycle Economy Remain

Many indicators continue to tell us the economy is very late in the cycle. The current economic expansion is now the second longest on record, surpassed only by the tech boom of the 1990s. Convertible bond issuance by tech companies is on pace to challenge the levels last seen in 2000. The stock market is struggling to return to its highs, even though S&P 500 companies spent $158 billion buying back stock in the first quarter, a record pace according to a report from the S&P Dow Jones Indices. Delinquency rates for subprime auto loans have surpassed the levels of the global financial crisis. Financial regulation has come full cycle, as Congress passed a deregulation bill in May and the Fed advanced a proposal to ease the Volcker rule,5 both aimed at reducing crisis-era regulations. The Fed is tightening, but rates are still far below normal at this stage of the cycle. Accommodative monetary policies continue to promote asset price inflation. In May, the Rockefeller Collection auction surpassed all expectations, raising $832 billion, nearly doubling the previous record for a collection, which was set in 2009.

Economic down-cycles are normally a healthy and somewhat painful way of cleansing the economy of bad debts, dead beat companies, and crooks. The extraordinary risk facing the financial system is that central banks have little to no room to stimulate when the current cycle comes to an end. There is no capacity for fiscal stimulus either and sovereign debt service could become very problematic. Fiscally, the developed world is looking more like Italy all the time.

The $1,365 Question

The second half of 2018 should be very interesting for the gold market. The chart shows the gold price has formed a wedge or pennant pattern that has been in place for several years. The positive aspect of this pattern is the trend of higher lows. Fundamentally, gold has been resilient, gaining strength from escalating geopolitical risks and uncertainties. The negative aspect is the ceiling that has formed around $1,365. There has not been a strong catalyst to take gold to a new higher trend line. Investors have been frustrated by this range bound price action, while speculators have been put off by the decreasing volatility. The apex of the wedge occurs in early 2019; therefore, we believe it is inevitable that gold will begin to establish a new trading pattern by year end. Similar patterns can be seen in the GDM and MVGDXJ indices and the price of silver.

Gold Price Chart, 2013-2018

Source: Bloomberg. Data as of May 31, 2018. Past performance is not indicative of future results.

Without a second half catalyst, gold will probably drift sideways, falling below the lower trend line and further eroding confidence in the metal. However, in the second half of the year, we could see catalysts that may boost gold to a higher range that draws new attention from investors. To start, the geopolitical risks that have been supportive of gold are likely to continue – tensions in the Middle East and North Korea, and uncertainty surrounding Trump administration policies. With the economy firing on all cylinders and lofty commodities prices, an inflation surprise is possible. Mid-term elections in the U.S. may result in destabilizing shifts in power if the Democrats prevail. Leadership changes in Italy are set to bring added risks to European banks, sovereigns, and the euro. Last but not least, signs that the post-crisis expansion is nearing its end may emerge.

Gold tested the low end of its trading range in May. As gold has shown price weakness ahead of Fed rate increases, we expect gold to continue to drift around the bottom of the range until the expected rate increase on June 12. Futures positioning and flows into gold bullion exchange traded products suggest gold is poised for another post-Fed meeting rally. If gold retests $1,365 in the second half, will it again act as a ceiling or become a new floor? We wish we could know the answer to such questions.

Important Disclosure

*Please note that the information herein represents the opinion of the portfolio manager and these opinions may change at any time and from time to time. Not intended to be a forecast of future events, a guarantee of future results or investment advice. Historical performance is not indicative of future results; current data may differ from data quoted. Current market conditions may not continue. Non-VanEck proprietary information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of VanEck. © 2018.

1 U.S. Dollar Index (DXY) indicates the general international value of the U.S. dollar. The DXY does this by averaging the exchange rates between the U.S. dollar and six major world currencies: Euro, Japanese yen, Pound sterling, Canadian dollar, Swedish kroner, and Swiss franc.

2 Safe haven is an investment that is expected to retain its value or even increase its value in times of market turbulence.

3 NYSE Arca Gold Miners Index (GDMNTR) is a modified market capitalization-weighted index comprised of publicly traded companies involved primarily in the mining for gold.

4 MVIS® Global Junior Gold Miners Index (MVGDXJTR) is a rules-based, modified market capitalization-weighted, float-adjusted index comprised of a global universe of publicly traded small- and medium-capitalization companies that generate at least 50% of their revenues from gold and/or silver mining, hold real property that has the potential to produce at least 50% of the company’s revenue from gold or silver mining when developed, or primarily invest in gold or silver.

5 The Volcker Rule refers to a part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, originally proposed by American economist and former United States Federal Reserve Chairman Paul Volcker to restrict United States banks from making certain kinds of speculative investments that do not benefit their customers.

Nothing in this content should be considered a solicitation to buy or an offer to sell shares of any investment in any jurisdiction where the offer or solicitation would be unlawful under the securities laws of such jurisdiction, nor is it intended as investment, tax, financial, or legal advice. Investors should seek such professional advice for their particular situation and jurisdiction.

Any indices listed are unmanaged indices and include the reinvestment of all dividends, but do not reflect the payment of transaction costs, advisory fees or expenses that are associated with an investment in the Fund. Certain indices may take into account withholding taxes. An index’s performance is not illustrative of the Fund’s performance. Indices are not securities in which investments can be made.

About VanEck International Investors Gold Fund (MUTF:INIVX): You can lose money by investing in the Fund. Any investment in the Fund should be part of an overall investment program, not a complete program. The Fund is subject to the risks associated with concentrating its assets in the gold industry, which can be significantly affected by international economic, monetary and political developments. The Fund’s overall portfolio may decline in value due to developments specific to the gold industry. The Fund’s investments in foreign securities involve risks related to adverse political and economic developments unique to a country or a region, currency fluctuations or controls, and the possibility of arbitrary action by foreign governments, or political, economic or social instability. The Fund is subject to risks associated with investments in Canadian issuers, commodities and commodity-linked derivatives, commodities and commodity-linked derivatives tax, gold-mining industry, derivatives, emerging market securities, foreign currency transactions, foreign securities, other investment companies, management, market, non-diversification, operational, regulatory, small- and medium-capitalization companies and subsidiary risks.

Diversification does not assure a profit or protect against loss.

Please call 800.826.2333 or visit vaneck.com for performance information current to the most recent month end and for a free prospectus and summary prospectus. An investor should consider the Fund’s investment objective, risks, charges and expenses carefully before investing. The prospectus and summary prospectus contain this as well as other information. Please read them carefully before investing.


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