May 18, 2020 - 4:27pm EST by
2020 2021
Price: 13.86 EPS 0 0
Shares Out. (in M): 26 P/E 0 0
Market Cap (in $M): 363 P/FCF 0 0
Net Debt (in $M): -3 EBIT 0 0
TEV ($): 360 TEV/EBIT 0 0

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  • perpetual value trap


Tejon Ranch is the largest independent land holder in California, owning 270,000 acres of land that begins 60 miles north of Los Angeles and ends 15 miles east of Bakersfield. For a long term holder, there is significant potential upside here, given the company’s enormous and potentially valuable land holdings, its existing commercial property income, and the fact that there are no more legal obstacles to its first major residential project on its owned land. Real estate names are broadly weak in the current market, and there are a wide range of possibilities such as HHC and various REITs. The advantage of TRC is that the company has no net debt, a massive and strategically located land holding, and its existing commercial real estate and farming is sufficient to fund its current operations. In addition, for decades the company has been tied up in litigation to develop its land, but the coast is now largely clear for its first major residential project.

As regards Tejon’s existing commercial activities, the company currently leases a portion of its land to the Pastoria power plant, which generates roughly $4 million in annual income. In addition, Tejon leases warehouses and an outlet center along the I-5 which generate roughly $4 million in operating income. The company continues to invest on growing its industrial warehouse square footage, planning to ultimately increase its commercial square footage from 5.3 mil square feet today to 14 million at completion.

The company also has a 50% stake in a Petro travel plaza which manages a highway rest stop and generates annual income of roughly $4 million. In addition, the company has oil and mineral leases, as well as farming operations. Those businesses are commodity price driven, but on average generate roughly $8 million in operating income on a combined basis.

Putting it together, and excluding development expenses, I estimate the company currently generates annual operating income of $20 million, before corporate expenses of $9 million, or roughly $11 million of pretax income, and roughly $8 million of after tax income, representing $100 million of value at an 8% cap rate. The value would be higher if you don't net out corporate costs, but given this is not likely to be sold I think it's reasonable to include those.

In addition, for the first time in decades, the company is in a position to build their first residential project on their owned land, Mountain Village. There have been many false starts on this front, as the company approached entitlements only to face new environmental and other legal challenges which took years to litigate. The Mountain View project is now fully entitled for 3,450 homes, 750 hotel rooms, and 160,000 square feet of commercial space. The company is seeking a JV partner to construct the property, and is targeting higher end vacation homes. Assuming the homes cost $600,000 and net gross profit of roughly $150,000 or $75,000 to each JV partner, implies a future value of roughly $300 million. I’d expect that to be realized over ten to fifteen years, and would expect the sales prices to gradually increase over time.

The company has two other large residential projects the late stages of litigation, Centennial and Grapevine. Centennial was granted final entitlement approval in 2019, after which an environment lawsuit was filed questioning aspects of the approval – “The Climate Resolve Action and CBD/CNPS Action seek to invalidate the Centennial Approvals and require LA County to revise the environmental documentation related to the Centennial project”. This is largely business as usual in the long process of approving development land near Los Angeles. I think there is a high probability TRC will prevail in the litigation, but it will likely delay planning. Centennial  targets 12,800 homes, 6,200 condos, and 8 million square feet of commercial space. These are meant to be more affordable primary homes. Based on an estimate of TRC’s profit share being $50,000 for houses, $30,000 for condos, and $50/square ft for commercial space, I estimate a future value of $500 million.

The other residential project is Grapevine, which would be located adjacent to the company’s operational commercial real estate. That project has also passed final entitlement, but that entitlement has been challenged by Convention on Biological Diversity (CBD), with a hearing scheduled for September 2020. Again, I believe this challenge is largely a delaying tactic. Grapevine as envisioned would include 12,000 residential units and 5 million square feet of commercial development.  Using the same profit assumptions as Centennial I estimate a future value $350 million.

Putting it together, I estimate future sales values of $1.15 billion. Assuming a 20 years sales cycle with annual price increases of 2%, and discounted back to today at 14%, I estimate a present value of $470 million. That combined with $100 million for the existing operations suggests total present value of $570 million, or $21 per share. That implies 50% upside from the current price, after discounting future profits at 14%.  

There is a lot of estimation here, and small changes in assumptions will have a big impact on the ultimate value realization. There is also the possibility one of the legal challenges is successful and the company has to rethink its development projects. The bigger picture bet is that this is a vast landholding which is in the early stages of monetization, in a part of the country where there is limited new construction and achieving zoning approvals is difficult. It’s possible my sales assumptions end up being conservative.

The risks include time and success achieving entitlement on Centennial and Grapevine. However in the event the company does not achieve those entitlements, I believe the stock is roughly fairly valued for the existing commercial footprint and the entitled Mountain View project, so I view longer term downside as limited.

I do think there is a fairly high risk this is just dead money from here until they are closer to completing the Mountain View project. This company has been litigating property entitlement for so long that they have exhausted more than a few investors, and are probably wearing down a few more. In addition, with Mountain View finally ready to begin building, they are now in an environment where real estate development funding may be constrained, and partners may be harder to find (although residential housing may be a bright spot going forward). So this is by no means a trade. That said, I think for a patient investor there is significant longer-term upside here, and fairly limited downside.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.


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