Dear Readers,
We are finally back in business! After a hectic couple of weeks including marrying my beautiful wife and honeymooning in Hawaii, we are finally back in Toronto doing what we like second best (second after spending time with my wife, of course!).
What a roller-coaster ride June has been. We will be providing an update and our thoughts in the next couple of days in a full letter, but let's just say our portfolio took a sizeable hit. We have reviewed our positions and given the theses remain sound, we are not too worried.
The purpose of today's entry is to provide a brief update on one of our favourite investment ideas in the last couple of months - Becker Milk (BEK.B-TSX). If you recall, a couple of months ago, we wrote that Becker Milk was a wonderful little company that has quite a bit of hidden asset value. Well, just this week, the Company announced its 2011 year-end results and it appears the auditors agree with us (although not to the same extent as we had hoped).
The actual quarterly/annual results were ho-hum, as the Company incurred some one-time expenses for the implementation of IFRS accounting standards. However, what really caught our eye was hidden in the IFRS disclosure in the MD&A, the Company reported that the Company's portfolio of real estate is worth $29.8 MM, instead of the $12.5 MM it is held on the balance sheet for. This is interesting for two reasons.
1) As disclosed in the MD&A, when the company starts reporting under IFRS in F2012 (sometime in August for Q1/F12), the investment portfolio will have to be carried at fair value on the balance sheet, meaning book value will jump from $8.80 ($15.9 MM / 1.8 MM shares) to $16.50 due to the $13.9 MM in net unrealized gain on the real estate portfolio. We agree with reader MR that Q1/F12 may prove to be a catalyst for the company as it reports a significantly higher book value.
2) The fair value appears low. Recall in March, we had valued the investment portfolio at $40 to $50 MM by using a cap rate of 8 - 10% on the rental income of ~$ 4 MM / year. What we find interesting is how did the auditors come up with a $29.8 MM fair value? A few paragraphs up in the MD&A, the company said that in May 2010, the real estate portfolio was valued using a 8.25% cap rate. Assuming it's an 9% cap rate in 2011 (unlikely, since real estate values have recovered in 2011 vs. 2010, but let's be conservative), $29.8 MM fair value means the NOI on the investment portfolio was $2.7 MM. But the rent is $4 MM. There's no mortgage. What gives? We suspect it may include some corporate SG&A and management salaries (we would love to hear your ideas?). But if that's the case, it also means a strategic buyer will be willing to pay more than $29.8 MM to acquire this portfolio, since they won't have to incur these expenses (or incur as much expense). Let say a strategic buyer can manage all 69 properties by spending $500 K instead of $1.3 MM. That means they can reasonably pay $3.5 MM / .09 or $38.9 MM or over $20 / share!
Anyway you look at it, BEK.B remains extremely cheap at these levels. On a purely book value basis, it is trading at 70% of intrinsic value with a 5% yield. If you believe in our analysis of a strategic buyer being able to offer more than book value for the portfolio, it is trading at a 50% discount to intrinsic value. Definitely a strong buy in our opinion (Disclosure, we own shares of BEK.B).
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