Best stock investments – Friday File part one — Real Money Portfolio updates

Best stock investments

Today I’ve got a couple notes to share with you — this first one is an update on several holdings in my portfolio, and after the market close this evening I’ll be sending you a more in-depth look at the gold-related positions in my portfolio, along with a new stock I’ve added to the portfolio in that sector.

So… what’s up with the positions in my Real Money Portfolio since I last wrote to you? I’ve got one sale to note this week, two partial profit-taking transactions, and a couple updates on stocks of interest.

First, the sell — this week I sold all my shares of Physicians Realty Trust (DOC), a medical office building REIT that I’ve held for almost two years with a total gain of 48%. This is a “growth REIT” and I bought it as such as it was building up its portfolio pretty aggressively, and they’ve done that, but I don’t see much indication of their ability to become a real dividend growth REIT… this is what I noted a month ago:

“Physicians Realty (DOC) also released earnings this week, that’s a growth REIT which is trying to build up its portfolio. As I mentioned back in January, I think we’re going to have to see FFO grow fast enough to generate the possibility of dividend growth to see the shares trade meaningfully above $20 for very long, and the lack of dividend growth also means they’ll probably be more sensitive to interest rate sentiment changes. They’re still growing the portfolio, but they’re not really growing revenue or funds from operations very quickly — they do have high quality assets, but those assets are also already leased up pretty tightly (occupancy is around 97%), so there’s not a huge inflection point where one would expect their revenue to really increase aside from the purchases of new properties they’re making (which will most likely require roughly 50/50 equity/debt financing, on average). I’ve been letting this one sit for a couple years because they’re building a good portfolio of medical office buildings, which should be valuable and relatively safe from regulatory risk (though if doctors lose money, of course, they have trouble paying rent), but I’m not interested in adding to this one right now given their lack of real dividend coverage (they can just barely cover the 22.5 cent dividend with their 24 cents of FFO, though it’s good that the dividend is now covered — it was not for the first couple years). I don’t see a lot of per-share growth potential this year, so I’ll not add at these prices near $20 and I’ve considered shaving some profit off of this position. No changes to the position yet, but I’m more likely to sell DOC than to buy more right now.”

As I’ve followed this one for the past month I’ve seen nothing to change that general sentiment, and the stock has gone up by about 5%, so this is, I think, an opportune time to sell. I don’t think there’s a crisis on the doorstep, but I think the likelihood is that the 4% dividend will represent the total return from this stock over the next year or two, given that I see relatively low odds of them doing any meaningful dividend increases in the near future, so I’d like to have this cash at hand to see if I can pick up shares of something more prospective the next time the market softens a bit.

I did add slightly to my holdings in another healthcare REIT, the very reliable dividend grower Ventas (VTR), with some of this cash from my DOC sale, though the change was pretty limited (I boosted that Ventas position by about 10%).

And I had two partial sales in the portfolio this week…

I sold about 20% of my position in NI Holdings (NODK).

NI Holdings owns a group of insurance companies in the upper midwest, and it was a mutual insurance company that converted to stock ownership (with continuing mutual control) over the Winter and then went public with those shares in March. As with the other mutual conversion in my portfolio, PCSB Financial (PCSB), NODK has shown insider buying post-conversion. That’s a pretty compelling signal for me with both of these holdings, because a couple insiders maxed out in the shares they could buy at the conversion and then bought more, at much higher market prices, once the stock was trading publicly.

So although the pricing for NODK is looking less compelling now at near $19 than it did at $14.50, I’m holding on to the majority of my position — though I am taking profits on about a fifth of this position because of the rapid run-up and the arguably rich valuation (more on that in a moment). This is not a company I feel committed to holding for a long time, I don’t think it’s uniquely fantastic, I just thought it was cheap when it when it went public back in March because of the special situation (the rare mutual conversion in the insurance space)… so I would consider selling the whole position if I have opportunities to invest with more conviction elsewhere or feel compelled to raise my cash levels, but for now I’m taking a small measure of profit. How’s that for wishy-washy?

The real determining factor for NI Holdings is whether they are analyzed based on their publicly traded shares, or on the full share count that includes the controlling stake owned by the mutual insurance company. They have so far not indicated that they plan to go to a full conversion, selling that remaining stake to the public markets, and the stake the mutual company holds is officially “non-economic” — so the shares held by the mutual company won’t receive dividends, for example, if a dividend is initiated (as is planned, though not promised).

Why is that important? Because only 45% of the shares are publicly traded, and if you value the company based on that 45% portion, it’s cheap… but if you value it based on the total ownership, including the 55% still controlled by the mutual company, it’s not so cheap. And though many people have strong convictions on this mater, there’s no rule for how you have to think about the company — on one hand, if they convert the rest of the ownership that will bring in a massive slug of cash; but on the other hand, if the offering is made at a valuation below book value, as the initial conversion was, it might also dilute the equity if you had been thinking about ownership as being totally in the hands of the 45% owners. And it may be that the mutual company is unwilling to give up control — or that they would lose something valuable, like their affiliate relationship with the North Dakota Farm Burea, if they do give up mutual ownership entirely.

There are 22.76 million shares of common stock outstanding for NODK, including the 55% controlling position still owned by the mutual company, so at $18.80 a share that’s a market cap of about $427 million. They have total shareholder equity of about $250 million in the company as of the last quarterly filing, including the $100 million or so they raised in the going-public conversion. So that looks, on the face of it, like a really expensive little insurance company — that means it’s trading at 1.7X book value, not unheard of for a growing insurance company but certainly quite expensive unless they’re doing something uniquely profitable.

They did post a profit in the last quarter, but not a big one, and they’re not going to dramatically explode the size of the business unless they make an acquisition with their extra capital (which they might)… and the investment side of the business is very much plain vanilla, they have roughly 90% of their cash and reserves in fixed income investments, and less than 10% in equities, so they’ll be buffetted by interest rate changes to some degree but, in the long run, would likely benefit from rising rates.

So there’s nothing all that unusual about NI Holdings… except that they have a mutual arm that owns 55% of the outstanding shares but doesn’t participate economically in the company. It’s a pretty normal insurance company with regional property and casualty insurance and a substantial crop insurance arm in North Dakota that’s affiliated with the Farm Bureau.

The bullish argument, then, is that the public shareholders, the ones who bought the shares in the conversion or bought the shares on the public markets, have full economic rights to the company even if they don’t have full voting control. If you consider that the company is really owned by those 45% shareholders, then there are really only 10.2 million “participating” shareholders (those were the shares created in the mutual conversion, the ones that trade publicly at NODK and that I own and company insiders own), and if you divvy up the equity in the company only to those minority shareholders, that would be a book value of $24.50 per share, and the shares at $18.80 would thus represent a steep discount (that would be a price/book valuation of 0.76X at recent prices). Lots of insurance companies trade at discounted valuations relative to their book value from time to time, so that too is not unheard of, but it’s an unusually nice discount for the current market.

As of the last earnings It’s still very much an under-followed company, since it’s not in any indexes and it’s only been publicly traded since March, so all of the large institutional owners are active funds — there’s no passive participation in this stock. And included in those active shareholders, interestingly enough, is legendary investor Michael Price, who ran some very successful funds for a long time but now mostly invests his own money. So there are bullish reasons to be in the stock, and that’s why I’m holding a stock on which I don’t have strong conviction about their future business prospects, but the 30% run in the shares over three months is enough that I do want to take some small measure of profit.

And I sold about half of my position in Criteo (CRTO)

Criteo (CRTO) had what amounts to a “flash crash” over the past week or so, and that seems to be almost entirely due to another wave of panic about ad blocking software.

If you’re not familiar with ad blocking, it’s just what it sounds like — you use some kind of software that acts as an intermediary in your browser or on your mobile device, and that intermediary blocks the ads that would appear and shows you just the content. There are all kinds of variations — some blockers just get rid of the most intrusive ads, like auto-play videos that drive us all crazy, or giant pop-up ads, but others attempt to get rid of essentially all advertising on web pages or in apps.

Which sounds appealing sometimes, but also, of course, creates consternation for publishers and the creators of content (like yours truly), who depend, at least to some extent, on the revenue provided by advertisers.

So there has been a bit of a war going on between the big publishers and the ad blockers — some publishers won’t show you an article or a video if you have an ad blocker turned on, or will replace those ads with big “you should feel guilty, subscribe now” pitches about how content has value… and some, like facebook, are pretty capable of sidestepping all but the most aggressive ad blockers (and the most aggressive ones also tend to be the hardest to use and update, which means they’ll have limited numbers of users, which means publishers are not nearly as worried about them — having super-techy IT nerds make some non-trivial effort to block ads is not a big deal, having Joe and Jane Shmo and their kids easily block ads by flicking a switch is a problem).

Criteo has been though this storm before, though this latest iteration is a little bit more serious, at least at first glance. The two big changes that have driven Criteo’s stock down recently are announced updates to Google’s Chrome browser that will make ad blocking more aggressive (and possibly even “turned on” by default, which is an even bigger deal) and, much more importantly, an announcement from Apple that its next version of Safari will include ad blocking that goes so far as to block or disable trackingby default.

Tracking people across devices is, really, the reason Criteo exists and is growing. Their software follows individuals and shows them relevant ads, then keeps following them as they go through the purchase process so they can prove that the ad is working — so if you browse Expedia for info on Caribbean cruises while you’re on the subway in the morning, then do some more research from your desktop at work, you’ll see more ads along the way for relevant cruise packages… and then, if you’re on your laptop at home that evening you’ll see yet more ads, and if you actually click on one of the many ads Criteo will make money… and if you buy a trip from Expedia then Criteo will earn more money on that ad. They have to be able to track you, using various methods, and they have to be able to get deep info about what happens to you when you’re on Expedia’s site and either researching or buying.

I wasn’t all that worried about Criteo’s last drop on ad-blocker panic, about a year and a half ago, but this one is a bit more worrisome. There’s a good article on the change from The Verge here.

So what to do? Well, I don’t think this will destroy Criteo’s business — but I do think that the increasing focus on anti-tracking regulation and on default cookie-destroying or anti-tracking settings in new browsers is a growing problem, and I think that trend substantially increases the risk to a small company like Criteo that doesn’t have very much leverage over the large players in the industry. Ironically, it may also increase the odds that Criteo gets acquired by someone, since their customers and systems would probably be more valuable in the hands of either a massive ad network or a telecom company.

And that changes my risk assessment for this company, which means I want to reduce my position — so I’ve now taken profits on half of my Criteo shares, and will hold the rest without being as worried about possible declines… and it’s possible that I’ll buy back in if they do fall precipitously.

Finally, I can’t seem to stop watching the train wreck that is Cannabis Wheaton (CBW.V, KWFLF). I never owned the shares, but I wrote about them for a teaser about a month ago and they caught my eye as an interesting business model with a ridiculous valuation and some questionable execution.

The shares were halted for a second time earlier this week, and the stock has been looking uglier and uglier despite the general appeal of the model — so to some degree, the lesson is that a business model that sounds appealing isn’t enough, you also have to have good execution and trustworthy management.

Management raising money while pretending it’s not an equity raise (using warrants and convertible debt) is silly, raising money on worse terms just so you can pretend it’s not dilutive equity… and perhaps investors were a bit wary of that, because the latest halt came because they had to downsize the offering from $80 million to $50 million.

The streaming deals they have so far look terrible, honestly — the ones I’ve looked at where they’ve provided some specifics are based not on current economics, but on some hypothetical world where prices rise dramatically for legal marijuana in Canada. That might come, but this is going to be a regulated market that might even have strong price controls, and I suspect a bank wouldn’t lend based on those estimates… a streaming company trying to expand quickly apparently will, and perhaps that’s why the streaming company hasn’t raised the $500 million they need to fulfill their end of the streaming deals they’ve made… and, it seems, is having some trouble raising even a tenth of that amount. Which, in turn, could mean that some of their streaming deals won’t close, because the deals that I saw described in detail were contingent on Cannabis Wheaton raising money.

I do kind of hope that this one hits a rational price as disenchantment continues, and they did bring in a new executive this week, presumably with some hope of righting the ship and restoring some credibility, but we’ll see — it’s quite possible that they missed their chance now. If you intend to build a long-term successful business, it’s short-sighted to be raising this money with junky convertible debt and warrants when there’s a lot of interest in marijuana equities, they could perhaps have set themselves up for a much healthier business if they had just sold a big slug of equity right away and kept expectations a little more in check… but, of course, that would have driven the price down a bit more, at least in the short term, and it seems to me that many of the marijuana market participants who are starting or listing companies in the public markets seem to be quite enthusiastic about getting their windfall profits quick before the story or sentiment changes. That’s probably a word to the wise for us all: Investors can obsess over share prices and have wild mood swings, but when companies themselves are focused on the short term stock price movement instead of on building a sustainable business, things can get ugly quickly.

And speaking of industries that are full of ridiculous and short-sighted management teams, I also have some thoughts on my gold holdings to share with you, including one small addition to the Gumshoe family. That will be coming in part two of your Friday File after the market close today. Enjoy!

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