In this podcast, Motley Fool analyst Bill Barker and host Ricky Mulvey discuss:
- Nvidia's quarter and data center growth.
- Why Comcast is spinning off its cable assets.
- MicroStrategy's unusual bond offering.
Then, in a replay of The Motley Fool's Scoreboard hosted by Anand Chokkavelu, Motley Fool analysts Matt Argersinger and Anthony Schiavone take a look at Sunbelt REIT EastGroup Properties.
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This video was recorded on Nov. 21, 2024.
Ricky Mulvey: Cable Networks are spinning and you're listening to Motley Fool Money. I'm Ricky Mulvey. Joined today by returning champion Bill Barker. Bill, how are you doing?
Bill Barker: I'm well. Thanks. How are you?
Ricky Mulvey: I'm doing well. It's good to have you back on the show. Haven't seen you in a few months. We've got a little bit of NVIDIA, and then I want to talk about this Comcast spin off. Dylan's going to cover this more on the Friday show, but it's the biggest company by Market Cap, or it's consistently trading places is the biggest company by Market Cap and they reported earnings yesterday. I think my big takeaways are that the data center business is rolling with revenue up more than 100% from the prior year and that's from a base of fourteen-and-a-half billion. Expectations are starting to match up to what they're doing and some investors are doing a little profit taking. What stands out to you about NVIDIA's quarter?
Bill Barker: Well, it's a phenomenal quarter and as you say expectations were largely met, and those that figured that NVIDIA always exceeds expectations and not only exceeds them by normal amounts but excessive amounts might find that this one time NVIDIA has only exceeded expectations by a normal amount and that they have beaten expectations and raised guidance but not to the extent that has been going on in some quarters in the past and that's really a function of the law of large numbers. It gets harder and harder when you start talking about quarters involving $37 billion to just be increasing things by an annual rate of 100%.
Ricky Mulvey: Also, you get more eyes once you start getting into that trillions of dollars in market cap for folks to make guesses about what money you're going to make. One number I want to zero in on because I think this is incredibly impressive for NVIDIA, and a lot of investors believe it to be impressive. This is a company that makes 75% in gross margin. Have you seen anything come close to that? What is NVIDIA doing to make that?
Bill Barker: Well, certainly nothing close to it in terms of hardware and in terms of chips, and it's a function of the demand that they are able to sell at rates that are unheard of. These are gross margin rates above that level in the software space are not unprecedented. But you're talking about something in the 30% or so range for Intel. I think their current gross margin is 34% and AMD's is 48% and so NVIDIA's at 75, 76%, that does, as you say a highlight that they are doing something that their competitors are nowhere close to doing.
Ricky Mulvey: I want to get to this Comcast story. This is big news for media observers, and that's that Comcast is spinning off its cable assets, including USA Network, MSNBC, and CNBC. Spin off is expected to be valued at about $7 billion, not going to take hold for a year, according to reporting I saw in the Los Angeles Times. Before we get into the specifics of why Comcast is doing this, this is something that stock market investors will experience sometimes. I think it recently happened with Kellogg spinning off its serial division. It happened a long time ago when GE owned the NBC Universal assets. Broadly, why do companies spin off departments, even when they're making money, making a profit into new publicly traded companies?
Bill Barker: There can be a variety of reasons. In this case I think it's a capital allocation decision. You've got one part of the company, for instance, that is growing but not growing as fast as another part and that slower growing part would like the attention of the company and like to have money thrown its way. They say if you give us a billion dollars, we'll turn it into 1.1 billion over two years. We will grow your investment 10% over two years and there might be another part of the company that is saying, well, you give us a billion dollars to improve our business we'll do double that.
This is a way of letting a very unified part of the company, that being the cable channels operate with their own capital allocation decisions and prove that maybe they could raise money from outside of the company or they can make deals with other cable channels that might need a new home in a way that becomes very uninteresting to a very large company. That is, as I think Charlie Munger or Warren Buffett, maybe Charlie Munger said to Warren Buffett, if something isn't worth doing at all it's not worth doing well. Even if you can take a small thing and grow it decently, if it just doesn't move the needle on a very large company, it's like, who cares if you can do something interesting? It doesn't matter to the big parent. You spin something off, it's a smaller entity and increasing something by a reasonable percentage is meaningful once you identify a small company that can allocate capital well.
Ricky Mulvey: Well, one thing the big parent certainly cares about is streaming, streaming subscribers and getting people to watch Peacock. One may think that you could take these cable channels, USA Network, MSNBC, CNBC, and make them play nicely in that streaming world. But ultimately, why don't you think that NBCU could make these channels work in this new streaming environment?
Bill Barker: I think that a lot of the sports and news coverage they've got is consumed live sports coverage, in particular, news coverage, maybe less so. But old news is just not interesting. To be able to forever go back and watch the November 21st edition of Cable news chat is not something that many people are going to go back to. If you've got what Peacock really is better at movies and shows. You don't need to watch a show within a year, 10, 15 years of when it came out it's just as good years later. That's not the case for most of these channels that are going to be part of this spin off.
Ricky Mulvey: I think it's impossible to have this discussion without mentioning like people have also lost a lot of trust in Cable news outlets, and in terms of viewership, they're slipping viewers a little bit. MSNBC losing viewers after the election of Donald Trump. One may think that after what happened in 2016 you would see a big spike in cable news viewerships but that's not playing out this time. Also the median age. The median age for cable news viewership for not just MSNBC, but Fox News and CNBC is also around 70. I would imagine the executives here are looking at this and saying, you know what? This is really expensive and we don't think we're grabbing that younger generation of viewers that we want to get onto these streaming platforms.
Bill Barker: I think all those data points are true. I think MSNBC is also potentially quite an anchor around Comcast's neck if it wants to make acquisitions and the administration is hostile to MSNBC for not being sufficiently praising the administration. They may just do exactly what has been promised, which is to exact retribution on whoever isn't on board. I think that's maybe a consideration but really these things don't seem to have a fascinating future in the current construction to Comcast and to many many others.
Ricky Mulvey: Let's talk about the spin off because the new CEO who's currently the NBCU group chair, Mark Lazarus told a group of employees, and this is, according to Los Angeles Times reporting, "I completely empathize with people who think that this would be a bittersweet thing. I think it's exciting because very few times in life you have the opportunity to be part of what I'll call a well funded start up." I think there is a way to make channels like CNBC work in 2024 and grab newer generations of viewers. But how could a group of cable networks function as a well funded start up, is it possible?
Bill Barker: Well, they have real viewers, real revenues. They are profitable. As a start-up mentality with a new horizon to look at and we can take what we've got right now and rearrange it and make deals with the other bundlers. There are lots of ways to pursue the future in this business and have at the very least intellectually exciting time with a changing landscape, and they are not in desperate need of anybody to fund them. They've got profitable operations. Look, he's obviously spinning things too. He's saying that he precedes this. Before I get to why this is exciting, I understand why there's a lot of fear. But let me now spin that for you. Both of those things can be true. There are a lot of people that are worried about their jobs and how this is going to play out and whether the future is any brighter than the present. There are people put in charge whose job it is to be positive.
Ricky Mulvey: Why don't you think Comcast shareholders are really reacting to this spin off? The stock barely budged on the news?
Bill Barker: Well, they're going to spin this off. The shareholders aren't really going to wind up with anything that different than what they started with. They will have Comcast independent of the spin off and the spin off. They'll have a little bit of both and both of them will be able to pursue their own agendas. It's marginally good, I think, if they had conflicting agendas, ones which the capital allocation decisions were affected by any politics or any internal strife. It's marginally positive to shareholders but not much. You're really you own the same things but in a different package.
Ricky Mulvey: The stock has barely budged in the past five years but it has paid a dividend. In 2014, Comcast paid a dividend of 45 cents a share. In 2024, that's $1.24. They're trying to use their balance sheet to return capital to shareholders and sometimes mature companies returning capitals to shareholders can be wonderful stock investments. But is there anything about this company that gets you interested as a long term stock investor?
Bill Barker: No. Not me. There are those that are interested. If you're talking about RemainCo, so you've got SpinCo. That's what's being spun off and RemainCo, what remains. It's been a well run company. It's doing things with Internet with Cable bundling that people will continue to use, and certainly the Internet, there's some pricing power at the moment there. But I think that they are more looking like a utility than they used to.
Ricky Mulvey: I want to move on quickly to this MicroStrategy story because Bill, this is wild. MicroStrategy, which is a Bitcoin holding company with a side of enterprise software has announced that it will offer institutional investors the opportunity to buy convertible bonds. It's 0% interest. They're going to sell about two-and-a-half billion worth of these bonds. It's 0% interest so it can buy Bitcoin. First of all, how do convertible bonds work and is it common for these bonds to pay nothing in interest? When you think of bonds you think about getting a little paycheck until the company pays back the value of the bond.
Bill Barker: Well, it is not common to have 0% interest. A bond is like a regular bond in other cases and pays interest to bondholders and on top of that has the option for conversion of the bonds into stock under certain scenarios. You don't have to offer as high a yield rate though the bond, the coupon doesn't need to be as high because you've got this kicker of some equity conversion opportunities. Micro strategy is 0%, there were conversion strategies and maybe there's a lot of fine print that you got to go through.
Do your homework on this one but you're betting on the price of Bitcoin held by MicroStrategy somehow making you money because the conversion opportunities on this one include dates out in 2028 and 2029 and MicroStrategy being able to convert into cash or a combination of cash and equity depending on its price and what it feels like doing. Buyer beware on this one. But there are many buyers today as there are for virtually anything that has the residue of Bitcoin upon it.
Ricky Mulvey: Instead of just the residue of Bitcoin, why not just buy the thing, or even an ETF? I don't understand why an institutional investor would do the loop de loop of buying a convertible debt for micro strategy to go buy Bitcoin that they can then return whenever they feel like it instead of just buying Bitcoin.
Bill Barker: Well, I think you've raised a good point. I'm not going to come out and defend what they've done. Although MicroStrategy has done this very effectively to date there's also a way in which it operates as a hedge against the actual direct holding of MicroStrategy so you can offset it with the convertible bond and reduce your risk. Because MicroStrategy has such a volatile stock price that if you hold a lot of it then you may want to hedge that with this. It's not something that explains itself on the first read I would say. But as you point out there is institutional interest and I think part of it is the hedging strategies made available through this.
Ricky Mulvey: Much like watching Fight Club. It changes every time you watch it. I also want to do a quick note. It's not anytime MicroStrategy wants. There are rules of when it can call back the bond, "Subject to certain conditions on or after December 4th, 2026, MicroStrategy may redeem for cash all or any portion of the notes at a redemption price equal basically to the principal amount." I got to get that one right if I'm talking about debt securities. Anyway, Bill Barker, appreciate you being here. Glad to have you back.
Bill Barker: Thanks. Thanks for having me.
Ricky Mulvey: How about a REIT without a Chief Investment Officer? That actually might be a good thing. Up next, Anand Chokkavelu hosts Matt Argersinger and Anthony Schiavone for a Scoreboard episode Breaking Down EastGroup Properties. Premium Motley Fool members get access to all Scoreboard episodes in the video library. But even if you're not a member, and by the way, you should be a member. It's a great way to get premium coverage of stocks and investment analysis. Anyway, if you're not a member, you can watch this one in full on YouTube, I'll include the link and share this.
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Anand Chokkavelu: Welcome to the latest Motley Fool Scoreboard. I'm Anand Chokkavelu. We've got longtime Fools, Anthony Schiavone and Matt Argersinger, giving a 1-10 rating to the Sun Belt area focused industrial REIT that I may or may not have thought made backpacks. It's EastGroup Properties, ticker symbol EGP, as always, we'll rate EastGroup Properties business, its management, and its financials. We'll talk valuation. If there's time Fools, play armchair CEO, and we will top it in about 12 minutes or less, maybe even shorter. Let's get to it. Matt, how do you rate the strength of EastGroup's business, including factors like its industry and its competition? Scale of 1-10, 10 is invincible, one is hopeless.
Matt Argersinger: Well, Anand, I'm going with eight pretty high for EastGroup Properties. As you mentioned, it's an industrial REIT. It is mostly focused on the Sun Belt. Most of its properties, almost all of its properties are shallow bay, distribution oriented think warehouses, logistics facilities in what they call last mile locations. Really strategic real estate, that's important for three big trends that I'm going to talk about which one being the obvious one is e-commerce. We are living in a more and more e-commerce world. More and more retail sales are being driven of course by online sales, that fits perfectly into EastGroup's strategy. The second big trend is, you said at Sun Belt, they derive about 70% of their operating income from states like Texas, Florida, Arizona, North Carolina. These are among the fastest growing states in the country. That's where a lot of people are moving to, a lot of businesses are going to. That's a big tailwind for them. Then post COVID we've seen this really need for companies to really optimize their supply chains, have higher inventory ratios, practice what they call just in case inventory management.
God, that's another big huge tailwind for EastGroup Properties. I would say one reservation I have about EastGroup and why I don't give it nine or 10 is they are among the smaller REITS. They are a large industrial REIT but they're still less than a 10th of the size of Prologis, for example. It's still a highly fragmented market with lots of supply and they're very development focused at EastGroup. It's more capital intensive than maybe other REITs. That's why I'm giving eight out of 10.
Anthony Schiavone: I'll go with the seven for EastGroup's business. Matt, you mentioned a lot of the major things, but another thing that I like about EastGroup is that about 50% of their portfolio has been developed internally. I think that's really important because they can design the properties to their specifications that can build them for the long term. Then the other thing that I like about them too is that they have the most diversified tenant base out of, I think any industrial REIT. Their top 10 tenants account for just under 8% of their total annualized base rent. I think that's really important. Then aside from the e-commerce and migration trends that you mentioned earlier I just think industrial real estate is an advantaged property type. If you think about a warehouse, it's just four walls. You have a ceiling, you have a roof. There's not a lot of recurring capital expenditures involved with maintaining a warehouse. That allows more cash to ultimately be returned to shareholders. I'll only give it a seven because this business is a little bit reliant on outside forces that aren't necessarily within the company's control so you think about supply and demand fundamentals, the health of the economy and migration trends as well although those have been positive recently but I'll settle with a seven.
Anand Chokkavelu: Given its smaller size, that diversification, Anthony, that you were talking about really gives me some comfort where it's not just reliant on, you won't want to see 32% is from this one big tech company. Let's move on to management, Matt. Scale of 1-10, 10 is Warren Buffett, of course, and one is Homer Simpson.
Matt Argersinger: I might be a little high here but I'm going nine out of 10 Anand, and that's because I'm just really impressed by CEO Marshall Loeb and what he's done. His tenure goes back to 1991 with EastGroup Properties. He was with the company for the first 10 years of his career. He went off to be an executive at a couple of other publicly traded REITs before rejoining EastGroup in 2015 and then becoming its CEO in January 2016. Since Loeb became CEO in January 2016, EastGroup has outperformed the S&P 500 by more than 80 percentage points. That's hard to do as a REIT, especially in recent years, real estate has been in a pretty big bear market, EastGroup has continued to outperform and deliver amazing returns. I'm going to steal a page from Ant's playbook here. But one of the great ways you can measure a REITs management is how they've grown the dividend versus the rest of the company. EastGroup has grown its dividend by about 13% annualized rate over the last 10 years. Over that same span, EastGroup shares outstanding and total debt outstanding have both increased at just around 5% annually. The dividend growth is boom way ahead of those critical capital parts of the company. I think that's a really strong sign of management so I'm very impressed here.
Anthony Schiavone: I'm also going to go high here at an eight. Matt you mentioned Marshall Loeb just been a tremendous CEO since he's been there. I also like looking at the proxy statement too for REITs because at the end of the day they're allocating capital, and that's what we need to focus on as REITs investors. If you look at their compensation incentives, they're based on FFO per share, so per share metric, that's good, based on SAM property NOI growth, and then a couple of balance sheet metrics like debt to EBITDA and fixed charge coverage ratios as well as total shareholder returns. I think it's rare for a REIT management team to be compensated on balance sheet metrics. I think that's definitely a good sign. Then something unique about EastGroup's management team that you really don't see in any other REIT is that they don't have a chief investment officer. I find that fascinating. All the development, all the acquisition, all the disposition activity is decided by the local teams that are operating those assets. I think that's good for talent development too. Like, Marshall Loeb was in charge of that at one point in his career at EastGroup. I just like how that EastGroup has a decentralized culture. The only reason I gave him an eight is because of low insider ownership at only around 1.5% of shares outstanding. That tends to be fairly common for REITs just because the way they're structured so I'll go with an eight.
Anand Chokkavelu: Financials Matt. A 10 is a fortress, a one is yikes.
Matt Argersinger: I'm dishing out another nine here. Just quick financial snapshot of EastGroup, looking at just the second quarter results, the most recent results, the operating portfolio was 97% occupied as of the end of June, rental rates, new and renewing leases up 60%. That's an incredible same property net income of 5% funds from operations which is the key measure of REIT's cash flow. That was up eight-and-a-half percent. I can't recall a quarter going back many years where EastGroup has not shown growth in funds from operations per share. The business is performing really well. If you look at the balance sheet you've got debt to total market cap of just 16.9%. Debt to EBITDA is less than 4x. Both of these metrics are very strong for REIT, and with interest rates headed lower now, EastGroup's balance sheet is only going to get de risks and their liquidity is only going to get higher. I just think they're in a really great position financially.
Anthony Schiavone: I'll go with an eight for the financials. Matt, you mentioned the FFO per share growth, the earnings growth. That earnings growth has led to phenomenal dividend growth as well. EastGroup has paid a dividend for 179 consecutive quarters. They've also increased or maintained their dividend for 31 consecutive years including increases in each of the last 13 years. This is a steady dividend grower. You can see that cash that they generate flowing back to shareholders which we love to see. In August, they increased their dividend by more than 10%. That's a good sign. Over the last 10 years they've grown their dividend by just about 150%. Really impressive there. Matt, you mentioned a strong balance sheet too. Debt to EBITDA is an all time best for the company. Their debt to market cap below 20%. Typically, in the private real estate market, you'll typically see loading the values closer to 60% or 70%. This is a very well capitalized company. I only give them an eight because of their size, which you mentioned earlier, Matt. There's a little bit smaller. They can't necessarily get the best terms, the best interest rates on new debt that they issue, like somebody like a Prologis can. That's the only reason why I give them an eight but definitely a strong company here.
Anand Chokkavelu: You can tell how much they like the company because they're both apologizing when they give an eight. [LAUGHTER] Let's talk valuation. How well will EastGroup stock do over the next five years, and how safe is it? Keeping in mind that 10 is a sure thing, one is a lottery ticket.
Anthony Schiavone: Yes, over the last 5, 10, 15, and 20 year periods, EastGroup has delivered a compound annual total return north of 10%. I'm going to go between 10 and 15% annualized over the next five years. Today, if you look at its dividend yields at a yield of about 3%, it's growing its dividend at a 10% rate. Theoretically that should produce a total return of around 13%. I think that's reasonable and then you factor in the tailwinds of e-commerce, Sun Belt migration, some of the rent growth that's already embedded in its below market leases that it has within its portfolio, I think that's going to lead to at least double digit returns from here.
Matt Argersinger: I'm also going 10-15%. I'm a seven in terms of my confidence with that. The valuation is a little high, if you look at what they're guiding for FFO per share this year. The stock right now is trading around 22, 23 times that figure. That's a little high even though I think EastGroup does deserve a premium. As Ant mentioned, dividend yield is right around 3%. You add that to the dividend growth or to the FFO per share growth. Easy to see double digit returns here. But valuation is a little high so I'm not super confident in it but I'll give it a seven for that.
Anthony Schiavone: I should say, I don't think I mentioned. I'm also going with the seven because of the valuation.
Anand Chokkavelu: We're going to skip armchair CEO in the interest of time and go straight to everyone's favorite top it. I expect to hear Prologis somewhere in here. Anthony, is there a company in EastGroup Properties space that you like better?
Anthony Schiavone: Yeah, there's this company called Prologis. That's my top it. Just a massive company. I think it has a market cap of over $100 billion but I still don't think the market fully grasps just how strong this company really is with its management team, its balance sheet, just everything involved with the company. It's just phenomenal.
Matt Argersinger: I got to say Prologis, as well. Real estate size does make a huge difference for returns. As Ant mentioned earlier, access to the capital markets. Prologis is the pick. I love EastGroup and I own both EastGroup and Prologis. But if I had to pick one, I'd probably go to Prologis.
Ricky Mulvey: As always, people on the program may have interests in the stocks they talk about and the Motley Fool may have formal recommendations for or against, so you don't buy or sell stocks based solely on what you hear. All personal finance content follows Motley Fool editorial standards and are not approved by advertisers. The Motley Fool only picks products that it would personally recommend to friends like you. I'm Ricky Mulvey. Thanks for listening. We'll be back tomorrow.
