Ah, sell-side analysts… All the information but no ability to use it, like a kid in a brothel. I was stunned when I read the recent KBW analysis of NorthStar Realty Finance (NRF) following the third quarter report. I was stunned not so much for its estimate of net asset value, but rather the analyst’s price target. I simply cannot fathom the rationalization, given the inputs.
The analyst produced a price target of $23 per share (reduced from $24) and an outperform rating, and I figured that there must be some mistake given the stock’s recent spinoff of NorthStar Realty Europe (NRE). Clearly, I thought, the analyst must not be correcting for the 1:2 reverse split, since $23 per share was right in the range of many analysts’ targets pre-spinoff. But no-o-o-o-o-o! KBW’s analyst really goes out on a limb with his $23 call. Meanwhile, a number of peers have targets at $40 and up. The stock is now $19.
So let’s run through some of the logic here.
The analyst neatly lays out his net asset value calculations, and it really couldn’t be any clearer, with each property type broken out. It’s all totaled up at the end, with GAAP book value of $22.62 and net asset value of $32.08. With only the briefest of explanations – “for external management” and “above-peer leverage” – the analyst offers a 27% discount on NAV and sets the price target at $23.
Does “external management” always get a 27% discount? Are there some management teams that get a greater discount? A lesser discount? While it’s typical for investors to discount an externally managed REIT, what makes this the special number that just so happens to bring the price target right to GAAP book value? Curious.
In fact, is there some reason this management team – given its track record of mid-teens returns for over a decade – should not receive a premium, however small? (Okay, there are a few, but investment track record isn’t one of them.)
Second point: the analyst clearly mentions the possibility of stock repurchases, and NorthStar’s announcement of a $500 million repurchase authorization (14% of outstanding shares at today’s price) is still recent. Management spent a huge portion of the conference call discussing how they were going to generate liquidity to fund the buyback. Those methods included the very specific – selling off the multifamily portfolio (including a specific price, suggesting some preliminary negotiations) – to the more general – selling stakes in some of its other businesses. It’s clear that management intends to repurchase stock, and well it should. But how is this information factored at all into the analysis? While the report acknowledges that “repurchases and asset sales could drive upside”, that information is not reflected in any forward-looking way (that I can see).
Third point: the analyst, incredulously, notes: “We reduce our price target to $23 (from $24), which equates to a 13.0% yield on our $3.00 dividend forecast and is supported by our NAV analysis.” The logic here is staggering. It completely ignores the central question that everyone wants to know and that is whipsawing the stock today – is the dividend sustainable? The assumption here seems to be that a 13% yield is perfectly normal, because of course it’s backed up by the NAV analysis. But, of course, that yield isn’t perfectly normal at all. A yield that high indicates that the market completely doubts the company’s ability to pay that dividend for more than a short period.
The resolution of that point – and it should be the job of such a professional analyst to determine – is really all that matters. It’s a binary outcome at this point. If the dividend is cut, then the stock falls. If it’s not cut and management can simply maintain profitability, then a 13% yield is much too high. And, of course, buybacks make the dividend even more sustainable, especially if management is realizing anything close to fair value as it monetizes portions of its portfolio. Even the KBW analyst admits that NAV is much higher. Moreover, his estimates out through 2018 (for what any estimates that far out are worth) indicate the dividend is sustainable.
So you don’t get to pretend a 13% yield is perfectly normal and supported by your analysis. In the end it seems intellectually dishonest to come up with a price target without tackling this issue. All the information and yet unable (or unwilling) to answer the fundamental question… Just the usual sell-side shenanigans.
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