This NorthStar Downgrade is a Joke, Right?

NRF imageThe NorthStar downgrade – where a Keefe Bruyette Woods analyst lowered his price target on NorthStar Realty Finance (NRF) from $23 to $13 per share – must be a joke, right? This downgrade comes from the same analyst we highlighted in November for his arbitrary discount for external management. Now he’s back with more of the twisted logic of that earlier report, except this time, in addition to the lower price target the analyst lowered his rating from outperform to market perform. All this follows after the stock has fallen well below even the revised price target of $13. Cart, meet horse. So what’s so backward about this downgrade?

Let’s return briefly to the point we made about the KBW November report.

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 a post a few days later we noted that management had come out with an even more conservative estimate of NAV than had the KBW analyst. So we should have seen the analyst apply his “management discount” to downgrade the stock on that new news, right?

Not likely, given what I surmise is the intellectual dishonesty behind the discount to begin with. That is, the completely arbitrary 27% “external management discount” was merely a mechanism to bring the price target in line with reported book value. It has nothing to do with a real estimate of the fair value of the stock.

In this most recent report on February 9, the KBW analyst provides lower valuations on assets, which in itself is not absurd given the decline in markets and asset values. Still, the American economy remains reasonably strong, despite what the market is signaling.

The humdinger, where the real intellectual dishonesty hides, is the reported increase in the discount for external management to 35%. This is the kind of dishonesty for which the investment banks are well reputed. So why does the “external management discount” suddenly grow from 27% to 35%? The analyst is again trying to make his price targets line up with the market, and again falls short. It’s this type of “fit the facts to the model” approach that’s disgusting.

After KBW’s reports and downgrades that chase the stock down over the last few months, where were the insightful analyses before the fact? And where’s the careful look ahead at a stock that’s trading at less than 3 times its trailing cash available for distribution and with cash and credit, as of the last report, to buy more than 30% of the company at current prices? This KBW report is the type that the Wall Street sell side is justly demonized for, “after the fall” downgrades with shoddy reasoning.

Looking for a REIT where there’s no question that management is aligned with shareholders? I’ve found a hidden stock that pays a 7%+ yield that should grow for years. It’s led by a proven internal management team that knows how to grow a business, because they helped lead their former business – one of the best around – to 24% annual returns for 15 years. If that sounds good, drop your name in the box at the top of the page, and I’ll send you our special free report on this hidden high-yield stock. It’s 100% free.

For all of our coverage on NorthStar, click here.

2 thoughts on “This NorthStar Downgrade is a Joke, Right?

  1. My take posted on IV board yesterday. I compared to KBW Jan 18 report with target of 23:

    KBW Jan 18 report
    About 3 weeks ago, KBW said this:

    “Investment Thesis
    While NRF?s strong historical performance includes its legacy returns pre-2008 and value creation
    from the NSAM spin-off in July 2014, we believe several factors warrant a valuation discount to Equity
    REITs including NRF’s externally managed structure and above-peer financial leverage. Factoring in
    discounts for these attributes, we derive a $23 price target, which warrants an Outperform rating. We
    believe asset sales and selective share repurchases may drive upside.”

    So in today’s report, KBW increased the cap rates on all the properties (hotels, the biggest sector by 1.5%), thus driving down the value of the properties. Consequently, total property value is less than book value, a preposterous position given real estate appreciation the past two years.Then they increased the discount for external management to 35% to get to 13 as the new target.

    IMO, a hatched job to keep KBW from looking foolish with a 23 target three weeks ago. Just a rationalization job to lower target closer to market. Nothing about fundamentals. Just ass -covering, imo..

    1. Like you say, this KBW report looks like a case of the analyst scrambling to fit his price target to the market and avoid looking bad, instead of actually evaluating the facts. Only after the stock has gone back up will he raise his target and again fall behind the market.

Leave a Reply