The month of May started off poorly for global markets but since mid last week global indices have shot off as the US pushed forward plans to reopen. Personally I think it's still too early and the market has gotten ahead of itself but who's to say? I have more than adequate protection in place so I'm comfortable continuing adding to my long positions across the board. To share, two of my investment ideas which I believe could do well:
Hasbro (Nasdaq: HAS)
Hasbro is among the largest toy companies in the world and with the recent acquisition of Entertainment One (eOne), building out its full IP monetisation capabilities via TV, Movies, Video Games and IP Licensing. The closing stock price on May 8, 2020 was $69.7 giving Hasbro a MCap of $9.6bn and EV of $13.6bn. Note the Net Debt of $4bn is from 2020Q1 period end (Cash $1.2bn; Debt $5.2bn) and entirely due to the $4.6bn cash purchase of eOne ($3.8bn for the equity and $0.8bn repayment of eOne's debt). Since the eOne deal closed in 2020Q1 it isn't consolidated in Hasbro's FY19 results: $4.7bn Sales, $525m NPAT (pre-abnormals). eOne's FY19 results was $1.2bn Rev and ~$120m operating profit (pre-abnormals).
The senior unsecured debt used to fund the eOne purchase had a blended interest rate of 3.4% (duration 6.1yrs) which effectively wipes out all of eOne's FY19 profits such that using consolidated FY19 results, Hasbro trades on ~1.6x P/S and 18x PE. If one believes Hasbro can achieve its target $130m of synergies (from combining its original production assets into eOne) by 2022, this reduces to ~15x PE. Not expensive but not particularly exciting either considering the virus led disruptions on physical toy sales channels, entertainment production and movie releases in 2020. But I think this neglects the significant upside potential within Hasbro. Some of these include:
Digital Games/Services: particularly Magic: The Gathering (MTG) and Peppa Pig + pre-school IP related products. MTG is among the oldest (1993 start) and remains the most popular collectable card game in the world. Despite this impressive heritage, it fell behind the likes of Blizzard's Hearthstone in online gaming which launched in 2014 and grew to >100m players. Today MTG is adapting but still far behind with 35m players and a PC only version of the game. I'm optimistic that their Mobile game, Mac version and China launches (Tencent partner) all later this year will show strong results. Digital card games market is worth $2bn pa and MTG could capture up to 30% if they 'play their cards right'. Habro finally seems to understand how important e-Sports and Mobile is to Gaming. Similarly across other IP, Hasbro has been a laggard on Mobile App adaptations of its IP. With the popular Peppa Pig (no 1 Youtube pre-school show) and other early age IP, Hasbro should be able to develop a large suite of Educational games.
Hasbro's extremely valuable IP library: including MTG, Transformers, Monopoly, Power Rangers, GI-Joe, Dungeons & Dragons, My Little Pony, Peppa Pig, PJ Masks, Cupcake & Dino, Ricky Zoom. While they've been good at the physical products side, the Entertainment/Licensing division was only 9% of Sales (ex eOne): $434m, but 16% of Segmental OP: $100m (23% OPM vs 12% OPM for Toys). eOne gives Hasbro scale, production assets and channels necessary to accelerate its IP entertainment services development. I believe the Entertainment/Licensing Rev growth should be at least double digits and LT profitability in the high teens to mid 20s OPM (higher if they get rid of Movies, Music and focus on TV, Games, Animation and Licensing).
Hasbro's traditional toy business: was severely disrupted in late 2017/2018 by the bankruptcy of Toys R Us. Since then Hasbro has been been rethinking and building its channels with emphasis on e-commerce and omni-channels. A significant part of Hasbro's toy business also comes from Partner IP, in particular Disney. With an expanding pipeline of movie and TV series releases based on Marvel, Disney Princesses (e.g. Mulan), product sales should continue to grow.
Cash profits of Hasbro is higher than P&L profits due to non-cash amortisation charges. This is ~$100m pa add to normalised NPAT (inc eOne).
Hasbro's capital returns history is strong. Dividends + share buybacks was close to $600m each year over the past two years. This could reduce given Hasbro's new debt position but in their recent 2020Q1 results the company said they remained committed to their dividends (~4% yield using current price).
Even with no expectations for improvement, Hasbro's valuation is reasonable. However I believe eOne will generate well in excess of the 3.4% funding cost on its $4.6bn price tag. If Hasbro delivers on its Digital Entertainment growth and target synergies, this adds another $160-260m to NPAT (assuming: high teens to mid 20s OPM, $130m cost savings, add $50 to high end estimate only for MTG earnings, -$136m interest cost, 25% tax rate). On this basis Hasbro trades on 12-14x normalised earnings and high single digits FCFE yield. Historically Hasbro is valued on high teens to low 20x earnings so which gives an upside range of 30-90%. The business can probably grow earnings post Covid19 at high single digits to low double digits whilst maintaining a 3-4% dividend payout.
Hasbro falls into what I call the cake investment: if nothing much changes you do ok (you get the basic cake) but if one or more things work out better than expected, the investment result could be fantastic (the cream and cherries on top).
At $69.7/share Hasbro is up 69% from its March trough and -33% below its early Feb 2020 trading price. Using these bounds, the risk/reward payoff is: -41%/49%. I'd been buying this company from the low $60s and have continued adding to my position over the last two months.
Hasbro's risks include:
China accounts for 55% of Hasbro's manufacturing. US tariffs may compress margins
Increased exposure to the Movie business adds significant volatility to earnings and cashflow
Production and distribution of TV, Movies has been disrupted by the virus. Original budget forecasts may no longer apply requiring write-offs
eOne poor performance and problems consolidating the operations
Charter Hall Social Infrastructure (ASX: CQE)
CQE is a REIT focused on early stage childcare centres across Australia. What makes this REIT special is that its leases are all long duration, triple-net leases. This is a rare form of lease where the tenant is responsible for practically all expenses (insurance, maintenance, taxes) - the landlord just collects rent. The leases are Real (inflation indexed) typically on 10yr terms with two options to extend another 5yrs each time (effectively a mark to market on rent).
CQE's portfolio characteristics:
391 properties
WALE (weighted average lease expiry): 11.7yrs
99.8% occupancy
Look through gearing of only 18%, interest cost of 3.8% with 3.8yr avg debt maturity
NTA/Share: $2.91 (post recent capital raising). The property valuation was based on 6.1% passing yield
56.8% of the portfolio rent is from non-profit and government tenants:
46.5% Goodstart: Australia's largest childcare centre operator and a non-profit organisation backed by four of Australia's biggest charities
6.6% BestStart Educare: New Zealand's largest childcare centre operator and another non-profit charity organisation
3.7% Brisbane City Council
These are high quality, low risk tenants with strong financial backers and federal support e.g. exemptions from major taxes - payroll, income, fringe benefits, etc. Given the average childcare centre earns ~20% margin after expenses: labor (55%), rent (15%), misc (10%); charity run centres have significant cost advantages.
The remaining 43.2% is leased to for-profit companies of which 19.8% are small operators and the other 23.4% are large childcare operators: Only About Children (10.2%), G8 (7.9%), Avenues Childcare (5.3%). Although these are higher risk tenants, Australian childcare is heavily subsidised by the federal government due to its productivity benefits (female workforce participation) and political sensitivity. CQE's portfolio is diverse and the risk of absolute loss (permanent location closure) is low:
CQE's average tenant's Rent/Income is only 11.2% (industry average is 15%)
Childcare centre zoning is tightly regulated (similar to schools) so limited local competition
CQE last traded at $2.27 giving it a MCap of $788m. This implies 0.78x P/B and ~8.8% NPAT yield (4.5% distributable income yield + 4.3% property revaluation gains). It's important to understand that Australian REITs generally operate as Unit Trusts which means they don't pay taxes but must distribute at least 100% of their taxable income (Rent received less Expenses and Interest costs). Many distribute >100% and this excess portion is treated as deferred taxation (a reduction to your original investment cost which is only realised on sale of the shares).
At the minimum an Investor can expect to be paid the net rental income: a real yield of 4.5% pa. Additionally the property values are constantly rising each year since: a) rent is rising from CPI and positive reversions (3.4% pa assuming 10yr mark to market and Rent/Income moving to 15%), and b) cap rates have been falling due to lowering of interest rates and premiums paid for these types of properties. In the low case scenario the real return to Investors is closer to 7.9% pa.
This may sound unexciting but I think that overlooks the attractiveness of this long duration inflation protected yield. To give some context, the 9/2030 maturity Australian Treasury Indexed Bond last traded at 0.166% implied yield. CQE's fair value is theoretically the 0.166% + Credit Spread. The lowest rated investment grade corporate bond (BBB) spread is currently ~200bps (jumped from just 100bps in Feb 2020). Even if you think CQE's risk is higher, this yield doesn't come close to the lowest case scenario return. Furthermore CQE will likely return well in excess of the low scenario:
Increase gearing: they can borrow at 3.x% and buy properties at 6-8% yield
Return more than 100% of net rental income: given capital value of properties are rising, they can payout 100% of the NPAT (or closer to 9%) and still maintain the same gearing
Development and disposal returns from properties
Historically CQE traded on a P/B range of 1.1-1.2x. Mean reversion equals a return of 41-54% and you get paid well above cash and bond rates to wait.
CQE should be a core holding for any superannuation/retirement Investor, especially Australian based ones (tax benefits). The inflation protection and triple net lease characteristics of this REIT is extremely valuable in today's world of money printing.
I'd owned CQE and its predecessors (consolidations) since 2009 until selling all positions in 2019 at $3.x/share. I rediscovered CQE in late March 2020 and had been buying from $2-$2.2x. It's been a great company though I was disappointed with CQE decision to raise up to $115m in early May 2020. I think it was unnecessary given: a) minimal virus disruptions (gov stepped in to pay 50% of all childcare centre Rev), and b) gearing pre-raising was only 25% with no refinancing pressure. Also they offered $100m to Institutional Investors when they should have just done a Rights Issue. The pricing discount was low at $2.2/share, but it still diluted NTA from $2.96 to $2.91 (1.7% dilution). We will fully participate in the raising since the price is attractive but I think management should have done better.
CQE update: 19/5/2020
I noticed my previous property rent reversion calculation was incorrect. The market average for Childcare centre Rent/Rev is 15%. So reversion from 11.2% to 15% over 10yrs (first market to market) is (15%/11.2%-1)/10=3.3% pa. I'd previously incorrectly used (15%-11.2%)/10=0.4%. The 3.3% pa fits historical experience since CQE has achieved ~4.x% pa property valuation: 3.x% from rent reversion and 1.x% from CPI changes.
So the Real annual return is 7.9% and not 5%. The return is higher if Dividends are fully reinvested. This is well above the compound annual return of the Dow since its inception on 5/1896 which was 6.7% Real (with all Dividends reinvested) and 2.2% (no Dividend reinvestment). You can check this at the link below (remember to tick 'Adjust for Inflation'.
https://dqydj.com/dow-jones-return-calculator/
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