Business Continuity Plan In Action

I’ll spare you yet another “Business Continuity Plan” email. You’ve no doubt gotten dozens of those by know from everyone from your banker to the local donut shop. You don’t need another one from me.

That said, the Covid-19 lockdowns have been an interesting experience in seeing an business continuity plan in action. It’s nice to know your plan actually worked when it needed to.

All About the Cloud

I moved all of Sizemore Capital’s critical functions to the cloud at firm inception. I was using the cloud before “the cloud” even existed as an expression. I simply couldn’t imagine running a company any other way.

Sizemore Capital was founded in 2008, and from day one all critical files were archived online. Today, I don’t archive online. The active files actually live online via Microsoft’s business version of OneDrive.

I can access my files from any computer in the world with an internet connection. If my hardware conked out on me today, I could have a new computer expressed delivered to me and be back in business in short order. Or, if that wasn’t possible due to coronavirus delays, I could even run the company for extended periods of time from my phone. It’s not ideal. But I could do it.

We’ve been calling clients, trading client accounts, meeting redemptions, wiring funds and doing all of the things you expect money managers to do… uninterrupted.

Communication With Key Personnel

As I write this, I’m stuck on a ranch in rural Peru and likely will be for another couple weeks. I was in Peru prospecting when all hell broke loose and they shut the country down. The airport is closed until after Easter.

It’s barely slowed me down. I’ve had minimal service interruptions and have been able to carry on remotely more or less as if nothing had happened.

My partners are geographically spread out. One is in Dallas, one is in Houston, one is in San Francisco and one is in Lima, Peru. We’re accustomed to communicating remotely, so this hasn’t been much of an adjustment.

I find face to face meetings to be a lot more valuable and productive. But if I get stuck on the ranch for months and my partners are stuck in their respective locations for months, we can keep this up. Indefinitely.

Shortcomings?

I haven’t had access to my office for a few weeks, and I know I have a few undeposited checks sitting in the office mailbox. It may be a while until I’m able to deposit those. But I would emphasize that those are not client checks. Client funds are deposited directly with the custodians we use, and that service has not been interrupted.

So, the worst that has happened is that I have been unable to pay myself a handful of checks.

That’s it.

I don’t have a lot of sympathy for firms that weren’t ready for this. Sure, few people saw coronavirus happening. I certainly didn’t. But it doesn’t matter. Look at the natural disasters that seem to be happening every other day: hurricanes, floods, tornados, etc.

If you weren’t already prepared for widespread business disruptions… what exactly were you waiting for? The tools have been around for over a decade now.

Clearly, there are industries that simply couldn’t prepare for this. If you’re a barber, a dentist, a bartender, a dry cleaner or another number of other professions that require face to face contact, there was really nothing you could do about this. Zoom and Skype aren’t particularly useful in these cases.

But to paraphrase an old Warren Buffett quote, now that the tide has gone out, it’s time to see who was swimming naked.

Is the Bear Market Over?

After rising more than 20% in three days, the Dow technically entered a new bull market.

That doesn’t mean the pain is over. A V-shaped recovery probably isn’t realistic.

The full economic impact of the lockdowns is still unknown.

I saw a headline last night that I feel obligated to comment on.

Because the Dow Industrials are up 20% from their recent lows, the bear market is technically over and we’re now “officially” in a new bull market.

This headline was published before today’s sell-off, of course. But what are we to make of this?

To start, it’s probably far too early to dump every cent back into market. I’m nibbling on some stocks I really like, and I think it’s likely that we’ve seen at least a handful of good stocks already bottom out. But I have a hard time seeing the market shoot straight up from here. We still have no idea how long lockdown conditions are in place and what the impact will be on corporate profits.

Plus, even if the lockdowns were lifted today, life doesn’t’ just magically return to normal. Small businesses that saw their revenues evaporate over the past month are going to be licking their wounds for a while and likely cutting back on hiring, inventory and any planned improvements. Most small businesses operate on slim margins, and removing a month’s worth of revenues is a major setback.

Think about it. That car you wanted to buy will still get bought, even if your purchase is delayed a few weeks or months. But the restaurant meal you would have enjoyed, the shirts you would have had dry cleaned, the haircut you would have had… Those revenues are lost forever. You’re not going to eat twice as many restaurant meals, get twice as many haircuts or get your shirts dry cleaned twice to “catch up.”

Small businesses employ roughly half of America. It’s helpful for Congress to send us checks. But to pretend this is going to keep consumer demand high and avoid a nasty recession is utterly ludicrous.

The most dangerous four words in the English language, at least with respect to your money and the stock market, are “this time is different.”

But in all seriousness, this time really is different. The volatility we saw throughout March truly was unprecedented. And while we’ve had plenty of recessions over the decades, we’ve never had the economy shut down like this. Not during World War II, not during the Great Depression and not even during the Spanish flu epidemic of 1918.

So, what should we expect?

To start, I wouldn’t expect the stock market to snap back to all-time highs any time soon. Remember, stocks were already trading at their highest valuations in nearly 20 years. By some metrics, the market was the most expensive it’s ever been… in history.

But that’s ok. There are still bargains to be had. So, with that said, here’s a checklist for April:

  1. If your job situation is secure, make a real effort to max out your 401(k) or IRA. Even if you’re not quite ready to drop the money into the stock market, you want to have the cash available for when the time comes. Plus, getting the money into the account gets you a tax break in the here and now. Be honest here about the safety of your job. Don’t put money into your 401(k) if you think you might be out of work in the coming months and in need of the cash.
  2. Make your list of stocks you’ve always wanted to own, and then check the prices. Starbucks (SBUX) briefly traded at $50 per share. That’s insane. Who wouldn’t want to own a world-class company for half the price it was trading at just a few weeks ago? I’m not telling you to run out and buy Starbucks. But make your own list of blue chips, and start averaging in. If we see more downside, we see more downside.  But if you’re getting a fantastic price, do you necessarily care? Instruct your broker to reinvest the dividends, and let time and compounding work its magic.
  3. Be patient and try to keep a level head. I don’t know when life gets back to normal, and neither do you. No one does, and we have no historical precedent to go on. I personally think it’s madness to shut the world down like this. I’m not minimizing the danger of Covid-19, but I think our leaders are minimizing the damage the shutdown is doing. A little over 1,000 Americans have died due to the virus. 40,000-60,000 Americans die every year due to opiod abuse. Approximately 80,000 die annually due to alcoholism. Now, you tell me. Do you think those numbers will be higher in a bad recession as hard-hit people have a hard time coping? What about an uptick in crime or spousal abuse? Or suicide? Live ruined due to depression? Young entrepreneurs that are financially ruined, eliminating the jobs they would have created?

I could go on all day. Most people dying of the coronavirus are already older and already have health problems. We should care about their plight… but in being overly cautious about their wellbeing, we’re creating new victims, and no one seems to notice.

I like to think our leaders are smart enough to figure this out. But maybe they’re not.

So, all we can do is try to nudge them in the right direction while not making the situation worse.

Hang in there. This will get better. But it get a lot messier first as we all try to sort it out.

Behind The Numbers Issues Buy Recommendation on EPR Properties

Jeff Middleswart of Behind the Numbers is one my favorite stock analysts. I’ve always been very impressed with the depth of his research and his understanding of complex accounting.

At any rate, I was interested to see Jeff initiate coverage of EPR Properties (EPR) with a rating of “Buy.”

An excerpt from his recent report:

We initiate coverage of EPR with a BUY rating and earnings quality coverage with a 4- (Acceptable) rating.  

EPR is definitely a unique REIT in that it operates primarily in the entertainment areas where demand by consumers has been increasing.  It has no exposure to retail shopping or office space.  Instead, it focuses on movie theaters, Top Golf, water parks, ski resorts, and other eat-and-play destinations.  

The overriding risk is the total amount of debt on these assets.  Not only is EPR leveraged 4.7x adjusted EBITDA, but many of its customers operating the assets are leveraged 3-6x adjusted EBITDA also.  EPR is also paying a dividend in excess of earnings and FFO at this point…

Missing some rent payments from tenants for a month or two is unlikely to derail EPR in the long-term in our view.  It has two years of revenue in cash on its balance sheet now.  In fact, after being shut-in their homes, many consumers may flock to an entertainment venue like a water park, Top Golf, or movie when this is disruption is over.  EPR’s own cash obligations look manageable given its own liquidity.  

It has the ability to pay the dividend now.  Reducing the dividend may help EPR further retire debt (it drew down $750 million on its revolver recently).   With its customers having their own financing obligations to pay without revenue coming in, they may ask for relief from EPR.  Also, EPR is slowing its growth plans substantially in 2020.  We doubt its cash flow will support the dividend in 2020.  This is still a REIT and has to pay out the bulk of earnings as a dividend and is very unlikely to cut it to zero.  A 20% cut would still leave this stock yielding 12%.  

Behind the Numbers 3/27/2020 report.

Charles here. I noted recently that EPR had recently authorized a stock buyback. If management were concerned about liquidity or solvency, that’s not something they would be doing.

Clearly, seeing major short-term reductions in rent is going to hurt EPR. That’s unavoidable. But are its properties suddenly 75% less valuable than they were a month ago?

I think it’s very possible the company may opt to reduce its dividend in the months ahead, at least temporarily. But it’s important to remember it’s long-term business model is solid and that this virus scare will eventually pass. Two years from now, anyone buying EPR and suffering through the volatility will likely be glad they did.

Disclosures: Long EPR

Thoughts On COVID-19 and the Economic Fallout

My colleague Bill Washinski compiled some data on the COVID-19 crisis and shared his thoughts. Enjoy!

Charles

It’s hard to find anyone who does not have a take on COVID-19.  The impact is unprecedented. I never imagined living in a world that has seen countries implement nationwide quarantines.  Its impact on the world has been nothing to take lightly from the enormous economic impact and the danger of overloaded hospital systems.  There is still a lot of fear and uncertainty surrounding COVID-19, with the two that seem most prevalent being how long the crisis will last and why the heck does it cause people to hoard toilet paper? 

Okay, the second obviously is not as prevalent, though its more mysterious.  One has a better chance to prove Fermat’s Last Theorem, but the good news is that there is more to data to make informed speculations about how long the crisis will last.

How far away are we from COVID-19 crisis ending?

The U.S. exceeded China in the number of cases on March 26 – reaching 83,836.  In monitoring the trajectory of testing in the U.S. over the last week; we’ve seen the enormous upticks in both cases (945%) and deaths (925%).  The U.S. testing response has been a little slow, as just a week ago the confirmed cases was less than 8,000 (118 deaths) which does give perspective to those percentage increases.  We simply do not know what the actual number of infected persons there were s prior to the increased level of testing.

As the U.S. has now surpassed 1,200 deaths, it’s hard to get a real estimate on where this is going and whether we begin to look like Italy, particularly in New York.

Surgeon Dr. Marty Makary from Johns Hopkins University has stated “The virus is following the playbook, this is playing out exactly as predicted in all the models and projections” and speculates that “we are probably still about 3 to 4 weeks away from its peak.” 

COVID-19 – Endgame

The initial death rate estimates on COVID-19 by the World Health Organization was 3-4% though that number is now disputed.  The UK has already declassified COVID-19 as a high consequence infectious disease as the death rate was significantly lower than expected. 

Different countries have handled it better than others.  China took draconian measures to Flatten the Curve, South Korea had a system in place to respond quickly due to its experience with the MERS outbreak in 2015, and Italy had numerous factors that have placed it at higher risk.

WHO Expected Death Rate too High?

That 3-4% number comes from a case fatality rate which has a numerator and denominator.  The numerator represents the number of people who have died from COVID-19, which is very easy to see and measure.  The denominator should be the number of people who have been exposed to and got the virus.  The problem is that the test being used is a test of RNA content to see if you have the virus actively in you.  However, what if you had COVID-19 and recovered?  At that point the virus is gone, and you have the antibodies to it and are likely immune.

A far more useful number is a denominator for both those populations (those who actively have the virus and those that have the virus and are cleared of it.)   The central piece of scientific information is the zero prevalence (the proportion of the population that has antibodies to the virus). With that information we could know the true death rate and how extensively it has spread.  Another missing number in the denominator represents people who are symptom free and have the virus, so there is no factual way to know if the disease is as deadly as initially forecasted.  The problem is that not knowing this data leads to uncertainty as there is no obvious best course of action to take. 

Antibody Testing – The Solution?

We need to expand our capacity on antibody tests very rapidly and the scientists that want to measure the problem do it and find funding to pay for it. The FDA itself was a hurdle and only recently approved the first antibody test for use in the United States.   If antibody testing can prove successful and you are immune with no risk of spreading it, then we can systematically get people back to work and end the lockdown faster.

Lockdown – The Solution?

With the absence of data to determine what the actual rates are and lacking a miracle cure, the only apparent way to halt the pandemic was to starve it.  The goal referred to as “Flattening the Curve” referred to avoiding a sharp increase in cases in favor of a lengthier outbreak that stays within the bounds of what the healthcare system can handle.

The decisions going forward are critical. Often characterizing the lockdown and resulting $2 trillion in stimulus as a choice of dollars vs. deaths, it’s important to take into consideration that economic depression leads to people dying too.  It’s impossible to determine how well the lockdown has been successful in preventing excess cases and deaths – which is an example of the uncertainty in practice.

There aren’t obvious answers, or at least not yet. But opinion makers — even in traditionally left-leaning publications like the New York Times, are at least starting to ask the right questions.

 

EPR Properties Planning a Share Buyback

More news from EPR Properties (EPR):

EPR Properties Provides Update Regarding the Impact of COVID-19
Announces $150 Million Share Repurchase Program

KANSAS CITY, Mo. — March 24, 2020

EPR Properties (EPR) a leading experiential net lease real estate investment trust, today provided the following update regarding the evolving impact of COVID-19.

Company CEO Greg Silvers stated, “As we are all keenly aware, our nation and the world continue to navigate through the unprecedented challenges brought on by COVID-19. Our top priorities are taking care of our employees and all of our key stakeholders, to make sure everyone stays healthy and to position the Company to best navigate these difficult times. As we all work together to mitigate the spread of the virus, many of our tenants are temporarily closing their operations. While this period will impact our tenants’ businesses, we are committed to working with them as appropriate for our long-term mutual benefit.”

Mr. Silvers continued, “We have the ability to withstand the situation as we currently view it, given the Company’s strong balance sheet and liquidity position, including a precautionary draw on our line of credit. Also, in response to the market dislocation of our stock price, our Board of Trustees has authorized a limited share repurchase program which we will selectively deploy while carefully considering our liquidity position. By placing a pause on acquisitions and development, we are intensely focused on maximizing our financial flexibility and capacity until we have better visibility to the depth and duration of this situation.”

Key Updates:

* Strong Liquidity Position – As of March 24, 2020, the Company had cash of approximately $1.25 billion, including $750 million borrowed by the Company on March 20, 2020 under its Revolving Credit Facility as a precautionary measure to increase its cash position and preserve financial flexibility considering the current uncertainty in the global markets.

* Share Repurchase Program – Today the Company announced that its Board of Trustees (the “Board”) approved a limited share repurchase program in response to the extraordinary dislocation in the Company’s stock price. The Company may repurchase up to $150 million of the Company’s Common Shares, but is not required to repurchase a minimum number of Common Shares. The share repurchase program is scheduled to expire on December 31, 2020, unless extended or earlier terminated by the Board.

* Reduced Capital Needs – The Company has no debt maturities until 2023. Additionally, as previously disclosed, the Company revised its 2020 anticipated investment spending to include only previously committed investment spending totaling approximately $100.0 million.

Mr. Silvers concluded, “Despite the current environment, we continue to firmly believe in the long-term advantages of our portfolio and our strategy. Once the country emerges from this pandemic, we believe the demand for affordable out-of-home entertainment will be stronger than ever, as people re-engage, socialize and enjoy the experiences that our properties provide.”

From Business Wire

Charles here.

I’m not privy to any inside information here. But if EPR is announcing a share buyback, then that means they are not worried about the health of their tenants, particularly AMC, the movie theater chain.

So, either management is delusional… or, more likely, their tenants have given them assurances that either government or insurance money will be keeping them afloat.

We’ll see how this shakes out. EPR was being priced as if it were going out of business. My rationale for buying was that, even if the company had to reduce its dividend for a while, the shares were cheap enough to warrant buying. And shares are down by roughly half since I first mentioned it.

If the REIT is talking buybacks, then it is likely to assume the dividend is safe. Unless management has quite literally lost its mind, which would seem doubtful.

I also really like the fact that management isn’t growing for the sake of growth. It makes NO sense to buy additional properties when the company’s own shares trade at such a deep discount. Assuming the company has the liquidity — and it appears it does — aggressively buying back shares is the only move that makes sense.

Again, we’ll see how this plays out. But at current prices, the shares are down about 75% from recent highs. Even if the worst case scenario were to unfold, EPR is cheap.

Disclosures: Long EPR