REITs often attract a great deal of investors because of their strong cash flows and dividends, and those investors often overlook other parts of the business, choosing to analyze the company under a different set of criteria than companies in other sectors. This can create a problem in that it becomes difficult to compare a REIT to an industrial, which is fine if you use the typical top-down approach to stock selection; however, a top-down approach invites speculation in the fact that you are theorizing which sector will perform well going forward. Benjamin Graham taught that we should avoid speculation as much as possible, which is why it is critical to develop a system for analyzing companies that will allow them to be compared across industries. This is best done by utilizing a systematic approach to analysis that will provide investors with a sense of how a specific company compares to another investment opportunity. By using the ModernGraham method one can review a company’s historical accomplishments and determine an intrinsic value that can be compared across industries. What follows is a specific look at how SL Green Realty Corp (SLG) fares in the ModernGraham valuation model.
Company Profile (obtained from Google Finance): SL Green Realty Corp. is a self-managed real estate investment trust, or REIT, with in-house capabilities in property management, acquisitions and dispositions, financing, development and redevelopment, construction and leasing. It operates two segments: real estate and debt and preferred equity investments. The Company owns interests in commercial office properties in the New York Metropolitan area, primarily in midtown Manhattan. The Company also manages an approximately 336,201 square foot office building owned by a third party and held debt and preferred equity investments with a book value of approximately $1.4 billion. The Company also invests in well-collateralized debt and preferred equity investments.
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Defensive Investor – must pass at least 6 of the following 7 tests: Score = 5/7
- Adequate Size of Enterprise – market capitalization of at least $2 billion – PASS
- Sufficiently Strong Financial Condition – current ratio greater than 2 – PASS
- Earnings Stability – positive earnings per share for at least 10 straight years – PASS
- Dividend Record – has paid a dividend for at least 10 straight years – PASS
- Earnings Growth – earnings per share has increased by at least 1/3 over the last 10 years using 3 year averages at beginning and end of period – FAIL
- Moderate PEmg ratio – PEmg is less than 20 – FAIL
- Moderate Price to Assets – PB ratio is less than 2.5 or PB x PEmg is less than 50 – PASS
Enterprising Investor – must pass at least 4 of the following 5 tests or be suitable for a defensive investor: Score = 3/5
- Sufficiently Strong Financial Condition, Part 1 – current ratio greater than 1.5 – PASS
- Sufficiently Strong Financial Condition, Part 2 – Debt to Net Current Assets ratio less than 1.1 – FAIL
- Earnings Stability – positive earnings per share for at least 5 years – PASS
- Dividend Record – currently pays a dividend – PASS
- Earnings growth – EPSmg greater than 5 years ago – FAIL
|Value Based on 3% Growth||$62.14|
|Value Based on 0% Growth||$36.43|
|Market Implied Growth Rate||8.96%|
|Net Current Asset Value (NCAV)||-$86.93|
Balance Sheet – March 2015
Earnings Per Share
Earnings Per Share – ModernGraham
SL Green Realty Corp is not suitable for the Enterprising Investor or the more conservative Defensive Investor. The Defensive Investor is concerned with the insufficient earnings growth over the last ten years, and the high PEmg ratio. The Enterprising Investor is concerned with the high level of debt relative to the net current assets along with the lack of earnings growth over the last five years. As a result, all value investors following the ModernGraham approach should explore other opportunities at this time or proceed very cautiously with a speculative attitude. From a valuation side of things, the company appears to be overvalued after seeing its EPSmg (normalized earnings) drop from $5.02 in 2011 to an estimated $4.29 for 2015. This level of growth does not support the market’s implied estimate of 8.96% annual earnings growth over the next 7-10 years, leading the ModernGraham valuation model to return an estimate of intrinsic value falling below the current price.
The next part of the analysis is up to individual investors, and requires discussion of the company’s prospects. What do you think? What value would you put on SL Green Realty Corp (SLG)? Where do you see the company going in the future? Is there a company you like better? Leave a comment on our Facebook page or mention @ModernGraham on Twitter to discuss.
Disclaimer: The author did not hold a position in any company mentioned in the article at the time of publication and had no intention of changing that position within the next 72 hours. Logo taken from the web; this article is not affiliated with the company in any manner.