Sold my last remaining REIT: Daiwa House Logistics Trust (DHLU)

In my 21 June post, I list all the REITs I sold. In the final paragraphs, I explained why I kept Daiwa House Logistics Trust (SGX:DHLU) in my portfolio. However, after some thinking, I also sold this last remaining REIT.   

On 3 August 2023, Daiwa House Logistics Trust presented its financial results for the first half-year of 2023. Link to the PDF of their presentation. The REIT is doing well, with 100% occupancy of its properties reached. The income growth looks satisfactory in Japanese yen terms, while the already low leverage has dropped even more. We can almost conclude that DHLU is a worry-free REIT until we reach the last part of the presentation. Management presents 28 pipeline properties suitable for inclusion into the REIT: 16 in Japan, 12 in Vietnam, Malaysia and Indonesia. These properties are all built by the REIT sponsor Daiwa House Industry Co., Ltd. This is the first time management included such a detailed list of potential acquisitions in its presentation. The message is clear: we can expect acquisitions from this pipeline shortly. This realization made me reconsider my holding. 

As we know, REITs have to finance new acquisitions by issuing new debt or equity. I am not excited about the idea of a rights issue. The share is currently priced at P/B = 0.74, which means a rights issue near the current stock price will be dilutive for the existing shareholders. Let's start with a general observation about P/B ratios. The book value of equity is often prone to manipulation by management, for example, by not writing down goodwill or inventory entries to reflect reality. However, DHLU's assets are modern, fully tenanted warehouses with straightforward valuations. Therefore, I consider DHLU's book value per share a good estimation of the value per share. 

Consequently, when DHLU would issue new shares at P/B = 0.74, it essentially sells a dollar for 74 cents. Warren Buffett buys back shares of Berkshire Hathaway when they are below his estimation of intrinsic value in order to create value for the company. Issuing shares below intrinsic value is the exact opposite and destroys value. Of course, I could participate in a DHLU rights issue to profit myself. However, my existing shares will still be diluted in value. My net benefit will be negative unless I buy a whole bunch of new shares. That would equate to doubling down, a dangerous psychological rabbit hole which I always avoid.

Will management wait until P/B = 1 before expanding the REIT? I doubt it. DHLU was initiated by its sponsor, Daiwa House Industry Co., Ltd., a prominent Japanese developer. The latter's incentive is creating a vehicle to purchase the warehouses it builds. The developer can then use the sales proceeds to build more properties, which is its primary business. The sponsor is not in the business of offering an optimal financial product for third-party investors. Of course, this observation applies to most REITs, and legal restrictions are in place to regulate the resulting conflicts of interest. However, it's good to be clear about the sponsor's incentives. Daiwa House Industry Co., Ltd has a stake of only 12.5% in the DHLU. The Related Parties Shareholding is one of the few weaknesses REIT-TIREMENT flags in its analysis.

Lastly, I have some concerns about this REIT's momentum. The REIT is among the last to be listed during a long Singaporean REIT glory period. The overall sentiment around REITs has turned more negative lately. DHLU's investors are mainly Singaporean private retail investors. We know this from the Annual Report 2022, in which a list of the Twenty Largest Unitholders are mostly nominees connected to retail brokers in Singapore. Private retail investors generally don't hedge currency risks. This means DHLU's share price is susceptible to the JPY/SGD exchange rate. Exchange rates are impossible to predict.

Adding to its fragility, DHLU has a modest SGD 400 million market cap. It's hard to see how DHLU would leap to the premier league of large REITs suitable for institutional investors other than by issuing shares and acquiring warehouses. Lots of them. Perhaps all the 28 pipeline properties. However, as explained, I do not support such rights issues. Not to even talk about issuing debt, which can be even more risky considering the current interest rate environment. 

In summary, we have a paradox. DHLU needs to grow, but I don't want them to expand. Damned if they do, damned if they don't. I chose to step aside.

Disclosure: Sold out Daiwa House Logistics Trust (DHLU)

More cosmetics: bought Creightons PLC (LSE:CRL)

My journey into micro-caps has started. Creightons could even be called a nano-cap with a market cap of only 22 million GBP. My market cap rule is not to buy companies below 100 million USD. I am scared that an incident such as a flood, a fire, theft, or a fraudulent employee would disrupt a small business too much and damage it permanently, even with proper insurance in place.

I decided to take a chance with Creightons anyway. The company has been under sensible and conservative management for at least 20 years. If you want to get an impression, YouTube provides an online presentation delivered by the current management. Financially, the company offers everything a value investor could wish for: insider ownership, high ROIC, free cash flow, little debt and consistent growth. The company is too small to be investable for professional funds. That may be the reason why the stock valuation seems low. I bought at an average of 0.32 GBP between June and August 2023, during which I accumulated a 4% position in my portfolio. Based on my DCF calculation, I estimate the stock's fair value to be 0.55 GBP.

Creightons invents, produces and distributes cosmetics and personal care items. They supply British supermarkets like Tesco, Sainsbury's and Boots with their house brands in these categories. They also do contract manufacturing, which means they can deliver one-off inventory orders placed by third-party personal care brands. For a detailed description of Creightons, I refer to this blog of Eddie Lloyd. A year later, Eddie wrote an update which includes a valuation model.

Another long-term shareholder is Adrian Ford of the Overlooked and Undervalued substack. Adrian highlights an important change in Creighton's strategy. The company bought and developed several own brands: Feather and Down, The Curl Company, Balance Active and Emma Hardie. These brands have the potential to grow.

Especially Emma Hardie is interesting. I did a quick and informal online review of this premium skincare brand. Emma Hardie's presence on TikTok is small compared to large brands like L'Occitane, but there are still a few dozen reviews, instruction clips and promotional clips. Emma Hardie has 63,000 followers on Instagram. The Amazon user reviews of their top-selling products are overall good. Creightons understands it has to work with these new media channels. It is nothing like the cases of HAI-O and Able Global, where the lack of presence on social platforms is unsettling.

I am betting that Emma Hardie or one of the other brands will break through internationally and drive Creightons' revenues upwards. Should the team fail, the house brand and contract manufacturing business will still be there. Heads, I Win; Tails, I Don't Lose Much.

Disclaimer: This investment is risky because of Creightons' small market cap and illiquidity. Do not invest without doing your own research first. The share trades under the SETSqx trading system of the LSE. This means there is only trading at 8am, 9am, 11am, 2pm and 4:35pm UK time. 

Disclosure: Long Creightons. Sold HAI-O and Able Global earlier this year.

Bought: L'Occitane International SA (HKSE:0973)

In an earlier post, I described how I disposed of almost all my REIT investments. I had initially intended these REITs as inflation hedges. History shows that real estate is a relatively stable asset class during (hyper) inflation. Turns out that a REIT is not the greatest wrapper for real estate holdings. It often comes along with a lot of debt. I decided to abandon my REIT strategy.

That does not mean my worries about inflation are gone too. I switched my attention towards consumer staples stocks to address those worries. 

The best businesses during inflation are the businesses that you buy once and then you don’t have to keep making capital investments subsequently, so you don't face the problem of continuous reinvestments involving more and more dollars because of inflation. That's one reason why real estate, in general, is good during inflation. It's a one-time outlay and you also get the rise in value as well. A brand keeps increasing in value and is a wonderful thing to own during inflation.

In contrast, the utilities and rail road business keep eating more and more money. Your depreciation charges are inadequate and the real economic profits poor. Any business with heavy capital investment tends to be a poor business to be in during inflation and in general for that matter.

(Paraphrased from Warren Buffett, Berkshire Shareholder Meeting 2015)

L'Occitane is a cosmetics company that offers several brands: L’Occitane en Provence, Elemis, Sol de Janeiro, Grown Alchemist, Melvita, Erborian, and LimeLife. Most of the products are targeted towards women. Let me disclose here that I am male and not familiar with any of these brands. Thanks to social media, I did some basic vetting of these brands. The Instagram page of L'Occitane has 947K followers, Sol de Janeiro has almost the same amount. Elemis has 533K, Erborian 219K, Grown Alchemist 167K, Melvita nearly 100K and LimeLife 68K followers. These numbers are for the general pages of these brands. Most have additional country pages with localized content and separate communities. To calibrate these numbers, let's look at competitor and market leader L'Oreal which has more than 10 million Instagram followers just for its leading brand. However, L'Oreal has a 241 billion USD market cap, whereas L'Occitane clocks in at 4.3 billion. This quick sanity check tells us that L'Occitane has a good position in the cosmetics universe but also has room to grow.

Stock researcher Morningstar considers the core brand L’Occitane en Provence as mature. It expects growth to come from Elemis and Sol de Janeiro. The Morningstar analyst also expects sales to shift from retail stores to e-commerce. The analyst is optimistic about L'Occitane's brand equity and attributes a narrow moat (= competitive advantage) to the business. In conclusion, Morningstar considers the share significantly undervalued. I don't want to reveal more details because this Morningstar research report is behind a paywall. I am a subscriber and find their research occasionally insightful. In this case, Morningstar's report was very helpful for my research.

Adding to my conviction is the family ownership of L'Occitane. Mr Reinold Geiger holds 72.82% of the shares. He is not the original founder of L'Occitane but has developed the group from a local French operation to an international business. At age 74, he is stepping back from the company, but two of his sons remain active.

L'Occitane sells its products on a worldwide scale. Its headquarters are in Luxembourg and Switzerland, while the listing is on the Hong Kong Stock Exchange. The dividend withholding tax is taken by Luxembourg, where it is 15% of gross dividends. This will be hard to claim back. If L'Occitane increases its dividend payout ratio from 0.2 to 0.4, as was common before the Covid lockdowns, we are looking at a 4% dividend yield. This is good for a growth company. At the moment of this writing, the share still seems cheap. 

Last minute addition: as I was finishing this post, news came out that Mr Reinold Geiger is considering de-listing L'Occitane by bidding on the shares listed in Hong Kong. He may then list L'Occitane on another exchange. This news is unconfirmed, but it is likely true, as such a move is common sense considering the circumstances. I am only holding L'Occitane for a few weeks, so this might become a quick profit for my portfolio. On the downside, I need to find a suitable replacement for L'Occitane, and I have not seen many bargains recently.

Disclosure: Long L'Occitane International SA, when publishing this blog