Value Library

The following is an excerpt from the ABC Perspective - July 2005 - Pg. 3

ROYAL HOST REIT

While Royal Host REIT became a public entity in 1998, the Trust can trace its history back to 1974. During that year, the Royer family, who still lead Royal Host to this day, selected Red Deer, Alberta for their first hotel operation. Nearly 25 years after they launched their first hotel, the Royer family packaged their various business ventures – from time share operations to marinas – into what is now known as the Royal Host Real Estate Investment Trust. The issue, with a unit price of $10, raised $128,000,000 in equity for the Trust. Today, the Trust’s hotel portfolio consists of 37 properties located across Canada with a total of 5,039 guestrooms. The REIT also has a franchise operation through Travelodge Canada.

As is evident by current unit prices, the last seven years have been anything but smooth for Royal Host. Events such as the September 11th terrorist attacks, the subsequent economic recession, and SARS, negatively impacted Canada’s hospitality industry. The challenging operating environment forced the Trust to cut its monthly distribution from $0.08 to $0.02 a unit.

We believe that Royal Host’s units are fundamentally undervalued, and several catalysts have emerged that will unlock unitholder value. The most important development has been management’s clear intention to re-focus the Trust back to its core competence: hotel ownership and management. The first stage of this plan is currently being executed. Troubled properties such as the Toronto Travelodge and the Oklahoma marina have been sold. In a related announcement, the Trust signed a deal with Humphrey Hospitality to expand its hotel management business.

For Canadian REITs, the key valuation metric is net asset value (NAV). We estimate Royal Host’s current NAV to be $6.50/unit. With a renewed focus, greater margins, and capital structure changes, Royal Host’s NAV could easily reach $7.00/unit. As the turnaround progresses, the Trust could raise its annual distribution to $0.48 per unit.

The other catalyst on the horizon for Royal Host is the presence of George Armoyan. Mr. Armoyan has a history of buying large stakes in undervalued companies – and then either taking them out entirely or convincing management of other strategic alternatives. Geosam currently owns roughly 18% of the Trust’s outstanding units. During Royal Host’s 2004 Annual Meeting, Mr. Armoyan’s influence went beyond merely economic. By using his voting rights, Mr. Armoyan disposed of three long-standing board members and installed three of his associates. With control of the Board, the Trust’s strategic repositioning will only be accelerated.

 

S&K FAMOUS BRANDS

S&K Famous Brands is a Richmond, Virginia-based men’s apparel retailer operating 235 locations in 27 states throughout the U.S. The stores carry an assortment of suits, sportcoats, slacks, shirts, ties and shoes at prices 20% to 40% less than regular, full priced department and specialty stores.

We recently purchased shares of S&K Famous Brands as a micro-cap stock for our North American Deep Value Fund. S&K has just 2.5 million shares outstanding and with insiders owning close to 28% of the company, its public float is even smaller. Trading in the stock is therefore very illiquid and not surprisingly, not one analyst officially covers it. With no need to raise money via a stock issue and given the increased time and money needed to comply with Sarbanes-Oxley, we wondered why S&K bothered to remain a public company.

Then on March 16th, 2005, the Company announced that it was voluntarily terminating the registration of its common stock with the Securities and Exchange Commission. The main reason cited was complying with the Sarbanes-Oxley Act which management said was costing the company over $300,000 a year. As a result, trading in the stock was moved from the NASDAQ National market to the Pink Sheets. Since de-listing from the NASDAQ, shares of S&K have continued to languish despite the fact that business has improved significantly. The Company recently announced that first quarter earnings would be in the range of $.88 to $.93 per share compared to earnings of $.67 a year earlier. In May, comparable store sales at S&K rose an impressive 10.1%.

At approximately $17, shares of S&K trade at an 18% discount to its book value of $20.75. Management recently stated that its $2.5 million stock repurchase program was still in effect and its shares currently “represent an attractive investment for the company”. We agree. In fact, completion of the buyback program at current prices could be accretive to book value by $1.50 per share. If you add to that over $1.00 in earnings this year, S&K could very well end the year with a book value of over $23.00. Given the company’s recent deregistration, small public float and attractive valuation, we would not be surprised if management eventually decides to take the company private. With a potential take out price of $23, investors purchasing shares of S&K today could be rewarded with a 50% return.

Irwin A. Michael, CFA