Value Library

The following is an excerpt from the ABC Perspective - January 2008 - Pg. 3

ABC Fund Value Favourites

LAKEVIEW HOTEL REIT

Established in 2004, Lakeview Hotel REIT is among several junior REITs that have launched over the last couple of years. At the end of Q3 2007, Lakeview owned 16 limited service hotels with a total of 1,197 rooms. Geographically, the REIT’s focus is on secondary markets in Alberta, British Columbia and Ontario. Secondary markets, while certainly not as glamorous as city centres, provide many opportunities for Lakeview. The main advantage is higher cap rates: average rates in these markets hover around 10% compared to 7-8% for urban cities such as Toronto, Calgary, or Vancouver. Additionally, secondary markets fall under the radar screen for larger industry participants. As a consequence, limited service hotel ownership is fragmented with many owned and operated by local entrepreneurs.

Unlike a typical hotel REIT, which may own a portfolio of hotels with various brands, Lakeview immediately re-flags purchased hotels with the Lakeview banner. While Lakeview’s strategy is essentially the same as all new REITs – growth via acquisition – the Company’s brand strategy is a competitive advantage and hidden asset. Each hotel is quickly brought up to the standards of the brand (which is usually accompanied by an increase in room rates). Marketing and brand positioning is vital in the hotel industry; once the number of hotels flagged under a brand reaches a critical mass, travelers begin to associate the brand with certain levels of service, comfort and pricing. As the number of Lakeview-flagged hotels grows, the brand’s value grows in lock-step.

On November 28th, Lakeview reported Q3 results. Overall, the Trust’s Q3 results were a substantial improvement over Q2 and demonstrate that Lakeview’s management team is doing a good job of navigating turbulent markets. Most importantly, the Trust’s payout ratio came in below 100%, which should give comfort to investors. Despite impressive top line growth, Lakeview’s hotel performance numbers continue to reflect reduced oil & gas activity in Western Canada. Lower occupancy in the quarter offset higher room rates to bring RevPAR (revenue per available room) down to $78.80 from the $86.06 achieved during the same period last year.

Like many REITs, Lakeview’s stock price declined after the subprime/asset-backed commercial paper turmoil surfaced in August. Additionally, a temporary payout ratio in excess of 100% during Q2 further bothered investors who then went on to seek larger capitalization, well-known names. As a result, Lakeview’s unit price now trades at a discount of approximately 50% to our calculation of net asset value. Based on a conservative forecast of accretive acquisitions and licensing revenues, we arrive at a NAV of $5.50 per unit. Given the management team’s conservative approach and extensive experience in the industry, we have confidence that Lakeview will emerge as one of the leaders of the new generation of REITs.

JO-ANN STORES INC.

Jo-Ann Stores is the largest specialty retailer of fabrics and one of the largest specialty retailers of crafts in the United States. It operates 194 large format stores and 595 small format stores throughout 47 states. Each store features a variety of competitively priced merchandise used in sewing, crafting and home decorating projects. Industry sales were approximately $30 billion in 2006, representing a 2.6% four-year compound annual growth rate. In addition, it is believed that approximately 57% of all US households engage in some form of sewing or crafting.

After reporting a $23 million loss in 2005 due to operational and industry issues, Jo-Ann Stores looked to new leadership by hiring Darrell Webb as its CEO in July 2006. Jo-Ann’s board hoped that Webb, previously the President of Kroger’s Fred Myers division, would use his big box merchandising experience to return Jo-Ann stores to sustained profitability. After embarking on a 100 day plan to assess the business, Webb initiated a “repair plan” to address the operational challenges facing the company including declining sales, inventory control and marketing.

The turnaround plan at Jo-Ann Stores was working. The third and fourth quarter results of 2006 showed steady improvement and it appeared as though the company was on the road to recovery. On May 31st 2006 shares of Jo-Ann Stores reached an all time high of $33.82 after it was reported that the company was in talks to be acquired by one or more private equity firms. The rumoured price was $1 billion which implied a per share value for Jo-Ann of $40. When news of a deal did not materialize, a lot of short term traders who purchased the stock for the takeover lost patience and began selling their shares.

Interestingly, the intense competitive nature of the fabric business seems to be subsiding. Hancock Fabrics, the second largest pure fabric retailer, has been closing stores and Wal-Mart recently decided to exit the category in the majority of its locations. This should result in better sales and improved margins in fabrics for Jo-Ann Stores going forward.   However, given the lackluster holiday shopping season and signs of a possible recession in the US, the shares of many US retailers have plummeted to severely depressed levels. 

Irwin A. Michael, CFA