P_Wei
It’s been six months since I last covered California land holding and development company Tejon Ranch (NYSE:TRC).
At the time, I had grown somewhat less pessimistic about the firm’s prospects, raising my rating from “sell” to “hold”.
Given the persistently higher levels of inflation, some investors are starting to look for inflation hedge securities and investments once again. I’ve seen several people mention the land bank equities as interesting ideas for the current macroeconomic environment. I share that sentiment generally, and there are several of the land stocks that I find interesting at or near current prices.
However, I don’t think Tejon Ranch has the same upside from that sort of scenario. In fact, I see the current economic climate as a challenging one for Tejon Ranch.
Shares have rallied 10% since my last report, and are now back to flat over the past 12 months. Though TRC stock has badly trailed the S&P 500 over the past year, the recent pop has apparently given traders some cause for optimism. I hold the opposite view; I see the recent rally as unfounded, and as such I am returning to a sell rating on Tejon Ranch shares going forward. Here’s why.
Underwhelming Earnings
Quarterly earnings are generally not the central factor in evaluating a land bank-style investment. That said, earnings are useful for seeing any operational momentum at a firm.
For example, St. Joe (JOE) the large land development company in Florida, posted strongly improving revenue figures since 2020. Specifically, St. Joe’s revenues soared from $127 million in 2019 to $389 million in 2023.
This gave investors tangible evidence that its properties are finding real resonance with consumers and developers during the pandemic-driven housing boom. St. Joe also became strongly profitable on an EPS basis over the span and its shares soared as a result:
Tejon Ranch by contrast has not shown sustained momentum for a long time.
That’s not an overstatement or hyperbole on my part. Just look at this long-term revenue chart:
Aside from one blip in 2022, Tejon Ranch has been stuck around $50 million or so of annual revenues for the past decade.
Zooming in, fourth quarter 2023 revenues fell from $20.7 million in 2022 to $18.8 million this past year. Net income fell from $2 million to $1.6 million. The company actually saw significant jump in its agricultural revenues as it enjoyed a better pistachio harvest than in the prior year; however, this was more than offset by slower activity elsewhere.
For full-year 2023, net income declined sharply from $0.60 per share to just $0.12 per share for fiscal year 2023. They should take away the bullish talking point that TRC shares were somewhat reasonably valued current ongoing earnings. It turns out the 2022 earnings were seemingly helped by particular factors and do not appear to reflect the true recurring earnings power of the business.
With the company earning just $0.12 per share in fiscal year 2023, shares trade at a lofty P/E multiple based on those results. That makes sense, as despite all of the development efforts over the decades, there is still not too much going on with Tejon Ranch besides the core agriculture operations. Real estate development has occurred at a snail’s pace, and the company’s earnings picture reflects that.
Will The Bullish Development Case Ever Occur?
My bigger concern comes not from earnings but rather the longer-term outlook.
I’m starting to wonder if there will ever be an economic rationale for developing most of Tejon Ranch’s land. The company’s long-running bull case was centered around the idea that suburban sprawl was inevitable, and it would only be a matter of time until Tejon Ranch found itself in the path of natural outward development from Los Angeles. But in a time when suburban shopping malls have lost their luster and commercial offices are in increasing trouble, it’s worth revising the core premise here.
For a while — certainly leading up to the 2008 financial crisis — developers were building homes in incredibly far-flung parts of California with huge commutes to the major cities and job centers.
Since that point, the climate has really changed. We’ve seen more building and redevelopment within the existing urban fabric. Today, developers are far more focused on in-fill apartments and condominiums located much closer to urban centers as opposed to massive new suburban communities. It seems that millennials and younger homebuyers are more interested in amenities, proximity to restaurants, transit, and so on as opposed to higher square footage and lot sizes.
Diminishing the appeal of L.A.-area suburban sprawl even more, California simply isn’t as appealing for massive new planned communities as it used to be. The state’s population has been declining since about 2015. While California continues to attract foreign immigrants and has somewhat more births than deaths, these positive factors have been superseded by domestic outmigration; massive numbers of Californians have moved to states like Arizona, Texas, and Florida.
This trend was already pronounced enough in prior years that California lost a congressional seat when the electoral map was redrawn in accordance with the 2020 census. And the pace of that outmigration accelerated during the pandemic; for example, according to a Stanford policy briefing California lost a net of 407,000 residents just between July 2021 and July 2022.
This indicates that the demand for new housing developments may be shifting to markets such as Orlando, Dallas, and Phoenix and away from Los Angeles. Perhaps instead of building out Tejon Ranch into a massive suburban development, those houses will instead go up in Phoenix or Dallas.
Does Los Angeles really need a huge development 75 miles outside of its downtown? What if the population and regional economic activity never really makes it that far outside of the core urban center?
The bull cases I’ve seen for Tejon Ranch always assume that it’s only a matter of time until this land is developed and that investors just need to put the right discount rate on it. For example, if the property gets developed in five years, it could deliver a huge IRR whereas if the wait is 20 years, it would result in a much lower IRR.
That’s the sort of framework I think investors have used to assess this company. However, what happens if Tejon Ranch is never developed in full and instead the company is still growing pistachios on the land 50 years from now? I think that’s a real question which investors increasingly have to think about.
There was the pandemic-driven housing boom, where developers engaged in a ton of construction activity around the country. Other land banks, such as St. Joe, saw their shares surge. However, it appears California’s demographics may have already turned downward to the point to make it challenging for development at a place like Tejon Ranch. And that’s even putting political and environmental constraints aside for the time being.
Now, with interest rates being stuck at higher levels for longer, and younger buyers being increasingly locked out of affordable mortgages, I wonder if the moment has passed. Tejon Ranch missed out on the early 2020s housing boom, which now appears to be winding down. Presumably, at some point, there will be another recession which will further depress sentiment around new housing construction. There won’t be demand to develop a massive suburban housing community during a recession.
On the other side of that, with California’s weak demographics, will demand still be there for Tejon Ranch in the 2030s or whenever this project could conceivably finally get going?
Don’t forget that there are other trends such as remote work and self-driving cars that could change the economics of remote suburban communities. A decade from now, will people still value having a house 60 miles away from a major urban center? As those new technologies take off, perhaps people will prioritize other factors and make the old suburban satellite communities model less relevant.
Simply put, I’m becoming increasingly skeptical that Tejon Ranch ever gets developed in a major way. The early 2020s were a golden opportunity for these sorts of land bank companies to gain momentum, and while some were able to seize the moment, Tejon Ranch did not. If Tejon Ranch’s land remains largely as it is now, I see little reason to think that the valuation would increase dramatically, even in an inflationary scenario.
I would much rather own land assets supported by things such as mineral royalties, timber sales, and so on. These have a clearer way to benefit from higher commodity prices.
In the event that most of Tejon Ranch remains effectively undeveloped green space, I see minimal appeal to the stock at today’s prices.
New CEO Could Be A Positive Development
An optimist can point out that Tejon Ranch’s CEO, Gregory Bielli, just announced his retirement. Shares went nowhere under Bielli’s decade-long run as the CEO of the company. Perhaps as the company turns to new management, this will spark a change in business strategy that leads to more favorable results for shareholders.
You can see something like with Maui Land & Pineapple (MLP) where the company brought in a new CEO in early 2023 and shares have doubled in short order. A fresh leadership team can make a huge difference in these land bank companies.
It’s possible that’s a new CEO will help get development rolling for Tejon Ranch. However, from my perspective, that seems like a pretty thin bull case. I see structural headwinds for Tejon Ranch including high interest rates, California’s demographic problems, and an increasing apathy towards large scale new suburban development far outside urban city centers.
This leads me to increasing skepticism that Tejon Ranch will ever really have its moment to shine. I am moving back to a sell rating on TRC stock, and I expect to see the stock trading to fresh 52-week lows in coming months.