While past performance is no guarantee of future results, Dundee has generated an impressive track record over the past twenty years for its shareholders. In addition, an investment in Dundee is providing a low priced hedge against a potential tail risk scenario. The share price is currently trading at a steep discount to its NAV leading to substantial positive optionality for the company’s private equity portfolio.
Over the last years, the fear of accelerated inflation spread around the world as central banks provided ever increasing amounts of liquidity. So far, this scenario has not played out yet as austerity, balance sheet recession and overcapacity put deflationary pressure on many economies. In fact, the IMF warns of deflation risk in its latest economic forecast. One investor who has proclaimed the risk of money debasement for some years now and has further increased the weighting towards hard assets in his portfolio is Ned Goodman, CEO, founder and largest shareholder of Dundee Corp. (Dundee). In his latest letter to shareholders, he makes the following comment:
“As the biggest buyer of Treasuries, it is almost impossible for the US Fed to turn around and sell without chances of collapsing the market. Surely any other holders of treasuries would want to front run the Fed, and what buyer would be foolish enough to get in front of the Fed freight train? The bottom line is that it is impossible for the Fed to fight inflation, which is precisely why it’s my view that they will never acknowledge the existence of any inflation to fight. Without the Fed’s buying, it would be impossible for the US Treasury to finance its new debt at rates it can afford. That is precisely why Dr. Bernanke has chosen to monetize the debt. Of course, officially acknowledging that fact would make his job that much harder. Without the monetization safety valve, the government would have to make massive immediate cuts in all entitlements and national defense, plus add big tax increases on the middle class, or any class. …If the Fed actually raised rates as a result of one of its movable goal posts being hit, the result could be a much greater financial crisis than the one we lived through in 2008. The bond bubble would burst, interest rates and unemployment would soar, housing prices would collapse, banks would fail, borrowers would default, budget deficits would swell, and there would be no way to finance another round of bailouts for anyone, including the Federal Government itself. It’s not really safe out there. In order to generate phony economic growth and to “pay” the US debts in the most dishonest manner possible, it appears that the Federal Reserve is leading the world to the destruction of the dollar. Anyone with wealth in the U.S. dollar should be concerned that the economic leadership is firmly in the hands of bureaucrats who are committed to an ivory tower version of reality that bears no resemblance to the world as it really is.”
So just another guy who is worried about inflation (stagflation)? Will the large central banks be able to take liquidity out of the economies before inflation becomes an issue? Will this be the big story of the next decade as everybody was preparing for inflation but it just did not come? Nobody knows for sure.
Though I define myself as a bottom up investor, I am not oblivious to macro trends in my investment approach. Moreover, in my capital allocation process I try to get exposure to investments that should benefit from tail risk scenarios. One of these scenarios is an inflationary environment. As a portfolio manager, I am looking for opportunities to profit from this potential outcome by investing in assets providing a margin of safety (This is not always easy as most of the time hedging is quite expensive). As a consequence, even if this scenario will not materialize, the odds that I will face the major investment risk, a permanent loss of capital, are low.
This brings me back to Dundee Corp. The overall investment thesis here is quite simple. Dundee is a Canadian holding company and has a variety of assets that are publicly-traded and some that are privately-traded. As the table below shows, at the current share price Dundee’s enterprise value is close to the value of its public securities holdings:
Currently, an investor is not paying for the company’s debt securities portfolio (book value of CAD 215 m), the private investment portfolio (CAD 202 m) and private subsidiaries (roughly CAD 150 m), which together are more than half of Dundee’s market value. Hence, the company is trading at something like a 35% to 40% discount to my assessment of NAV.
DREAM is a real estate company with approx. 9,000 acres of undeveloped land in Saskatchewan and Alberta, Canada. Dream is converting undeveloped land for end use in developed lots. The company also owns the largest residential home builder in Saskatchewan and an option to build on the developed lots or sell them to independent home builders. In addition, the company has approx. 2,100 condominiums in various stages of active development in the greater Toronto area. Apart from that, the company also has a contract to manage approximately CAD 10 bn of real estate assets across three publicly traded REITs (Dundee REIT, Dundee Industrial REIT and Dundee International REIT). In 2013, DREAM received management fees of approx. CAD 40 m on the assets of the three REITs. As this is kind of an open ended funds, the company can rely on an ongoing cash flow from a permanent capital base. DREAM is a spin-off from Dundee Corp. and has been listed at the Toronto Stock Exchange since May 2013.
Dundee Precious Metals owns two operational mines in Bulgaria and Armenia producing Gold, Silver and Cooper. Apart from that, the company owns a smelter in Namibia and has an interest in a number of other mining projects. With net debt of only CAD 35 m and relatively low cash costs the company seems to be well positioned in the current difficult environment for mining companies.
Dundee REIT and Dundee International REIT are both managed by DREAM. Dundee Corp. did not participate in the latest rounds of capital increases. So their share in these two REITs declined over the last couple of years. At the current price Dundee REIT provides investors with an 8% yield which is above average compared with its Canadian peers (6% to 7%), but is even more compelling if one compares this to the US REITs which currently yield on average below 5%. It is important to note that Canadian REITs have a lower payout ratio than their US counterparts. In addition, with a loan-to-value of 50% Dundee REIT seems to be rather conservatively financed. Dundee International REIT is investing in German commercial real estate and acquired over CAD 1.0 bn of office properties in 2013 doubling its assets under management. Current loan-to-value is 54%. Both REITs are currently trading slightly below book value.
The major private equity subsidiaries are:
Dundee Agricultural focuses on sustainable agriculture investments. Its largest holding is an 82% share in Blue Goose which is producing organic beef, chicken and fish. Blue Goose is the largest organic beef operator in North America, with operations in British Columbia, Ontario and Colorado and more than one million acres of predominately certified farm land under management. Blue Goose’ branded beef is sold to major grocery retailers and to luxury restaurants and hotels in Canada and the U.S. The acquisition of suitable capital grazing land to date gives Blue Goose the ability to handle up to 45,000 heads of cattle.
Management has a clear vision about the future of this company:
“Blue Goose is building a strong operating platform backed by valuable real estate that will leverage three critical factors: the burgeoning global population, the limited availability of arable land and the trend towards healthy, safe, clean food. The opportunity to build a premium brand of protein that connects with customers has never been better. “
Nichromet Extraction is a private research and development company. Recently, the company has developed a process that can extract gold from a mine’s gold ore concentrate without the use of cyanide. Cyanide has been banned for usage by most countries and there are many gold ore bodies that are lying idle for lack of a process that can extract the gold without cyanide. Nichromet process operation costs are similar to cyanidation on a USD/oz basis. Hence, this could be a game changer for the gold mining industry.
United Hydrocarbon is a private, oil and gas exploration, development and production company with activities in the Republic of Chad. Since 2012 the company owns the exclusive right to explore and develop oil and gas reserves in two proven oil basins by having paid a fee of USD 92.2 m to the Government of Chad. In case of successful oil production there will be made additional royalty payments to the Government of Chad. The total area covered under the agreement is approximately 5.3 million acres. The company targets a production of up to 10,000 barrels per day in mid 2015. If successful this oil production will be only 14 km away from a currently underutilized pipeline to the Atlantic coast. The company is also planning an IPO once production has started. Definitely very risky.
Apart from that, the company’s private investment portfolio consists of a variety of minority interests predominantly in small and mid sized mining companies. For the last four years alone, I counted 28 investments in different mining companies with an average equity investment of approx. CAD 3.0 m. Information is limited. Most of these companies seem to be in an exploration stage, so uncertainty is quite high here.
I could not find detailed information about the company’s debt securities portfolio. Part of it (CAD 66.7 m or 31%) seems to be invested in senior secured convertible bonds in relation to United Hydrocarbon. This hints to a relatively high risky below investment grade fixed income portfolio.
Why is the company cheap?
There are several reasons why the company trades at a discount to its NAV.
First, the company is seen as a conglomerate by the market and this provides for some complexity in valuing its assets or estimating the future cash flow generation of Dundee Corp. as a whole. However, it is important to note, that Dundee has generated an impressive 18% annualized return for its shareholders over the past twenty years. This has come from superior capital allocation and a shareholder friendly policy, where Dundee’s management has consistently worked on eliminating the discount to intrinsic value. The latest example is the spin-off of DREAM as the management regarded the value of this holding not reasonably reflected in Dundee’s share price. The same applies to the former listing of its REITs. To some degree this strategy is also comparable to the much larger Brookfield Asset Management where they unlock the value and then get management fees up to the top parent corporation. So I believe that in the future an investor can expect additional share buybacks and corporate transactions which are in the interest of shareholders. To borrow from valueandopportunity’s categorization of holding companies, I would argue that Dundee is a value adding Holdco in which case no discount should be appropriate.
Apart from that, the company’s holdings happen to be in sectors that are difficult times right now. For instance, concerns about a bubble in the Canadian housing market and a potential correction continue to linger. The Canadian market did not have a comparable decline like in the US. To the contrary, the volume of outstanding mortgages has almost doubled between 2006 and 2012. Housing expenditures make up a substantial 17% of GDP. However, there seem to be some important differences between the Canadian and US mortgage market. There is a very informative report about the Canadian housing market from CMHC, the Canadian public mortgage insurer, available. Based on this report, the Government implemented more stringent rules as to requirements to getting loans and requirements for servicing current loans (e.g. lowering max LTV, reducing the max amortization period). In addition, the rate of 90 days mortgage arrears in Canada is only 0.31% as at August 2013 (average since 1990 is 0.41%), according to the Canadian Bankers Association. This compares to about 1.26 % for prime fixed-rate mortgages in the U.S. for the first quarter of 2013, according to the U.S. Mortgage Bankers Association. Most of DREAM’s assets are in Saskatchewan, where there is a large presence from the mining industry, and which is experiencing very high new household growth and very high job growth. Residential building permits increased from 3,193 in 2003 to 8,643 in 2012.
That’s what Mr. Cooper, CEO of DREAM, is saying about a potential bubble in the market:
“We have been dealing with this sentiment for a long time, however, that doesn’t mean that it’s not going to happen. CMHC (public mortgage insurer) is calling for a reduction in housing starts next year, but when you drill into it, our markets are predicted to have very high housing starts although not quite as high as 2012. Our lands are in very attractive markets and are among the best in each market. Although there is always risk, having the best lands in growing communities is the best place to be. Our balance sheet is very strong and we are well positioned to manage our way through tough times, should they appear, and, at the same time, we are well positioned to benefit from continued strength in our four major markets.”
In addition, most investors shun away from the mining industry as falling commodity prices and ever increasing costs have a negative effect on profit margins. The mining industry is one of the few industries at the moment where capital is a scarce resource. In 2013, Dundee sold its remaining stake in Bank of Nova Scotia and invested part of the proceeds in additional mining investments. Dundee as an investor with strong expertise in the mining industry (Ned Goodmann is actually a geologist) should be able to negotiate attractive deals with miners and should be able to profit from the current situation. So Dundee could be a good investment vehicle to participate in a recovery of this industry. Furthermore, as an individual investor I get in the position to not being diluted again and again which seems to be specific for equity investments in the junior mining industry.
Dundee provides an attractive hedge against a potential tail risk scenario. There are certainly other potential investments available in other industries which are also inflation proof (Mastercard would be an example as the company gets a fixed share of credit card transaction volume). However, from my perspective Dundee is also trading at an attractive valuation as many potential risks are reflected in the current share price. In addition, I see the potential for a recovery in the mining industry. Dundee might be a good investment vehicle to profit from a rebound. Furthermore, given that the current enterprise value is covered by the public holdings, the private assets contain substantial positive optionality.
I will establish a 4% position for the portfolio with a share price limit of CAD 17.2. Please click here for more information on WertArt Capital and the virtual portfolio.
The content contained on this site represents only the opinions of its author(s). I may hold a position in securities mentioned on this site. In no way should anything on this website be considered investment advice and should never be relied on in making an investment decision. As always please do your own research!