General Commentary
The U.S. economy continues to grind ahead and recover from the COVID crisis. The corporate news flow is filled with noise as we are now comparing current results to those that occurred during the depths of the crisis. Given the extremes that occurred last year the comparative data is difficult to use in making near-term decisions. The Federal Reserve is attempting to understand the true level of inflation, what is transient and what is permanent. Corporate CEOs are trying to understand the true level of demand for goods and services, not sure what was a onetime COVID purchase vs. an established new habit or mindset that has taken hold post COVID. The exercise can get overwhelming and paralyzing.
It is for this reason that we spend little time trying to form, and hold, an opinion regarding the direction of the economy. Our preferred path forward is to partner with, and allocate capital to, those that we believe will prosper irrespective of the economic landscape. Our strongly held position is that we want to partner with a firm or an individual that will adopt a long-term view and execute a well thought out plan and adapt to the environment around it. We adopt the same mindset whether capital is being deployed into public equities, real estate, or private equities.
While Carmel Capital Partners has been operating for 20 years it was only recently that we adopted a broader investment approach. The firm was founded with a mandate to invest in both public equities (stocks) and fixed income(bonds). We operated as such for the first 15 years of our existence. Because we have always embraced the entrepreneurial mindset of “adapt or die” we began thinking about better ways to serve investors. To that end, we first introduced an evolutionary step towards private equity and real estate investing in our Q3 2016 update on October 20, 2016. It was in this update that we outlined our rationale for adopting an expanded investment approach.
As quoted from the Q3 2016 letter:
“Our decision to move down this path is driven by several factors:
- First, we would like to expand the investable universe to deploy your capital beyond traditional stocks and bonds. As a firm we have a long history of opportunistic investing and applying this to private equity and real estate is a natural evolution.
- Second, the ability to invest across a broader set of asset classes will produce a more diversified and durable portfolio over the long-term. While we will surrender liquidity with these two investment options, we will gain exposure to attractive areas that might not necessarily be available in the public markets.
- Third, we believe our private equity investments will offer an opportunity for increased returns over time and we are comfortable sacrificing medium term liquidity (3 – 5 years) to achieve better returns.
- Finally, our goal with real estate is to consider capital preservation first, income second, and capital appreciation third. We will view all our real estate opportunities through this filter. Doing so allows us to again surrender liquidity in favor of incrementally better returns compared to publicly traded fixed income.”
And so, we marched ahead with our new mandate, making our first investment in February 2017.
Let us review the progress we have made, the early results we’ve enjoyed, what we’ve learned, and where we are going.
Real Estate
Through June 30, 2021, we have completed 17 real estate investments in the following areas: multi-family, office, self-storage, industrial, and retail. Geographically we have purchase assets in eleven cities, across seven States.
There have been three realized investments, one sold (Las Vegas self-storage) and two exited with a 1031 exchange (Boise and Boise 2.0). The remaining holdings are either mature (finished with their value add) or still in the middle of development/value add. Currently nine are paying distributions, and the balance are in development/value add mode. For those that are distributing the average yield is 9.54% on cost and for those that are mature we have generated an average Internal Rate of Return equal to 17.57%. All this information can be found on the last page of our quarterly real estate update. The three holdings we have exited, on average delivered an IRR of 36.45% and an MOIC of 1.79X.
We are pleased with our results thus far and especially pleased with the performance of our holdings during COVID. The partners we selected have all lived up to our expectations. All have delivered news (good and bad) in a timely manner, showed prudent and measured thinking in times of stress (think March 2020), and made decisions that lead us believe we have chosen well.
As expected, one or two investments have progressed faster then expected, and one or two have moved slower. As with any portfolio of investments, we expect a similar outcome in the future.
The below map highlights the location of our holdings.
Private Equity
We have made two investments over the past five years, roughly one every two and a half years. Our first investment was made in November of 2017 with the creation of Quantum Restaurant Group. We acquired 45 Little Caesars Pizza franchises in Tennessee, Georgia, and Florida. Thus far we have earned an IRR of 21.1% and an MOIC of 1.8X.
In June of 2019 we created Fulcrum Building Group to purchase three lumber, building, material distributions businesses in the Florida panhandle. As of June 30, 2021, we have generated a 57.6% IRR and a 3.76X MOIC.
We are pleased with the results thus far and are thankful that both businesses successfully navigated COVID.
In both cases we have acquired an operating company, recruited a management team, and formed a physical corporate office. Along this journey we have goals that have been achieved and others that are still, shall we say, in progress. We have been successful in conducting regular and productive quarterly Board meetings, established standardized financial reporting and KPIs (key performance indicators) and focused the team on the established long-term goals. Overall, we are thankful for the team we have in place and their hard work, especially during COVID.
For our private equity capital, our goal to expand the opportunity set in the coming years with the expectation of deploying capital with greater frequency. However, we will not compromise on quality and valuation as we do so. As a firm we have purposefully established a flexible investment mandate and are under no pressure to invest for the sake of investing. We allocate capital to those opportunities we believe offer the best risk/reward profile, and mostly remain agnostic as whether it is public equity, real estate, or private equity. To that end we added a new person to the Carmel Capital team at the end of June. Zack Israel joins us from KPMG where he was a Deal Advisory Senior Associate in the Mergers & Acquisitions group. Zack will be working on analysis and reporting for our real estate and private equity holdings. He will also be assisting with underwriting of all new investments. Zack brings youth, energy, intellect, and strong technology skills to the firm. We are excited to have him aboard.
Equity Update
The strong start to the year continued during the second quarter with our average equity portfolio generating a +18.57% return.
During Q2 2021 we added new positions in DoorDash (DASH), Home Depot (HD), RPM International (RPM), Twitter (TWTR).
We sold Grocery Outlet (GO), Extended Stay America (STAY), and View (VIEW).
We sold Grocery Outlet as the grocery landscape is shifting in a direction that we believe comes with increased uncertainty. Delivery has a role to play but is still unclear what format it takes. Existing grocery players are accelerating their investment (Amazon Fresh) and other digital enablers like Instacart are also increasing their presence. Add to the mix new players like DoorDash and Uber that now have relationships with grocery stores. Given the uncertainty and what we believe is an increasing risk profile we sold our position.
Extended Stay America was acquired by Blackstone and Starwood Capital, and we were forced to sell our position at what we believe is below fair value.
We decided to sell View after a very brief holding period. Immediately after purchasing our position, we became concerned about the company’s ability to fulfill its backlog of orders at the premium pricing they projected.
Both GO and VIEW were sold at small losses (less then 5%) and STAY was sold with a modest gain of 7%.
DoorDash (DASH) / Market Cap: $58 billion
DoorDash is one of three U.S. based food delivery platforms. The company’s mission statement is to “Grow and empower local economies”. The describe DASH as simply a food delivery service would be akin to describing Amazon as an “online booker seller” in the early 2010.
While DASH started off primarily as a food delivery platform it is quickly expanding into a service offering and strives to be the delivery solution for anything a user wants in 45-minutes or less. Today DASH offers delivery of food, convenience store (CVS, Rite Aid, 7-11), groceries from Pavilions, and even Petfood from PetSmart.
DoorDash offers a subscription service called DashPass, where for $9.99/month consumers can eliminate delivery fees and enjoy an experience close to Amazon Prime. Current DashPass users have demonstrated a purchasing frequency that is multiples higher (we believe this is 3X higher) than non-DashPass members
Over time as more users subscribe to DashPass it will drive higher order frequency and higher revenue for DoorDash. As more merchants are added to the platform the fly wheel effect will be more orders per user. While DASH foregoes delivery fees and service fees on each DashPass order, it does collect the $9.99/month.
The DoorDash management team has laid out a transparent business plan, which if successfully executed we believe will result in DASH creating significant shareholder value.
Home Depot (HD) / Market Cap: $348 billion.
Home Depot dominates the DIY (Do It Yourself) home improvement industry and also services the professional builder through its Pro Desk. We believe the macro tailwinds of first time home ownership for millennials and the continued repair/remodel of aging housing stock , will drive the company’s sales for a number of years into the future.
HD generates a significant amount of excess cash flow which it currently uses to pay a generous 2.05% dividend and repurchases roughly 5% of its stock annually.
Recently Home Depot announced the purchase of HD Supply, a company they previously owned. HDS sells a wide variety of products into the Maintenance, Repair and Operations (MRO) industry. Specifically, HDS services the MRO needs of the multifamily, hospitality and healthcare industries. The $55 billion MRO industry is highly fragmented with HDS owning only 5%. There is a large runway for HD to use its excess cash flow to accelerate consolidation of the MRO industry.
HD’s management and Board have a strong track record of thoughtful and prudent capital allocation. We look forward to seeing management continue with its success as it deploys capital to consolidates the MRO industry.
Twitter (TWTR) / Market Cap: $57 billion
TWTR is a leading platform for global real-time discussion and curated news. The company has been successful in attracting users who create and/or consume content, and it occupies a unique space in social media as a diverse, real-time conversational platform for both businesses and individuals.
Revenue comes from advertising on the twitter site/app and from the sale of user-generated data for targeted advertising campaigns. TWTR, however, has far-underperformed the leading social media platform, Facebook, which generates over 20x more revenue. Historically, limiting factors have included: (1) technology infrastructure that did not scale well for new features, (2) poor execution in monetizing its user base with outdated targeting tech for advertising, and (3) a platform concept that was too limited, too slow to adopt change, and time-consuming for new users to find relevant content.
In the past 2-3 years the company has begun to turn things around. It started with modernizing the underlying technology platform, which in turn has enabled the introduction of better and more relevant advertising concepts and improved usability for consumers – especially those who are new to the platform. Likewise, for content creators, it recently introduced multiple options for individuals or businesses with a substantial follower base to monetize users which will incentivize higher-quality content and new (non-advertising) revenue-share income for Twitter. These changes have led to an acceleration in growth for both users and revenues, but the company still has less than a 3% market share of global digital ad spend. We believe the opportunity ahead is much larger as new revenue opportunities develop over time and its ad market share begins to reflect a much-improved platform.
RPM International (RPM) / Market Cap: $11 billion
RPM manufactures coatings, sealants, cleaners and other performance-enhancing products for construction, infrastructure, consumer and specialty markets. It’s highly diversified with dozens of brands and hundreds of product lines, selling to both professional and consumer do-it-yourself markets. Rust-oleum is its largest consumer brand. Professional construction supplies include innovative products such as its hurricane-proof wall system for homebuilders.
The company has grown through a combination of niche brand and product acquisitions, and in-house product innovation and line extensions. The company is also amid an internal program to improve margins through cost and facilities rationalization, improving operational procedures and implementing company-wide software systems.
From a macro industry standpoint, durable growth drivers include consumers’ spending on home improvement, rising home ownership for the Millennial generation, US infrastructure spending, and environmental conservation goals which are aided by many of RPM’s products which improve energy efficiency or help extend the life of existing infrastructure.
We sold Grocery Outlet (GO), Extended Stay America (STAY), and View (VIEW).
We sold Grocery Outlet as the grocery landscape is shifting in a direction that we believe comes with increased uncertainty. Delivery has a role to play but is still unclear what format that takes. Existing grocery players are accelerating their investment (Amazon Fresh) and other digital enablers like Instacart are also increasing their presence. Add to the mix new players like DoorDash and Uber that now have relationships with grocery stores. Given the uncertainty and what we believe is an increasing risk profile we sold our position.
Extended Stay America was acquired by Blackstone and Starwood Capital, and we were forced to sell our position at what we believe is below fair value.
We decided to sell View after a very brief holding period. Immediately after purchasing our position, we became concerned about the company’s ability to fulfill its backlog of orders at the premium pricing they projected.
Both GO and VIEW were sold at small losses (less than 5%) and STAY was sold with a modest gain of 7%.
Fixed Income Update
Our fixed income portfolios continued to build on solid returns from Q1 2021 with the average portfolio generating a positive +3.8% year-to-date.
Year-to-date five fixed income positions have been called away and we added two new positions. As painful as it is to remain under invested, we remain disciplined and await a more attractive fixed income environment.
Real Estate
We completed two new real estate investments in Q2 2021. One is a retail center redevelopment in Sacramento, CA. The other is a tax free 1031 exchange with our Boise self-storage proceeds. More details about the Boise exchange can be found in the Real Estate Update.
Our pipeline is robust with opportunities that continue meet our underwriting criteria.
A more detailed description and update can be found in the “Real Estate Update” included with this letter.
Private Equity
We did not make any new private equity investment in Q2 2021.
We continue to evaluate the two Quick Service Restaurant (QSR) opportunities mentioned last quarter.
We ultimately decided to not move ahead with the Orlando grocery opportunity due to some concerning issues that materialized at the very end of due diligence. The quality of our partners is an area where we are not willing to concede even slightly and moving ahead with this investment would’ve required a concession. This was not a hard decision.
We are quite fond of the Will Rogers quote “It is not the return on my investment that I am concerned about; it’s the return of my investment.” Despite the simplicity and brevity of this saying, it was heavily applied here.
A detailed update on our current holdings can be found in the “Private Equity Update” included with this letter.
Concluding Remarks
With our equity portfolios at all time highs, real estate performing well, and our private equity firing on all cylinders, it’s hard to believe we’re only 18 months out from a massive global pandemic. It is easy to become complacent and relax one’s discipline in this type of environment. We remain on guard to ensure neither of these occur.
Sincerely,
Russell Silberstein
DISCLOSURE
Carmel Capital Partners is an SEC registered investment adviser. Carmel’s investment advisory services are available only to residents of the United States in jurisdictions where Carmel is registered. Nothing in this material should be considered an offer, solicitation of an offer, or advice to buy or sell securities. Past performance is no guarantee of future results.
Any historical returns expected returns [or probability projections] are hypothetical in nature and may not reflect actual future performance.
General Disclaimer: The information provided represents the opinion of Carmel Capital Partners and is not intended to be a forecast of future events or guarantee of future results. It is not intended to provide specific investment advice and should not be construed as an offering of securities or recommendation to invest. Not for use as a primary basis of investment decisions. Not to be construed to meet the needs of any particular investor. Not a representation or solicitation or an offer to sell/buy any security. Investors should consult with their investment professional for advice concerning their particular situation.
Carmel Capital Partners and their representatives do not provide legal advice. Your tax, legal and financial situation is unique. You should consult your legal advisor for advice and information concerning your particular situation.
Pursuant to the Securities Exchange Act of 1934, Carmel Capital Partners must provide clients with certain financial information.