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Real-estate backed department store operator Hudson’s Bay (HBC) had
another volatile month, ending with a gain of 14% after being down as much
as 17% at one point. The sell-off was prompted by further declines in its
retail sales; the recovery followed the publication of a letter from an activist
investor, Land & Buildings, calling for the company to accelerate the
monetisation of its valuable real estate assets. The letter contained no
information or ideas that are unfamiliar to anyone who knows HBC well and
our concerns are not that management is unwilling to take further steps in
this direction but that the company may now be in a position where it is
unable to do so. There is unquestionably an enormous amount of value tied
up in the company’s real estate, but sales and margins have deteriorated
faster than we had anticipated and there are now serious question marks
over whether further monetisation of the real estate can take place at
valuations acceptable to management given market concerns around retailexposed
commercial property. Furthermore, our thesis relied in part on an
in-specie distribution of the property JVs following their anticipated listing.
Not only is the timeframe for their IPO now more uncertain, but we now
believe the dividends from HBC’s stake in them are too important to the
company’s finances for an in-specie distribution to go ahead. Land &
Buildings’ letter called for retail stores to be closed down and the property
repurposed for alternative use. While this would be a clear route to
unlocking the trapped value, we do not believe the Chairman Richard Baker,
who together with his family owns 18% of the company, would countenance
such a move in the foreseeable future. HBC is a polarising stock and we
have up until recently been in the bull camp, but our concerns are now
sufficient that we reduced our position following the share price spike
towards the end of the month.

Hudson’s Bay’s share price continued its roller-coaster ride, climbing 15% in April. This followed comments from Chairman Richard Baker on the Q4 results call reiterating their intent to IPO their real estate portfolio. A large portion of this portfolio has already been placed into separate JVs, giving clear visibility on the cash flows and dividends generated. Further disclosure on this and the company’s debt and capital structure were also well received by the market. During the month, AVI visited the company’s flagship store in New York and spent time with senior management including Richard Baker. The trip was useful in gaining greater insight into the way in which management view the company’s real estate, and on the implications of different ways of monetising it and we left with our conviction in this compelling value story undiminished.

The depth of valuation work we carry out on our holdings’ underlying assets
gives us the conviction we need to run a concentrated portfolio and large
positions and, as importantly, to hold on to or to add to them when the
market is suggesting we are wrong. This is certainly the case with Canadian
retailer Hudson’s Bay. Over the month, it was our biggest detractor. The
previous month, it was our top contributor. The month before that, it was
our biggest detractor. At the time of writing, it is our top contributor for April
so far. This is a protracted way of saying the shares are volatile. Operating
in a sector that faces secular challenges and regular comment on the death
of bricks-and-mortar retail, it is unsurprising the shares are affected by wide
swings in sentiment. Amidst the volatility, it is our conviction in the value of
the company’s real estate and management’s ability to surface that value
that keeps us invested and able to take advantage of Mr Market by adding
to our position opportunistically

Last month’s largest detractor was this month’s joint star
performer as Hudson’s Bay (HBC) recovered from its lows,
increasing 23% over February as the market responded to
speculation that HBC is poised to make a bid for its much larger
rival Macy’s which, like HBC, owns valuable freehold real estate.
Whether HBC can pull off a deal for Macy’s remains to be seen,
but the news has certainly served to highlight the value in the
real estate of both retailers. HBC is much further on the journey
to monetising its property holdings, having already spun off a
sizable portion of them into private JVs. We continue to believe
the ultimate end-game of Richard Baker, HBC’s Chairman and
largest shareholder, involves a full separation of the retail and
property assets with a listing for the latter highlighting their true
value. HBC contributed 71bps to BTEM’s NAV over the month,
justifying our decision to add to the position after it had fallen
dramatically during the previous month.

The most significant detractor by far was Hudson’s Bay (HBC), which cost 93bps over the month as the shares fell by 24%. HBC is a Canadian-listed retailer with department stores across Canada, the US, and Germany. Our interest lies in its freehold property, which is worth considerably more than the company’s market cap. The US retail environment has been weak for a while, but it was the announcement of a cut in earnings guidance in early January that precipitated the latest and most severe decline in the company’s share price to $10 per share.

The market views the company as a retailer and hence prices it based on operating performance. Sell-side analysts are unwilling to apply anything approaching a full value for the real estate assets, as the timing of a monetisation event is so unclear. Our conviction in the story is based on a number of important facts that analysts appear to be ignoring. Firstly, the Chairman Richard Baker – who has a business background in real estate – owns a c. 27% stake in the company worth C$500m. Secondly, a big proportion of property assets owned by HBC has already been transferred into private JVs via commercial arm’s length transactions with third party investors. HBC’s stakes in these real estate JVs contribute CAD16 to our NAV estimate for HBC. Were they to be listed we believe it would provide transparency to the market on the valuations of these vehicles and this should be reflected in HBC’s share price.

This analysis also ignores the material value to be found elsewhere in HBC’s real estate portfolio, most notably its SAKS Fifth Avenue store which we also believe to be worth comfortably more than the current share price on its own. In an interesting development after month-end, it was widely reported that HBC is in discussions to acquire Macy’s, whose US$9.5bn market cap is 6x bigger than that of HBC. While neither company has confirmed the reports and the story is yet to unfold, we are mindful that Macy’s owns a significant real estate portfolio, estimated to be worth more than its current market cap, and that HBC has funded acquisitions in the past using the acquired company’s real estate as a currency. We added to our position in HBC in January following the decline in share price.

Our biggest detractor was Hudson’s Bay (HBC), which reduced our NAV by
40bps after a downgrade of their full year forecasts. HBC is suffering
alongside much of the North American retail landscape from a myriad of
headwinds, and its European operations that had previously offered
protection have seen sales impacted by warm weather in Germany. In early
December, the share price fell further following Q3 results that, although in
line with updated guidance mentioned earlier, missed consensus forecasts
as like-for-like sales fell 2% over the nine months.

Due to the number of transactions carried out by the company over the last
twelve months, quarter by quarter results have proven difficult to forecast.
However, as these begin to roll off, we should see comparable numbers
come through that will allow the market to better judge operating
performance and cost improvements implemented by the company.
However, we are cognisant that the company needs to work hard to improve
operations, which we believe they are doing through a number of initiatives.
We maintain our view that the vast majority of the value in this company is in
its owned real estate portfolio. HBC own many of the properties from which
they operate, in JVs and directly, which are typically in down-town locations
on prime retail pitches – their most iconic building is the Saks 5th Avenue
store. We have spoken with management since their Q3 results were
announced and remain convinced they are committed to realising the value
embedded in their real estate portfolio while working hard to improve
operations. We added to our position in November and at the start of
December.

Hudson’s Bay (HBC) was the only meaningful detractor. HBC released Q2
results during the month and while EBITDA guidance was still within their
original C$800m-C$950m range, they expect EBITDA to “trend towards the
bottom end of the range”. While this is disappointing, it is of no great
surprise given weak North American retail numbers over the year so far. We
believe, however, that the share price weakness on the back of such
numbers provides opportunity. The confirmation of the value of their
real estate, through partial sales or the eventual listing of their real estate
JVs, is the main driver of our investment case. With their real estate
portfolio accounting for nearly 75% of assets in our sum-of-the-parts
valuation, share price weakness on the back of weaker retail numbers that
we had anticipated gives us an opportunity to buy the real estate at ever
cheaper values. We added to our position in September.

The next biggest contributors included Hudson’s Bay (improving numbers
from North American department store sector), Wendel (discount in from
40% to 36%), and Aker (continued NAV strength; strong Norwegian Kroner).
Just behind was JPEL Private Equity, which posted a strong June NAV
(+5%) and has now delivered +13% NAV growth in Q2 2016 as the
attractively-priced and fast-growing investments made over the last couple
of years bear fruit. In our view, the shares are mis-priced, trading on a
discount of 28% despite the company now being in run-off.

Again the largest detractor, Hudson’s Bay (HBC) deducted 50bps
from NAV with a near-11% fall in its share price exacerbated by a
weak Canadian dollar. HBC, a Canadian retailer with substantial
property assets, reported slightly negative Q1 same-store-sales
growth figures which were superior to its peers and did not lower
guidance. We believe the market is punishing HBC indiscriminately
along with the rest of the North American department store sector,
and is failing to appreciate the international nature of its assets.

Moreover, our investment thesis rests on further monetisation of
the company’s majority-owned property assets including its Saks
Fifth Avenue store. While painful in the short term, the market
reaction provided an opportunity to add to our position on a near60% discount to our estimated NAV, and we were pleased to see
the company recover over half of the month’s losses in the early
part of June.

The largest detractor was Hudson’s Bay, the Canadian retailer with
substantial property assets, whose share price fell on little news but
in sympathy with other North American retailers.

Hudson’s Bay was a detractor over the month. The share price
fell by 4.6% as some of the gains seen in December were given
back as an immediate announcement on their real estate
strategy was not forth coming. We always expected this
announcement to be made in the coming months, when we
believe further value from their real estate portfolio will be
recognised by the market. To compound the weak share price
the Canadian Dollar fell versus Sterling, moving from C$1.81 at
the beginning of the month to C$1.92 at the end of January as
the Canadian Central Bank cut rates by 25bps to 0.75%.

We have also started to reduce our position in Hudson’s Bay after the
company announced JV’s with Simon Property Group and RioCan REIT
for their US and Canadian freehold property portfolios at the end of
February. These transactions valued the company’s freehold property
portfolio at C$9.2bln – well above market expectations. We have taken
advantage of strong demand and reduced our position.

The second corporate event over the month was Hudson’s Bay (HBC),
the Canadian retailer that owns the majority of its property assets.
Hudson’s Bay was a fairly muted performer during the 2014 financial
year however, its shares jumped by 24% during the month as the
company announced details of the valuation on one of its major assets –
the Saks 5th Avenue store in New York. Part of our investment thesis
was that HBC’s property assets were significantly undervalued by the
market and thus when they managed to monetise or prove valuations
the stock would re-rate to reflect this. In the second half of November
the company announced an agreement with Merrill Lynch to provide
finance against the SAKS 5th Avenue store. Under this agreement
Merrill Lynch appointed a third party appraiser who valued the building
at US$3.7bn, well above market consensus of US$1.5bn. The company
has stated by April 2015 they will announce plans for the remaining real
estate portfolio, which we believe will prove further upside from the
current share price.

The third largest contributor to performance during the month was our
investment in Hudson’s Bay, the North American retailer. Our original
thesis was the monetisation of their real estate portfolio, which we
believe is assigned very little value in the share price. Their Q2 results
mentioned an expectation to announce details of their real estate
review no later than April 2015, giving a much clearer time frame for
investors. The company has high end real estate on its balance sheet
which includes Saks 5th Avenue in New York and Beverley Hills, the Lord
& Taylor flagship store in New York, as well as properties in Vancouver,
Calgary, and Montreal, and we believe the sale of these assets could
provide significant upside.