Fed's Beige Book Shows Economy Slowing

   The US Federal Reserve (AKA. The Bubble Factory) today released its beige book which details economic conditions within the Federal Reserve bank districts. The main take away from this report was that while economic activity increased for the period, the rate of growth slowed pointing to a weakening economy. From the report:

Economic activity has continued to increase, on balance, since the previous survey, although the Cleveland and Kansas City Districts reported that the level of economic activity generally held steady. Among those Districts reporting improvements in economic activity, a number of them noted that the increases were modest, and two Districts, Atlanta and Chicago, said that the pace of economic activity had slowed recently.

   Surprisingly manufacturing did pretty well according to the report. It will be interesting to see if the trouble in the markets impacts future manufacturing activity considering there is usually a lag between the stock market and manufacturing. The Beige Book also outlined that consumer spending was relatively strong except for auto sales (consumers can't get enough of those Iphones, IPad's. etc):

 Reports on retail sales during the early summer months were generally positive, although in most Districts the increases were modest. Retail sales in the New York, Philadelphia, Minneapolis, and Kansas City Districts were higher than year-earlier sales, and Dallas reported solid gains. But sales in the Boston District were mixed compared with the previous year. Recent sales increased slightly in the Cleveland, Atlanta, Chicago, and San Francisco Districts; sales in the Richmond District weakened; and sales in the Kansas City District were flat compared with the previous report. Several Districts cited apparel, food, and other necessities as recent strong sellers, while big-ticket items were weak sellers. Contacts reported satisfactory inventory levels in the New York District, mixed inventory levels in the Boston District, and low or declining inventory levels in the Richmond, Atlanta, and Chicago Districts. The outlook for sales was mixed: Retailers in the Philadelphia, Cleveland, Kansas City, and Dallas Districts reported that they expect modest positive sales growth in the upcoming months; contacts in the Cleveland, Atlanta, and Chicago Districts reported a less optimistic outlook going forward than in the previous report; and retailers in the Boston District reported a cautious outlook.

   The Districts that reported on auto sales during the early summer months generally noted a decrease in recent sales. Since the previous report, auto sales in the New York, Philadelphia, Cleveland, Richmond, Chicago, and San Francisco Districts declined, while auto sales in the Kansas City District increased and were unchanged in the Dallas District. Compared with last year, auto sales in the Atlanta and St. Louis Districts were higher. New York, Philadelphia, Cleveland, Chicago, Kansas City, and Dallas all reported that inventory levels were low or declining. Auto dealers anticipate little change in sales for the rest of 2010 in the Philadelphia District and expect sales to increase slowly in the Dallas District. Contacts in the Kansas City District expect continued strong demand, while those in the Cleveland District do not anticipate strong growth in the coming months.

   The most important part of this report was the discussion on the real estate market and how it is holding up after the expiration of the egregious home buyer's tax credit. The answer is not good with declines reported in construction spending, housing starts, homes sales, etc. The report aslo mentioned the precarious situation of the commercial real estate marker:

Commercial and industrial real estate markets continued to struggle in all twelve Districts. Overall, vacancy rates were flat to slightly increased and continued to exert downward pressure on rents. Construction activity remained weak in most Districts. The New York District noted that commercial development remained generally sluggish despite some pickup in office and retail leasing in New York City. Atlanta, Minneapolis, and Dallas reported that construction activity continued to be weak or to decline, and Cleveland reported that the increase in construction from previous reports has begun to diminish. Philadelphia reported that projects funded with federal stimulus support were near completion with no prospects for additional major construction, while Chicago reported that public infrastructure construction picked up. Developers reported difficult credit conditions in the Cleveland, Richmond, St. Louis, and Kansas City Districts, while the Dallas District reported a few developers going out of business. The outlook for commercial and industrial real estate across the Districts ranged from further declines in activity to slow growth.

    The Beige Book noted that loan volume at banks declined, especially for mortgage loans indicating that banks are still not lending to the real economy. Another problem was that loan demand was weak.

Most Districts reporting on credit standards continued to note that lending standards remain restrictive. New York reported tighter credit standards for all categories except consumer loans, while Kansas City reported tighter commercial lending standards. Reports on credit quality were mixed in Cleveland and Kansas City, while quality was stable in San Francisco. Credit quality improved slightly in Philadelphia, Richmond, and Chicago. In the Dallas District, nonperforming loans have stabilized and are not expected to worsen. Meanwhile, Philadelphia, Cleveland, and Richmond continued to report delinquencies above historic norms. Delinquency rates in the New York District decreased for consumer loans but experienced little or no change in other categories.

   Overall there is not much news from this report from the Fed. The economy is expanding but the rate of growth is slowing quite a bit. The real estate market looks weak and is likely to double-dip without further government stimulus. Credit is hard to come by because the banks are more interested in borrowing from the Fed a 0% and buying 10 year US treasuries yielding 3-4%. It is hard to see how the economy can ever recover if this process keeps up.

Black Swan Insights

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Fed's Beige Book Shows Economy Slowing

How Low can Home Prices go?

   














    With the expiration of the home tax credit we can now expect home prices to roll over and continue their downward trend. The question is: How much lower can they go before the market finally clears? As you can see from the chart above. nationwide home prices are currently hovering around $166,000, but this is very misleading because of the large fluctuations in regional home prices (West expensive, South and Midwest cheap). But it does show that in aggregate, home prices could fall to around $150,000 to get back within the historical norm. This would represent at least another 10% decline. This is likely a conservative estimate because post bubble prices usually overreact to the downside which could send nationwide prices into the $125,000-135,000 region.  However, there is one key variable in the housing market, and that is interest rates. If rates increase even 100 bps, this could have a very negative effect on prices. Currently, rates are at historical lows of around 4.7% which is allowing people to afford more house than they would normally be able to purchase. If you look at a longer term chart of mortgage rates, you will see that they usually average between 6-8%. Since  it is hard to see rates moving any lower (unless the Federal Reserve steps in), one would have to conclude that rates will eventually find their way back to the historical range.  This should keep prices capped for an extended period of time as the market establishes an equilibrium.

   One last thing to remember about the housing market is that there is no need to try to time the bottom. The housing market, unlike stocks or other asset classes, moves incredibly slowly. If you look at other boom/bust cycles in the housing market, you will see that once prices hit bottom, they usually stay there for a while and tread water (3-5 years). So don't believe the liars at the National Association of Realtors who claim that you have to "get in now" to get the best price. When it comes the housing market, patience is a virtue.    

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How Low can Home Prices go?

My Investment in the Limoneira Company

UPDATE--Position Sold July 1--$21

I was first attracted to Limoneira because I live within 25 miles of the company's headquarters in Santa Paula, CA. I was intrigued with the company's many valuable assets, mainly its large land holdings. What is particularly interesting is that no one on Wall Street had ever heard of the company. There are no analysts following the company, and it is largely forgotten as it trades on the pink sheets. These kinds of companies are my favorite because they are completely unknown except to local investors. This creates opportunity!

About Limoneira

Limoneira engages primarily in growing citrus and avocados, picking and hauling citrus, packing lemons, and operating housing rentals and other real estate operations. The company also engages in real estate development:

Market Cap. Approx $197 million

Company Website: Limoneira.com


Investment Analysis

While growing and packaging agricultural products provide the company with the majority of its revenue, the real value in Limoneria is the company's land assets totaling 7,300 acres: 4,000 acres in Santa Paula, 500 acres in Santa Barbara, 700 acres in San Luis Obispo, and the rest in the San Joaqin Valley. Anyone who lives in Ventura County area will tell you how desirable the location is with the beach only a few minutes away and a pleasant climate.

The company's most promising assets are two properties called East Area 1 (563 acres) and East Area 2 (44 acres) located in Santa Paula. The East Area 1 property was entitled for development in 2006. This is a major accomplishment considering the strict zoning laws which normally prevent the conversion of agricultural land to better uses. The company did an excellent job of garnering local support for the initiative, and voters approved the measure by an overwhelming 80% majority. This makes Limoneira the only company currently approved for a major real estate development in the area. The development of East Area 1 is expected to be completed in a series of phases over a 20-year period.

Limoneira also owns other quality properties including a partial interest in Windfall farms, which is a 720 acre horse property  in Paso Robles. The company has invested over $25 million in capital improvements and plans to subdivide the property into 10 acre lots in 2012. While this is an excellent property, this is a slow moving project that requires time to sell. The company is also working on developing and selling a few parcels in Santa Barbara. The company was able to get the parcels entitled for development for residential and commercial units. As with Windfall farms, this will also take time because of the problems in the housing market but should move quickly when the market improves. The company has partnered with Bellagio Builders to construct two luxury spec homes in Paradise Valley, AZ. The company began this project at the top of the real estate market in 2007, is having problems selling the homes, and is currently leasing them out. Paradise Valley is an exclusive address and has held up better than other parts of Arizona in the real estate market. The company should be able to recoup its investment in time.

Limoneira also owns a few other real estate properties including workforce housing for their employees. These consist of small bungalow style units and apartment complexes.

Along with prime California real estate, Limoneira also owns significant water rights and interests in mutual water companies. The majority were acquired a long time ago and are thus valued at cost on the balance sheet ($1.2 million). But the fair market value of these water rights is much higher because it is such a precious commodity in California. From what I have been able to gather, the company has rights to approximately 15 million acre feet of water in the Santa Paula and Filmore Basins. These are important strategic assets and are worth a lot of money ($100's of millions at a minimum) to future developers or cities. The value of the company's shares in mutual water companies is uncertain, but I have read that they are worth approx. $100 million.

Management

Overall, I believe management is competent at Limoneira and is acting in shareholders' best interests. I give them credit for organizing the East Area 1 project, which took many years and required the company to work with the local community very carefully. I am also pleased that management finally decided to list on the NASDAQ even if it required them to implement the onerous Sarbanes-Oxly regulations. This move will help the company achieve a higher stock multiple compared to remaining on the pink sheets.

I have only two things against management. The first is regarding stock options. While not terrible compared to other companies, I would prefer if management used their salaries to purchase stock rather than diluting shareholders through stock options. The second reservation I have concerns a few peculiar business endeavors that the company strayed into previously including Movin' Mocha--a chain of coffee houses in Fresno, CA. Fortunately, the company has discontinued this money losing business. I hope that the company will stick to its area of expertise and focus on monetizing the company's real estate assets.

Financials

It is very easy to pass over Limoneira's balance sheet without seeing the real value of the company's assets. The company has been around since 1893, so the majority of the company's assets is valued at almost nothing on the balance sheet.

One other concern is the company's rather large amount of long-term debt at $69.2 million. This company has used debt to finance some of their real estate projects. The debt will be reduced when they sell some of their slow moving real estate. The good thing is that all of the debt is not due until 2013 and is structured at very low rates. The only thing I do not like is that all of the debt is variable rather than fixed so they are exposed to rising rates, but this is a small concern.

What I like regarding the company's financial position is that it can use the cash flow from agricultural operations to help finance its real estate projects. On average, the company will have $10-14 million in cash flow, which along with some debt, allows the company to fully fund its operations. I do not expect the company to have to raise capital through dilutive equity offerings.

Major Owners

Limoneira is a controlled company in the sense that the founders' families currently control 80% of the common stock. This certainly has its drawbacks as I have seen many family run companies systematically loot shareholders. In the case of Limoneira, I have not seen any egregious outrages which destroyed or wasted large amounts of company resources. However, there was one company action that I take issue with, and that is its "investment" in Charlie Kimball's auto racing career. Charlie Kimball is the son of the Limoneira's director Gordon Kimball who decided that the company should invest $500,000 to further his son's racing career. This smells of nepotism and misappropriation of company assets but is not large enough to merit much concern. Unfortunately, I have seen much worse in corporate America in many large companies.  As far as I can see, there are no other corrupt related party transactions at the company.

The only other major investor is Calavo Growers which owns 15% of the stock. A few years ago, the two companies agreed on a partnership which allowed Calavo to package, market, and sell Limoneira's crops. To consummate the agreement, both companies agreed to purchase stakes in each other with Limoneira purchasing 1,0000,000 shares of Calavo. So far, the investment has been sound,  and they have already realized a gain from selling 335,000 shares in 2009.

Opinion and Summary

Limoneira is a promising investment that remains under the radar of Wall Street and institutional investors. The company's excellent assets have been largely ignored and mispriced by the market. But I expect this to change as the company officially has listed on the NASDAQ stock exchange, which should bring it more exposure. It should be pointed out that this is not a get rick quick type situation but rather a long-term investment which will reward shareholders. The majority of the company's assets need to be developed over a period of years before shareholders  realize the company's full value. However, I decided to purchase shares now because I believe that now that the company lists on the NASDAQ, it will eventually get a higher valuation than it did on the pink sheets.

Full Disclosure

20% of my portfolio is invested in Limoneira (I know it is a large stake, but I am fine with that). My cost basis is around $12.40.

 Disclaimer

I am not an investment advisor and nothing on this site should be interpreted as investment advice. Please consult with your own financial advisor before investing in the stock market or any financial asset.

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My Investment in the Limoneira Company