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By Graeme Brawn, Analyst

We believe Hudson’s Bay real estate value alone is worth significantly more than the current stock price of $10.92/share.

Founded in 1670, the Hudson’s Bay Company has long operated at the epicentre of Canadian commerce. But with the retail landscape changing and the future of brick and mortar stores hanging in the balance, HBC has felt the pressure of rising costs and evolving consumer preferences. In 2017, they operated with over a $600mm loss and burned through $52mm of cash. The market responded accordingly, and while department store indices are up nearly 40% this year, HBC’s stock has risen only 4%.

Behind their disappointing operations lies nearly $11B of real estate. HBC owns many of their department stores, including the flagship locations of their HBC brand, Saks Fifth, and Lord & Taylor.  We valued their real estate using projected net operating income and a market capitalization rate of 5%. Liabilities against their properties consist primarily of mortgages and planned renovations. Our model indicates approximately $30 per share, shy of the $35 promised in prime third party appraisals.

Lord & Taylor Flagship

Saks Fifth Flagship

The valuation of their real estate alone suggests a significant market mispricing. The market has been unable to separate the immense value of their real estate from their disappointing operations relative to peers.

In response, HBC has contributed a significant portion of their properties to joint ventures with established Canadian and European REITS. The joint ventures are mandated to acquire additional real estate assets and diversify the tenant base (although they primarily lease back locations to HBC and its affiliate brands). Since its IPO in 2013, HBC indicated that it has “deliberately structured its real estate joint ventures to facilitate the future public listing of these entities,” allowing the market to value their real estate and retail operations separately, ultimately delivering shareholder value.

Canadian Tire underwent a similar strategy in 2013, spinning out their wholly owned locations into a REIT. The retail company currently owns an approximate 90% interest in the REIT, which also allows for greater liquidity as opposed to selling the properties themselves. The retail company’s stock has soared 80% in the 5 years since the REIT IPO.

Critics, however, suggest that HBC’s properties are only valuable insofar as the retail company can occupy them. They suggest that the only suitable tenants for such properties are other department stores, and cite the vacancies in closed Sears locations.

But tying the fates of HBC’s retail operations and real estate portfolio neglects the prime locations of the real estate. Perhaps a closed Sears location in a suburban mall could only host other department stores, but 650,000 square feet on Fifth Avenue could easily be converted into a hotel or office building. HBC has already demonstrated the potential for a diverse tenant base through its relationship with WeWork, an office space provider.

For $10/ share, investors get the retail operation for free and the real estate portfolio at a 70% discount. When the public markets get the chance to value the large swathes of real estate held in the joint ventures, which we foresee happening in the very near future, investors can anticipate a 180% return.

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