Buying Ugly with Getty Realty

 | Mar 19, 2012 | 11:25 AM EDT
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As a deep value investor, I like to identify distressed situations. Sometimes companies are distressed for good reasons, and you would not want to touch them with the proverbial ten foot pole. But there are times when there's an overreaction to events and investors move to the exits, providing opportunities for those with an iron stomach. 

It's buying ugly at its finest. And, if you are right, the rewards can be great.  If you are wrong, goodbye capital. That's always a possibility in these situations.

Getty Realty (GTY) has seen better days. The company is the largest real estate Investment trust (REIT) specializing in gas station, convenience stores and petroleum distribution terminals and has seen its shares plunge more than 45% since late July, when largest tenant Getty Petroleum Marketing (GPMI) began to unravel. Getty Realty has a master lease with GPMI, which covers 69% of Getty Realty's 1,149 properties. GPMI does not operate the properties, but rather subleases them to other operators or petroleum distributors. The way it's supposed to work, in a nutshell, is property operator pays GPMI and GPMI pays Getty Realty.

But back in August, GPMI initially missed a lease payment and it became clear that the company was in deep financial straits, including a $230 million judgment against it regarding environmental cleanup costs. Although GPMI finally made the payment later in the month, the situation was unwelcome news for investors, many of whom no doubt owned Getty Realty primarily due to its $0.48 quarterly dividend. 

In September, Getty Realty cut the dividend nearly in half to $0.25, due to continuing troubles with GPMI. In late November, Getty terminated the master lease with GPMI, due to nonpayment of November rent. Just one week later, GPMI filed for Chapter 11 bankruptcy. In early January, the US Bankruptcy Court affirmed Getty Realty's right to receive post-bankruptcy rent for December 2011 and January 2012. Since then, GPMI has paid the company $10.3 million of the $19 million in rent due between December 2011 and March 2012.

It's an ugly story and the saga continues. On Friday, Getty Realty shares endured an 11% haircut as the company released fourth quarter results, which were chock full of charges related to the GPMI debacle. The big news was that management deferred a decision on the next quarterly dividend. That's not what a REIT investor wants to hear and shares were hammered on six times the normal average volume.

While the near term will no doubt be rocky for the company, I believe that Getty Realty will ultimately right the ship. More than likely, in my view, the company will retake possession of the properties leased to GPMI and structure new deals with the current tenants. (GPMI simply acts as a liaison, collecting rents from tenants and not actually operating the businesses. If GPMI was actually operating these businesses, the situation would be worse). While this process will no doubt cause some disruptions, and there are no guarantees that the company will be able to charge the current level of rent, it will be a step in the right direction.

The real attraction to Getty Realty, the current disruption notwithstanding, is the real estate. The company currently owns 996 of the total 1149 properties, located in 21 states. With a current market cap of $475 million, there's just over $170 million in debt and enterprise value is just $633 million. One of the arrows in Getty's quiver is to sell off some of the properties, and the company currently lists dozens for sale on its website.

I've been following the Getty saga for months now, but finally took a small initial position last Friday. There are a lot of warts here and I expect a great deal of volatility in the stock price in the near-term. I plan to opportunistically add to my position as the story plays out.

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