The Next Great Logistics Trend That Barely Anyone Is Watching
Editor's note: Today, we're going back to our colleague Dr. David "Doc" Eifrig for the second time during this year's special Digest holiday series...
Last Thursday, we shared Doc's recommendation from Retirement Millionaire to buy "the worst business in U.S. history." And now, we're turning to another one of his services...
Today's holiday series essay is adapted from the September issue of Doc's Income Intelligence. In it, you'll see he has identified an ideal way to play an emerging logistics trend...
The Next Great Logistics Trend That Barely Anyone Is Watching
In John Steinbeck's bestselling novel East of Eden, which he considered his greatest work, a rich man named Adam Trask wanted to build a legacy...
Trask had inherited a family fortune and, while living in California's Salinas Valley in the early 20th century, had grown bored. He came up with what he thought was a great idea to make his own money...
He would pack the valley's freshly harvested lettuce in ice, load it onto railcars, and ship it to the big cities on the East Coast, where consumers would gobble it up.
Trask buys an ice factory and packs up a railroad car with the food. The town comes out to celebrate the departure. But along the way, the train runs into rails blocked by a snow slide, encounters a heat wave in the Midwest, and is delayed by a mix-up that left the cars sitting in Chicago for five days.
Instead of receiving fresh lettuce, the New York railyard got "six carloads of horrible slop with a sizable charge just to get rid of it," Steinbeck wrote.
Trask, a novice businessman, hadn't even tracked his costs or his wealth prior to the venture. He was essentially wiped out. "Adam was a fool," the town concluded. "These know-it-all dreamers always got into trouble."
We don't often use Income Intelligence to recount stories from 1950s literature, but this tale holds multiple business and investing lessons. (And it's interesting coming from Steinbeck, given he was accused of being a communist... Though there's also evidence he spied on communists for the CIA.)
The lessons from this story apply directly to an investment we can make today...
First, better risk management – an investing fundamental – would have helped Trask.
Second, don't take high-risk bets when you've already got a fortune (because you should be focused on protection).
Third, even with a brilliant idea, you need to be lucky enough to have the right timing, or to avoid the bad timing.
Clearly, Trask had the right idea. Steinbeck knew that as he wrote the story in 1952, and we know it, too. Today, we don't worry about seasonality or geography when we eat food.
There are oranges in winter in New York. And there are lobster rolls in San Diego. Can you imagine not getting to eat a salad just because it was winter?
The city of Chicago exists as it does today largely due to its role as a refrigeration hub for the meatpacking industry.
Even by March 1962, the New York Times reported...
Many of the apples now arriving in the stores have all the characteristics of the freshly harvested fruit with excellent color and crisp texture. This is the result of special controlled-atmosphere storage where apples, which were picked at the peak of quality, were sealed until late winter in a cold warehouse with a low level of oxygen and a high level of carbon dioxide to slow their respiration rate. These apples extend the season until early summer, or almost until the new crop is available.
Trask was right, but he paid dearly for his poor judgment. Of course, with a little luck, the train would've gotten through on schedule.
Or, a few years down the road, the railcars could've been better refrigerated or even insulated.
You see, if the technology isn't fully ready (or if you hit some bad luck), you could be dead right about your business concept, but end up bankrupt.
And just as important, the customer needs to be properly primed for your product, or you might also lose all your money.
When Trask conferred with a successful businessman regarding his idea, the businessman shot it down on the grounds that, "People in the East aren't used to vegetables in the winter. They wouldn't buy them." To hear that, even if the lettuce made it to the East Coast, it was possible people wouldn't care.
So, the technology must be ready. And the customers must be ready. And when those align, business soars...
As we'll detail today, we're seeing one of these opportunities right now with an income investment in modern-day refrigeration, no less, that would have made Steinbeck proud... and would have paid Adam Trask some dividends on his inherited fortune.
Customers and Suppliers Are Gearing Up for a Big Shift
Do you buy things online? We bet you do.
Do you get your groceries online? The statistics suggest that you don't... but you will soon.
Online grocery delivery has long held out as a laggard in e-commerce. One of the highest profile blowups of the dot-com boom was grocery delivery company Webvan. The company's valuation peaked at $4.8 billion on $178 million in revenue, and it went bankrupt in a span of five years.
Since then, we've become more reliant on online technologies. We used to be reluctant to give our credit-card information to a website... Now, people use their phones to hail cars driven by strangers to take them where they want to go.
But grocery delivery hasn't exactly been "digitized." While about 16% of all retail sales occur online, only about 2.7% of grocery sales in the U.S. do... but the trend is growing, up from 2.2% last year.
We think this dynamic comes down to some unique elements of the customer experience. We're accustomed to strolling aisles, pondering what we see on the shelves, and choosing our own produce. And that behavior has made people slow to shop for groceries online.
That's changing rapidly... In our own experience, once you order groceries online two or three times, you'll never want to go back to the store. A slight change in your planning saves you two hours a week and the frustrating trip to a crowded grocery store.
And now, more consumers are buying groceries online. In Coresight Research's 2019 U.S. Online Grocery Survey, 36.8% of consumers had bought groceries online in the last year, up from 23.1% the previous year.
And industry website Grocery Dive recently reported on a survey in which 66% of respondents expected to buy their groceries online in the next five years.
Many of those groceries come from Amazon (AMZN). Since the online behemoth bought supermarket chain Whole Foods in 2017, it has been investing in its food delivery logistics. Other orders get packed at your local supermarket.
Years from now, we predict the supermarket will be a rarity, and the bulk of our food will be shipped to us from logistics centers.
That's down the road, but today, cold-storage facilities – kind of like the idea Adam Trask once had – around the country are jam-packed with food, they're in short supply, and they're highly profitable...
More Trends Filling Up Refrigerated Warehouses
It's not just online delivery that's filling up cold-storage facilities.
For one, we eat more fresh foods now. As younger shoppers move away from processed and packaged foods, they buy more produce, meats, and other perishable goods. Refrigeration gets more important when you "go organic."
"People are now investing in quality – organic milk, organic eggs, organic everything – and in order for a company to meet their customers' demands, you're going to need cold chain," says Matthew Mugar, CEO of a private food-logistics firm.
Besides e-commerce and freshness, there's also rising demand from the simple growth of the population.
Cold-storage facilities only make up about 1% to 3% of the industrial warehouse market. That's not enough.
The Global Cold Chain Alliance, an industry quality control organization, expects that square footage will grow 4% per year over the next four years. CBRE, a real estate consultancy, expects storage space will need to grow between 70 million to 100 million square feet over the next five years – up from a current level around 214 million square feet. And building just hasn't been happening at that rate.
A few private-equity firms have spotted the opportunity. As Bloomberg Businessweek reported in July...
Cold storage is the kind of niche business that Wall Street long ignored – it amounts to just 3% of public warehouses – but now it has become its latest darling. Roughly two dozen private-equity firms have latched onto this corner of industrial real estate. They're aiming to capitalize on the growing preference for grocery deliveries to homes, which requires warehouse space, and looking for a hedge in the next recession. (Eating isn't cyclical.)
Betting on cold storage is the next logical step for private equity (and public investors) that have already made money on warehouses and logistics...
Step outside of cold storage and look at what e-commerce has done to plain old room-temperature warehouse and logistics space...
The "Amazon effect," and that of other online retailers, has driven returns on warehouse and industrial properties well above those of the broader real estate markets.
In private markets, behemoth real estate equity firm Blackstone (BX) started buying up warehouses early and often and it has made great returns over the last half-decade. And today, the firm is still plowing forward with it... Earlier this year, it just made the largest private real estate deal ever, buying 179 million square feet of warehouse space for $18.7 billion.
"Logistics is our highest-conviction global investment theme today, and we look forward to building on our existing portfolio to meet the growing e-commerce demand," says Ken Caplan, global co-head of Blackstone Real Estate.
In public real estate investment trusts ("REITs"), the 15 members of the Bloomberg REIT Industrial/Warehouse Index trounced broader REITs with returns of 100% versus 26% over the five years leading into our September recommendation.
We've been watching this trend and feeling that these warehouse REITs have been too expensive for two years. (We've been wrong... They've kept rising.) And the trouble with this warehouse space is that it's too easy to build new supply.
Nothing could be easier than finding cheap land near a highway and plopping a square building on it... so we're cautious about paying too much.
The opposite holds true for cold storage. These warehouses take expertise and capital to build. Location is more important because you want to be near both the food suppliers and the customers.
More important, we're likely in the early stage of cold-storage warehouse growth. And barely anyone is watching.
This niche storage market hasn't gotten the attention of the mainstream media or even much of the financial media yet. We've found a couple of recent Wall Street Journal articles mentioning cold storage, but by no means are folks talking about it at their cocktail parties.
The fact that this area of business has been overlooked also leads to some challenges. There's no one tracking serious data on cold storage.
When you study industries like office or residential building, you can study the number of permits issued, square footage under construction, current capacity, and more with ease to gauge growth.
The National Agricultural Statistics Service publishes total U.S. cold-storage capacity numbers every other year. That only gets us to the end of 2017... before many of the current trends started ramping up...
These numbers, for one, show a decline in cold-storage capacity in the last two years of available data. And the compound growth rate of 1.4% is well below the nominal gross domestic product ("GDP") growth of 4.3% in that span. In the last quarter of 2019 alone, traditional warehouse space grew at an annual rate of 2%. Cold storage just isn't keeping up.
Furthermore, the investment we're about to share is the only pure-play publicly traded cold-storage investment you can make. That means we have no "comparables" to measure its performance against.
That makes investing in this space a challenge, but it's also an opportunity...
It means there's a greater likelihood investors have mispriced shares... or in many cases, just ignored it until they can use their standard tools to value the business.
Given the overall growth in demand, we think it warrants an investment today...
The Only Investment You Can Make
There are essentially two big names in cold storage: privately owned Lineage Logistics and our recommendation today, publicly traded REIT Americold Realty Trust (NYSE: COLD).
The Atlanta-based company's history dates back to the early 20th century, around the time of the first ice and coal companies, when entrepreneur Ernest Woodruff – who later bought and ran Coca-Cola (KO) – merged three cold-storage warehouses to create Atlantic Ice & Coal.
Today, its descendant, Americold, is the largest publicly traded temperature-controlled warehousing and distribution-services provider in the world.
It owns 176 cold-storage facilities. Of those, it owns 141 outright, leases 24, and manages 11 for services revenue.
In total, that accounts for more than 1.1 billion cubic feet of storage. Cold storage is measured in cubic feet rather than the traditional warehouse metric of square feet, since the height of the refrigerated area matters as well. The footprint of Americold comes to 45 million square feet.
The company owns about 26% of the cold-storage market. Lineage Logistics, its top competitor, has about 29%. Two other sizeable competitors add up to about 12%. The rest are small operators with a facility or two.
The potential for Americold to buy those competitors will be another area of growth. As much as we may like small businesses, in certain industries, it is very difficult for them to compete because of the costs and scope of the technology involved.
Of course, refrigeration technology is complex and expensive to build. On top of that, the modern cold-storage industry has a complex logistics system. To keep costs low, Americold has cutting-edge logistics technology to load pallets, access food stocks, and interact with refrigerated transportation.
Americold has big clients – like food producers Conagra Brands (CAG) and Kraft Heinz (KHC) and grocery store chain Safeway – and it knows what its clients order and when, as well as what they are about to put on sale. Those items (take your pick of your favorite food) get moved to the front of the facility before the large orders come in to increase efficiency.
Building this kind of system takes expertise and capital, two advantages that allow the big operators to keep getting bigger.
Americold's customer list also includes food-production giants McCain Foods, Danone, and Unilever (UL). On the grocery side, it stores food for Trader Joe's, Sysco, and Kroger (KR).
Competition for cold-storage space is fierce, and Bloomberg Businessweek even reports that small food producers are getting kicked off of shelves as Americold and Lineage raise prices and focus on larger customers.
That's not great for fans of artisanal ice cream, but it's great for Americold's bottom line.
Profitable, Growing, and Conservative
Americold makes money from storage and from service fees it charges to get products in and out of its facilities.
This sets the company apart from other industrial REITs. While a traditional warehouse would charge rent and hand the keys over to the tenants, Americold takes the product and gets it in and out of the facility. It needs to do that well to keep customers happy, but that also allows it to distinguish itself from its competitors.
Americold can also charge a lot more than a traditional warehouse. That also makes it difficult to value against traditional warehousing REITs.
But the main point, and a big part of the reason we're recommending this investment today, is that Americold is profitable and providing good returns on capital.
The company's revenue grew about 10% in the last 12 months, and projections put sales growth around that level for the next two years, as you can see in the chart...
The real moneymaker is the storage fees Americold collects. Warehouse fees account for 76% of revenue, but 93% of net operating income. The company also derives 15% of revenue from managing external customer warehouses... and it only contributes 3% of net operating income.
That's because Americold provides these logistics services to, say grocery store operator Kroger, and that feeds the customer relationship back to warehouse services. The company does the same with its transportation division, which brings in 9% of revenue and 4% of net operating income.
Put another way, the services business is low margin at 6%, but it feeds the warehouse business that boasts a margin of 66%.
Americold has used the strong cold-storage market to convert more customers to long-term contracts. A full 45% of revenues are now under signed contract with an average stated term of six years and current remaining life of three years. These commitments help create consistent and dependable revenue.
While cold-storage facilities are expensive, the levels of capital expenditure are quite low. Over the last three years, Americold spent about $120 million per year on capital expenditures and repairs and maintenance. That's only about 6% of revenue, though it will rise a bit this year.
The company was taken public only in early 2018 (by billionaire Ron Burkle – who's had a number of successful food-related investments, including Golden State Foods, Ralphs, and Wild Oats Markets).
Based on earnings before interest, taxes, depreciation, and amortization ("EBITDA"), a general business evaluator, and funds from operations ("FFO"), a REIT-specific cash-flow measure, margins and levels have been growing since the 2018 IPO.
Meanwhile, Americold has maintained a low debt level. It owes $1.7 billion in total debt.
Now, Americold is a growth REIT... and it's priced for growth. It only yields about 2.4% today, but its distributions have been on the rise.
For now, we've got a niche investment with strong trends pushing its business in the right direction.
We'll use a stop loss to limit our downside, but Americold's share price has more than doubled since its IPO, and we think it can grow another two times within a year or two.
This is a great growth play to add to our income portfolio.
Buy Americold Realty Trust (NYSE: COLD) up to $42 per share. We'll set our initial sell stop at $29.99. I recommend putting no more than 2% to 3% of your portfolio into this investment.
Here's to our health, wealth, and a great retirement,
Dr. David Eifrig
Editor's note: To celebrate the holidays, we've been offering Digest readers a significant discount off the normal cost of some of our most popular research over the past week. We're doing the same thing today with Doc's Income Intelligence... Right now, you can get instant access to all of his research in the publication at a 33% discount. Learn more here.