H&R Real Estate Investment Trust HRUFF

Scotia comment after conference

[incomedreamer11]

Moving Along in the Right Direction

OUR TAKE: Slight Positive. We maintain our SP rating, but contrary to 80% of our universe (avg. target price decline with Q2 reporting = 4%; Exhibit 3), our H&R target price is +$0.50 (+3%) to $17.00 on a similar increase in our 2023E AFFOPU (Exhibits 1-2 = key estimate change summary). H&R produced an in-line Q2 print (Exhibit 12), but more importantly, demonstrated an ability to sell assets (albeit with some complication) in the current tape after a Q1 breather (Exhibit 4), an important step in its goal of becoming more of a pure-play U.S. Sun-Belt Residential and CAD Industrial REIT. Our 2022E/2023E SSNOI are mostly intact at 7%/4%, with the 4% = 3rd-quartile (Exhibit 5); realization of that forecast growth will be key to the unit price in our view. H&R is +2% since our Q1/22 Results note (vs. -2% for sector), but still trades at a 4% and 23% discount to our Shadow REIT on NAV and 2023E AFFO, respectively (Exhibits 6-8; P/NAV has narrowed since Q1). We’ll be reviewing our ratings mix heading into the fall, but we still like H&R below $14.00 (in Q1 it was at ~$13.50; TP = +$0.50) and continue to believe H&R is trending in the right direction as improving capital allocation does the same for investor sentiment.

KEY POINTS

What changed since our last note? Our 2023E FFOPU and AFFOPU are +$0.03 primarily on a $130M decline in 2022E dispositions (to $400M, ex. already announced). Our intact target 17.5x multiple (vs. 14.3x 2023E) assumes U.S. Residential becomes ~40% of FFO vs. Q2/22A of ~25% (i.e., need additional Office/Retail dispositions). Our NAV cap rate is +5bp on a 25bp uptick in Industrial plus DT Toronto and Calgary Office, leading to a $0.25 and $0.50 decline in our Current and Forward NAVPU, respectively (our NAVPU estimates would have been flattish otherwise). Our NAVPU includes an intact 4.0% cap rate on Lantower (every 25bp = 7bp to our cap rate = 2.2% to our NAVPU).

Call highlights. The primary focus was on Lantower operations and dispositions. H&R noted no apparent slowdown in Lantower performance (Q2/22A rent growth = 17% y/y), with rent-to-income ratios still in the low-20% range (we don’t think wage growth has been +18% y/y; new tenant incomes are likely higher vs. existing). That said, Lantower tenant turnover has fallen to ~40% vs. 45%-50% historically. Net-net, we think continuation of 10%+ Lantower SSNOI growth (Q2 = 25% ex. Jackson Park) is key to a higher unit price. In terms of dispositions, HR achieved rezoning at 145 Wellington in Toronto (1.6Msf Office property) that we think could improve the potential for disposal (some of the residential upside is already in IFRS; zoning for 500+ residential units on top of 13 new Office floors has been approved). The planned sale of 100 Wynford and associated Bell lease is structured similar to The Bow sale, where H&R has retained a re-purchase option, thereby complicating the accounting behind the sale (our preference would be for straight dispositions, all else equal).

Q2/22 Highlights & Developments

OUR TAKE: Positive. Reported and recurring FFOPU was $0.283 vs. $0.278 q/q and down 25% y/y, in line with our $0.286 estimate and $0.285 consensus (range = $0.28-$0.29).

IFRS NAVPU was +5.1% to $22.14 (Q1 = +19% to $21.06) vs. our $17.75, despite a $17M IPP FV loss (Q1 = $1.1B gain), illustrating the benefits of an active NCIB. Equity value per unit (i.e. including the DTL in NAV like we do was $20.94 vs. $19.88 q/q). From memory, this is one of the highest q/q IFRS NAVPU increases in our universe, excluding Tricon. Total portfolio IFRS cap rate was flat q/q at 5.1% (Q1 = -33bp q/q). H&R repurchased 10.5M units at an avg. $13.01 (3.5% of units o/s) vs. 9.4M units @ $12.99 in Q1, and 2.2M units more post Q2 @ an avg. $12.76/un. We note that H&R has been the most active REIT on its NCIB in our universe YTD (Exhibit 9).

Same-asset (SA) cash NOI increased 18.8% y/y (Q1 = +19.1%, 2021A = -5.2%). In local currency, Canada was +1.9% y/y (Q1 = +3.5%; +1.6%) and U.S. was +32.2% y/y (+34.7%; -13.2%). Stripping out all the noise, SANOI by asset class was: Residential (+21%), Industrial (+5%), Office (+1.5%), and Retail (-3%).

Solid disposition activity disclosed. Bigger deals include HR selling a 100% interest in Bell lease cash flows at 100 Wynford Drive (Toronto Office) to 2036 for $121M (close to IFRS value) and retained a buy-back option for $160M in 2036 (i.e., similar complex accounting to The Bow). It sold its only asset in San Antonio, a 312-unit apartment for $69M (@3.65% cap), 7 auto-retail properties in the U.S. for $58M (@5.2% cap) other CAD office/retail properties for ~$50M (close to IFRS value). Some proceeds funded the acquisition of 23 acres in Florida, supporting the development of 805 residential suites. All-in, H&R closed on $168M of sale in Q2 and has another $168M under contract for a combined ~$330M or ~3.5% of Q1/22 IPP.

Operations update. Total occupancy fell 40bp q/q to 95.8% (Q1 = -40bp q/q) on a 200bp and 60bp decline in Residential and Industrial; SP occupancy fell 10bp q/q to 96.1% (Q1 = +140bp). The 18.8% y/y SANOI growth (Q1 = +19.1%) was driven by 43.7% and 23.2% y/y growth in Residential and Office assets (Q1 = 31.2% and 24.3%), respectively (due to Jackson Park and free-rent expiring at Hess Tower, respectively).

Leverage inches higher. Liquidity fell $241M q/q to $691M (Q1 = -$0.2B), including $72M in cash and $620M in credit facilities. H&R unencumbered assets of $4.6B = 93% of total debt (Q1 = 116%). Debt/GBV was +90bp q/q to 44.0% (at HR share; Q1 = -350bp) and Debt-to-EBITDA was +0.9x q/q to 8.6x (Q1 = +0.5x). The flat 5.1% IFRS cap rate included an 8bp increase in Lantower to 3.79%, offset by 2bp and 7bp declines in U.S. Industrial and Retail cap rates, respectively.