RE:CIBC commentsInvestment Thesis
We like Primaris REIT’s dominant position in secondary markets that have few alternatives for shoppers and tenants alike. The pandemic has masked the advanced stages of stabilization in the portfolio, following a period of elevated vacancy. We consider the impact of the pandemic as largely transient and expect the underlying steady growth profile to emerge once temporary headwinds fade. Primaris is uniquely positioned as the only publicly traded mall REIT in an era when institutional owners are seeking to trim mall ownership, creating a sizeable growth runway. As the REIT establishes a track record of growth and as broader retail sentiment improves, we believe valuation can improve. We particularly like the REIT’s conservative financial profile and high cash flow retention.
Quality Tenant Roster:
Value retail and essential services tenants comprise ~40% of rent, followed by apparel at ~36%, and ~42% of overall rent is from investment-grade-rated tenants. The REIT has addressed a majority of former Target and Sears space with higher-rent-paying tenants. A significant portion of space arising from store closures during the pandemic has been re-leased, and while a degree of ongoing retailer bankruptcies and store closures is expected, we view the REIT as much better positioned today
Room For Upside: Our run-rate net operating income (NOI) and management’s forecast are about 10% below pre-pandemic levels, and likely conservative given the uncertainty around the pace of recovery from the pandemic. Our net asset value (NAV) also does not ascribe any intensification value (estimated at ~$1.20/unit). Using fully stabilized NOI and adding intensification value, our NAV would increase to $23.50/unit
Potential Catalysts: We believe units could be re-rated on the REIT demonstrating a growth track record, and disclosure around organic growth and leasing spreads could help counter the negative narrative around the asset class generally. As Primaris is relatively more sensitive to the recovery and reopening, we expect units to react positively to an improving retail sentiment. Units could also benefit from NCIB activity. We initiate coverage of Primaris REIT with an Outperformer rating and a $17.50 price target. Our price target is ~10% below our $19.50 NAV estimate using a 6.5% cap rate. Trading at a ~29% NAV discount, we regard valuation as attractive.
Making A Return With A New Spin Primaris REIT has returned to the public markets following about nine years of ownership by H&R REIT. The REIT maintains a predominantly secondary market focus where there is less competition and where trade area populations average 211,000 and have an average five-year expected population growth rate of +5.5%. HOOPP’s (Healthcare of Ontario Pension Plan) ~26% ownership offers institutional endorsement and the REIT is on track towards an investment-grade credit rating. The conservative capital structure in particular is differentiated, along with the low payout, high cash flow retention approach.
\We see multiple prongs to Primaris’ growth strategy:
1. Internal Growth: We expect NOI to benefit from leases committed but not yet rent-paying, particularly from re-leasing of vacant anchor space at higher rents. Over the long term, an improvement in in-place occupancy from ~86% to 92%-93% can drive further organic growth. The REIT manages internal growth by refining the merchandising mix in favor of higher productivity tenants with the ability to pay higher rents.
2. Acquisitions: The REIT’s acquisition criteria encompass mid-market retail centres in major cities and dominant enclosed malls in secondary markets. Institutions have been increasing their allocation to other real estate asset classes while seeking to trim retail exposure but a lack of liquidity has proved a roadblock. We estimate major institutions own ~55MM sq. ft. of enclosed mall space, implying a wide opportunity set for Primaris, with little to no competition.
3. Value Creation: Sitting on 900 acres, the portfolio has significant intensification potential, and several properties are located close to transit nodes. While high cash retention enables internal funding of developments, the REIT could also monetize excess density while maintaining low leverage.
Overview Of The PortfolioPrimaris was established December 31, 2021 following an internal reorganization of H&R REIT which saw the spin-out of the latter’s enclosed malls and certain other assets. The REIT is internally managed and the portfolio consists of 35 properties totaling ~11.4MM sq. ft. with 27 properties spun-out from H&R and eight properties acquired from HOOPP. The $2.4B H&R REIT portfolio includes 17 enclosed shopping centres, eight open-air shopping centres, and two office properties across six provinces, with a majority of the assets located in secondary markets. The office properties and nearly all of the open-air centres are located adjacent to or in close proximity to the REIT’s enclosed retail properties. The HOOPP assets comprise five enclosed shopping centres, an open-air centre, an office building, and an industrial property, and similarly the non-enclosed mall assets are located adjacent to or in close proximity to other assets. These assets are concentrated in three provinces and are largely in secondary markets. The properties were appraised at ~$800MM, and the purchase was funded with PMZ units and debt, following which HOOPP has a ~26% interest in the REIT. The overall portfolio is primarily composed of enclosed malls, and the average property size is ~326K sq. ft. Ontario and Alberta constitute the REIT’s largest provincial exposures, together comprising nearly three-quarters of NOI. About 75% of NOI is derived from secondary markets