CIBC comments on resultSoftening Fundamentals Portend A Looming Recession
Our Conclusion
Allied reported an in-line Q3/22, although negative commentary around the current leasing environment, a negative SPNOI print and a minor impairment of the residential development pipeline and Calgary portfolio may serve to weigh on the unit price, which was already under pressure owing to a generally negative sentiment surrounding the office asset class.
While generally optimistic on the broader “return to office” (a sentiment we indeed do share), the REIT’s acknowledgement of the potential for a weakening backdrop likely increases the importance of, and investor attention to, generating internal growth through its significant development pipeline (properties under development represent ~12% of the balance sheet and are expected to generate ~$82MM of additional EBITDA over the next few years). In conjunction with introducing our 2024 estimates, we are modestly increasing our cap rate, by 25 bps to 5.50%, and lowering our forward NAV estimate to $38.00. Accordingly, we are maintaining a modest discount to NAV, and lowering our price target to $36.00; Allied remains Outperformer rated.
Key Points
Q3/22 Results
Recap:FFOPU of $0.61 was above our $0.59 estimate and in line with $0.61 consensus (range of $0.58-$0.62). Occupancy of 90.7% (consisting of 91.4% on the stabilized portfolio and 74.6% on the transitional portfolio) was down 20 bps Q/Q and came in below our 91.2% estimate. Average in-place rents grew 3.8% Y/Y (1.1% Q/Q) to $25.56, a touch above our estimate. Total portfolio SPNOI was down 1.6% Y/Y and the reported IFRS NAV was down modestly to $51.10 (on a flat 4.58% cap rate) due to a decline in value of the Calgary portfolio.
Leasing: Allied renewed or replaced 148K square feet of maturing leases at an average rent lift of 7.3% (8.6% excluding Calgary); leases on another ~0.4MM sq. ft. (~2.9% of GLA) are maturing in the remainder of 2022. Space for sub-lease was flat Q/Q at 2.4%, with a ~66% decrease in Vancouver offset by an ~81% increase in Calgary.
Balance Sheet: Allied’s Balance Sheet remains robust with 34.3% debt/GBV, up slightly from 33.9% in Q2/22. Interest coverage is 2.9x, while net debt/ annualized adjusted EBITDA remains slightly elevated at 9.6x. Allied has ~$356.4MM of available liquidity, and $9.5B of unencumbered assets.
Development Pipeline: Allied recorded a $15.7MM asset impairment on its KING Toronto residential development, citing higher estimated costs to complete. While the charge is relatively minor at ~$0.10/unit, it does highlight inflationary concerns and the potential for additional cost overruns on the REIT’s remaining $1.4B of active developments.
Investment Thesis 1) AP's flexible, thoughtfully-designed downtown office product is ideal for hybrid work models, particularly tenants in high-growth tech and creative-class industries; 2) AP is one of few Canadian REITs with significant exposure to fast-growing data centres; 3) Allied has a substantial pipeline of redevelopment and new-build projects; 4) AP has a strong balance sheet (debt/GBV in the low30% range) and financial flexibility to execute on its growth strategies.
Price Target (Base Case): C$36.00 Our $36.00 price target reflects a 5% discount to our current NAV estimate, assuming a 5.50% blended cap rate , based on 2023 NOI estimates; this equates to 14.1x 2023E FFO.
Upside Scenario: C$46.50 Our upside scenario of $46.50 reflects parity to our NAV estimate with NOI 5.0% above forecast on higher rent & occupancy growth and 50 bps cap rate compression.
Downside Scenario: C$20.00 Our downside scenario of $20.00 assumes a stagflationary environment and reflects a 30% discount to our NAV estimate with NOI 10.0% below forecast on lower occupancy & rent declines and 50 bps cap rate expansion.