cibc analyst: target C$ 12.50, NAV C$ 14.75Quick Start To Transformation, Patience Needed Ahead
Our Conclusion
As of August 5, we are transferring coverage of Artis REIT to Sumayya Syed. Since the announcement of the business transformation plan, the REIT has shown quick progress on executing first steps through the sale of the GTA industrial portfolio. The improvement in the balance sheet is tracking well, and deleveraging and continued unit repurchases have helped offset the NOI loss from the disposition; however, we expect that next steps in the transformation could take longer to execute (as noted in the timeline of the transformation plan) and could weigh on valuation in the interim. Given the ongoing formulation of the REIT’s strategy and the inherent uncertainty, we maintain our Neutral rating. We adjust our NAV to $14.75, maintaining our 6.75% cap rate and our price target of $12.50.
Key Points
Q2/21 Results And Special Distribution: FFO per unit was $0.34 and in line with consensus. The REIT has ~$2.3MM of rent deferrals outstanding, and has recorded an allowance for doubtful accounts of ~$1.6MM. The GTA industrial sale is expected to close in Q3 and the REIT expects to make a special distribution to unitholders that will be determined later in the year. Operations: SPNOI on a constant currency basis grew +3.4% (-3.9% including f/x) compared to last year, with growth across all asset classes in Canada (strong +13.8% growth in the retail segment and +8.6% in office), while south of the border in the U.S., industrial growth of +3.5% was offset by a decline of -5.8% in office. Same-property occupancy declined 50 bps for the overall portfolio largely due to U.S. office. Services Agreement: The REIT’s negotiations with Sandpiper regarding the provision of services culminated in an agreement whereby Sandpiper will provide research, advisory, and due diligence on potential active investments and co-investments in public companies. In return, Sandpiper will receive fees on a declining scale: 50 bps of the net investment value for years one to three, 40 bps for year four, and 30 bps thereafter. Balance Sheet: Debt to GBV was 48.2% at Q2, down sequentially from 49.9% as the REIT recorded a fair value gain of ~$174MM on its investment properties. The REIT’s liquidity remains strong with ~$295MM in cash and undrawn facilities and the REIT’s unencumbered asset pool grew to ~$2.4B.Capital Allocation: Since the start of Q2, the REIT has repurchased ~4.7MM units at a weighted-average price of ~$11.30/unit, in addition to ~65k preferred units at ~$23.60/unit. The REIT also purchased third-party equity securities totaling ~$18.6MM.
What Really Matters?: As Artis continues to explore options to optimize its portfolio operations, the REIT’s ultimate future, including which asset classes to focus on, its target geographies, desired leverage, and long-term growth prospects are yet to be determined. The REIT’s foray into public securities investing alongside Sandpiper (50-50 co-investments) with limitations on disclosure could also add a level of uncertainty. However, relative to the overall balance sheet (~$5B of assets at Q2), the REIT believes the size and scale of coinvestments will not be overly material. We expect that this transition phase and pending details on the next phase of transformation could limit valuation upside. Leasing: Committed portfolio occupancy declined by ~70 bps sequentially to 91.8%. On ~326k sf of renewals leasing that commenced in Q2, the REIT achieved an average renewal rent lift of +7.3% vs. prior in-place rents. The REIT estimates that market rents are ~1% above-average in-place portfolio rents. For the remainder of 2021, ~10.9% of the portfolio is scheduled to mature (largely split between industrial and office). Developments: The REIT continued to progress on four ongoing projects, and commenced construction on Blaine 35, its industrial development in the Twin Cities Area, MN during Q2. The REIT continues to plan for its future longer-term development pipeline, which entails two projects in Madison, WI and a project in the Greater Houston Area, TX, with the three projects combining for a potential ~1.4MM sf. Transactions: The REIT acquired a development land parcel in the Twin Cities Area, MN for ~US$2MM. Post quarter, AX sold its King Edward industrial portfolio in Winnipeg, MB for $3.2MM and announced an agreement to sell its East Landing retail portfolio in Regina, SK for ~$19.1MM. Artis also plans to sell a property leftover from the GTA industrial transaction. The sole property remaining from the GTA industrial portfolio was held back due to timing and technical challenges, but AX anticipates this asset will be sold this year. Distribution Sustainability: The REIT currently pays an annual distribution of $0.60. Under our base-case scenario, this represents an AFFO payout ratio of ~61% for both 2021E and 2022E, indicating a low risk for a distribution cut in the near term. Historical Valuation: AX currently trades at a ~21% discount to our NAV estimate. On a historical basis, AX has traded at an ~10% discount to consensus NAV.
Price Target Calculation Artis trades at 8.6x our 2021E FFO, a ~21% discount to our $14.75/unit NAV estimate at a 6.75% cap rate (from $15.50 at a 6.75% cap rate), and a yield of ~5.2%. Historically, REITs have traded in a relatively wide range of discounts and premiums to NAV. Our price target of $12.50 (unchanged) reflects a 15% discount to our NAV estimate, to account for economic uncertainty in the REIT’s markets, and equates to 9.3x 2021E FFO.