Analysts update ollowing weaker-than-anticipated first-quarter results, Echelon Partners analyst David Chrystal thinks cost inflation will remain a significant financial obstacle for Canadian Apartment Properties Real Estate Investment Trust (CAR.UN-T) moving forward, however he continues to expect revenue growth to “accelerate.”
“Despite a tightening apartment market, CAPREIT’s softer-than-expected Q122 results reflect near-term challenges owing to (1) a tight regulatory environment that limits the REIT’s near-term organic revenue growth, and (2) inflationary pressure on operating expenses, particularly utilities, wages and repairs and maintenance costs,” he said. “Though we expect to see revenue growth accelerate through 2022, and cost pressures to ease somewhat for the remainder of the year, we expect that NOI [net operating income] margins will be softer, and organic NOI growth muted for the next few quarters.”
On Monday after the bell, the Toronto-based REIT reported revenue of $246.6-million, up 8 per cent year-over-year but below Mr. Chrystal’s $245-million estimate. Earnings before interest, taxes, depreciation and amortization (EBITDA) rose 3 per cent to $135-million and adjusted funds from operations gained 2 per cent to 45 cents, also missing his forecasts ($144.9-million and 48 cents, respectively).
“Though CAPREIT delivered modest year-over-year organic revenue growth (2.3 per cent) reflecting rising occupancy (up 60 basis points) and average rent, a 9.6-per-cent increase in operating expenses resulted in a 1.7-per-cent decline in same-property NOI,” he said. “The cost increase was in large part due to rising natural gas and electricity prices and consumption as well as increased weather-related maintenance (including boiler maintenance and snow removal) in a particularly cold Q1. We expect that some cost pressures will ease in Q2 and Q3 as weather-related costs are eliminated; however we note that wages, contracts and supplies will likely continue to see inflationary pressure going forward. While organic NOI growth will likely turn back positive, margins will likely remain under pressure until revenue growth returns to pre-pandemic levels (4-5 per cent).”
During Q122, average lifts on turnover in the Canadian apartment portfolio were up 10.2 per cent above prior rents, the strongest figure since Q120. Management commentary, and strengthening demand into the spring/summer leasing season suggest that this figure will continue to rise in the coming quarters. We expect that lifts on turnover will ultimately meet or exceed the 13-14-per-cent range achieved in 2018-2019 pre-COVID. However, renewal lifts (up 1.3 per cent in Q122) remain constrained in the near term due to relatively low allowable increases across most jurisdictions with rent control regulations (more than 90 per cent of NOI). We see a stronger revenue growth outlook in 2023, when we expect that allowable increases will be somewhat higher (more than 2 per cent on average), and lifts on turnover will reflect growing demand in supply-constrained markets.”
Mr. Chrystal reduced his 2022 estimates to reflect the quarterly results and a “slight” reduction to his NOI margin assumptions. That led him to cut his target for CAP REIT units to $62.50 from $68. The average on the Street is $65.08.
Keeping a “buy” recommendation, he said: “We are confident in CAPREIT’s long-term outlook, irreplaceable portfolio of assets in supply constrained markets, and exceptional financial position. That said, in the near-term we believe the muted organic growth profile and headwinds of rising interest rates will continue to hinder unit price performance.”
Elsewhere, others making target adjustments include:
* Raymond James’ Brad Sturges to $66 from $70 with a “strong buy” rating.
“The recent sell-off in CAPREIT’s unit price has created an extremely wide disconnect between public and private market pricing for the Canadian multifamily REIT sector,” said Mr. Sturges. “Given this pricing dislocation, CAPREIT has established a normal course issuer bid (NCIB). While there are limits to the activity level that CAPREIT can realistically achieve, we believe incremental unit buyback activity by CAPREIT can provide a positive signal of inherent underlying value to investors. We also view the re-election of the Ontario PC government in the upcoming June election as a possible material near-term positive catalyst for CAPREIT’s deeply discounted unit price.”
* Desjardins Securities’ Michael Markidis to $65 from $67 with a “buy” rating.
“Fundamentals are getting stronger and operating metrics are trending in the right direction,” said Mr. Markidis. “Our revenue forecast assumes that vacancy loss, incentive amortization and new leasing spreads will return to pre-pandemic levels in 2H22. We expect that opex inflation will continue to weigh on profitability in the short term. On a total portfolio basis, our model employs an NOI margin assumption of 64.8 per cent for 2022 (down 60 basis points vs 2021). Continued top-line momentum, combined with more modest cost pressure, is expected to drive 40 basis points of margin expansion in 2023.”
* RBC Dominion Securities’ Jimmy Shan to $66 from $69 with an “outperform” rating.
“Q1/22 reflected a tough winter but improving revenue outlook, which H2 should better reflect,” he said. “Given current valuation, NCIB is being considered with asset sales. Valuation is tricky—a glass-half-full investor looks to inflationary impact on replacement cost & rents; a glass-half empty investor looks to the negative/thin investment spread impact on cap rates.”
* iA Capital Markets’ Johann Rodrigues to $60 from $65 with a “buy” rating.
“We would advise investors to pick away at the stock, choosing to time their entry points, but to not miss out on a discount that occurs 1-2 times a decade,” he said.
* CIBC World Markets analyst Dean Wilkinson to $60 from $63 with a “neutral” rating.
* TD Securities’ Jonathan Kelcher to $66 from $70 with an “action list buy” rating.