BMO analyst updateHR.UN-TSX
Rating Outperform
Price: Nov-15 $12.40
Target ↓ $15.50
Total Rtn 30%
Sticking to the (Strategic Repositioning) Plan
Bottom Line:
H&R REIT remains a high conviction top pick idea. We are reducing our target price to $15.50, driven by a lowered NAV/unit estimate to $17.11 (from $18.82) from +25bps to the utilized cap rate. Despite the uncertain macro outlook, management remains committed to its strategic repositioning plan (albeit with some timing flexibility), and closing the valuation gap over the next four years. HR.UN's valuation is attractive and has ample wiggle room, trading at -28% to BMO's NAV and -45% to IFRS NAV.
Key Points
H&R REIT is a Best of BMO pick, and post Q3/22 results, remains a high conviction top pick among Canadian REITs. Q3/22 results were stable y/y and ahead of expectations on a headline basis (link), but met consensus excluding one-time income.
Capital allocation still top priority. Notwithstanding a lack of visibility on potential transactions and development amid high interest rates and an uncertain macro environment, management remains committed to recycling capital (though with less certainty on timelines) and buying back stock at a deep discount to IFRS NAV. The current NCIB (expires 12/15/22) allows for another 5.4M units or $67M, after which it can be renewed.
What's notable/new this quarter? Management noted the transaction market has slowed across the board, even for industrial. However, H&R is still “absolutely committed” to dispositions as per the strategic repositioning plan, but timing may be pushed out. YTD, H&R sold nearly $500M of assets; we assume dispositions of $200M for 2023E and $300M for 2024E.
U.S. multifamily fundamentals continue to be strong, as management expects the elevated mortgage rate environment to drive more current renters to continue renting. Additionally, management expects supply to “fall off a cliff” starting in late 2024 and into 2025 with development activity slowing dramatically, which is expected to leave the market further under-supplied. U.S. multifamily currently comprises 39% of BV.
Taking cautious approach on development. Management has decided to pause some construction starts, including Bayside in the U.S. multifamily portfolio, taking time to reflect where interest rates, cap rates, and development spreads will settle, pointing to a lack of visibility for 2023. Development spend for 2023 for the two U.S. residential developments under construction is US$117M (US$210M total cost, 5.7% yield), but management was reluctant to provide guidance for development starts in 2024.