New Coverage - TD Waterhouse
Nexus Industrial REIT
(NXR.UN-T) C$7.86
Recommendation: Hold
12-Month Target Price: $8.50
Canadian Industrial REIT with Ability to Resume FFO/unit Growth
Event
We are initiating coverage of Nexus Industrial REIT with a HOLD rating and $8.50 target price. Our full initiation report will be published later today.
TD Investment Conclusion
At over 90% of NOI, Nexus stands out versus its peers as having the highest concentration in the Canadian industrial property market — which we view favourably. That said, at this time, we prefer to wait for Nexus to deliver on per-unit FFO/AFFO growth before getting more constructive on our rating.
Nexus has an elevated concentration in secondary markets and lower exposure to the primary markets (i.e., Toronto/Montreal). Rent growth in many of these secondary markets (e.g., S.W. Ontario including London) has outperformed over the last year, partially due to a catch-up effect to the overall market and a boost in warehouse demand ignited by some large government-subsidized investments. However, given this secondary market focus, we do not expect Nexus' SPNOI growth to match our 6%/7% forecasts for its pure-play industrial peers (GRT.un and DIR.un). That said, we expect SPNOI growth similar to PRV.un at close to 4%, which is attractive versus non-residential REITs.
Recent unit price and relative valuation underperformance can be largely attributed to negative revisions to consensus estimates (e.g. 2024E FFO/unit has thus far been revised 12% lower).
That said, we now see potential for Nexus to deliver more predictable unitholder returns and per-unit AFFO growth going forward. We forecast a 4% two-year CAGR to 2025E, ahead of our flat expectation for PRV.un, but below the 8% average we forecast for GRT.un/DIR.un.
On valuation, Nexus is trading at an 11.6x P/FTM consensus AFFO multiple, 22% below its pure-play industrial peers (vs. historical average of a 26% discount). We view the current discount as fair, given Nexus' relative positioning on portfolio quality and market exposure, as well as higher balance-sheet leverage and recent negative earnings revisions. That said, we acknowledge the appeal of acquiring Nexus units at today's low relative valuation and approximately 8% cash distribution yield.
Outlook
Overall, we are forecasting a 0% three-year AFFO/unit CAGR for 2022A-2025E (due to the decline in 2023) and a more attractive 4% two-year CAGR for 2023E-2025E.
1. SPNOI Growth: We are forecasting average SPNOI growth of 3.75% for 2024E[1]2025E, which matches the average reported in Q1-Q3 2023. This is below our 6%/7% forecasts for Granite/Dream Industrial, but in line with our forecast for PROREIT.
2. Acquisitions/Dispositions: We have not included any acquisitions beyond the two that closed in Q4/23. On the disposition front, we have included $200 million of dispositions through 2025E, which largely reflects Nexus’ goal of exiting all its remaining non-core retail and office properties (e.g., the Sandalwood portfolio). Our 7.0% disposition cap-rate assumption represents a built-in headwind for per-unit FFO and AFFO growth.
3. Leverage: The combination of SPNOI growth and our steady pace of assumed dispositions result in our forecast Debt/EBITDA falling to 8.7x in 2025E from the high[1]9s Debt/EBITDA currently.
NAV estimated at $10.00/unit. We derive our $10.00 NAV/unit estimate by using a weighted average ~6.1% capitalization rate applied to our $117mm 12-month forward NOI estimate. By comparison, Nexus’ IFRS fair value NAV/unit of $12.89 uses a 5.98% cap rate and $133mm “stabilized NOI”.
Valuation
Nexus is currently trading at 12.1x 2024E AFFO/unit, 2.3 multiple points below its pure[1]play industrial peers (Granite and Dream Industrial), and 1.8 multiple points below PROREIT. On a P/NAV basis, the REIT is trading at a 21% discount to our $10.00 NAV estimate, versus its pure-play industrial peers at an 18% discount and PROREIT at a 22% discount
Justification of Target
Price We derive our $8.50 target price by applying a 12.5x-13.0x P/AFFO multiple on our 2025E. This results in a 15% discount to our current NAV/unit estimate. Our target multiple is primarily based on a +/- 25% discount to our target valuations for the larger[1]cap pure-play industrial-focused REITs, and is also 2% above our target multiple for PROREIT. Our 85% target P/NAV compares with 103% for the pure-play industrial[1]focused REITs and 72% for PROREIT. If Nexus achieves consistent earnings growth and disposes its remaining non-industrial properties, we envision future upside to the relative valuation.
Nexus will report Q4/23 results pre-market on March 14, with a call at 10:00 a.m. EST (416-915-3239). We are forecasting FFO/unit of $0.19, which is in line with consensus.