May 13, 2022
Summit Industrial Income REIT Big picture, tailwinds are still at its back
Our view: Post another round of in-line results, our view of SMU is intact. Against a backdrop of elevated inflation, we believe SMU remains well- equipped to navigate. Indeed, our call for mid-single-digit organic growth is intact, with market rents in ON and QC 75% and 46% above in-place rates, respectively (and rising). We’re also pleased to see the growing number of value-creation opportunities through development, particularly amid a much tighter spread between acquisition cap rates and debt costs. In short, we see valuation as well-supported. Sector Perform, PT to $24 (-$1).
Key points:
Amazon is just one piece of the demand equation. SP NOI increased 1.8% YoY, markedly slower than the +4.8% in 2021. Yet, excluding prior year bad debt reversals, SP NOI rose 3.5% YoY, led by ON (+6.7%). Blended leasing spreads remain impressive, up 42%, well ahead of the 25% last year. Amazon’s recent comments of excess fulfillment capacity have certainly rattled industrial markets (see Exhibit 11 for Amazon’s Canadian sq. ft. growth). Still, we believe demand from other segments remains robust (e.g., transportation, logistics, food), particularly as users build supply chain resiliency, while others are still playing catch-up on e-commerce. All said, our forecasts reflect mid-single-digit % SP NOI growth through 2023.
An active start, but sharpening the pencil on capital deployment. SMU has completed >$200MM of income property ($112MM @ ~4.5% cap rate) and development ($72MM) investments YTD. A further $95MM of acquisitions are in progress in the GTA. Considering the sharp rise in bond yields, SMU prudently appears to be taking a more cautious view, with more attractive returns on offer through its expanding development program. Indeed, the pipeline grew to ~$290MM (+$108MM QoQ). While cap rate expansion is certainly possible, we expect robust rent growth and rising replacement costs to provide superior insulation to industrial asset values.
FFO estimates trimmed, NAV moves up. Our 2022E-23E FFOPU are $0.74 (-$0.02) and $0.81 (-$0.03) with revisions for lower assumed acquisitions, higher debt costs, and recent financings. Our 2021A-23E CAGR is a solid 7% (excluding 2021 debt prepayment charges), in line with its industrial peers and ahead of the sector (5%). Our NAVPU increased to $19 (+$0.50) from higher NOI and equity issued above NAV, with no change in our cap rate. Our $20.50 (+$0.50) one-year forward NAVPU reflects 8% YoY growth.
Sector Perform, price target tweaked to $24 (-$1) on a lower target multiple (~18% premium to our forward NAV vs. prior +25%), as sector valuations recalibrate for higher rates. SMU is trading at 1% above NAV (30x 2022E AFFO/3.8% implied cap rate), ahead of its Canadian peers (7% below NAV/4.8% implied cap), US comps (12% NAV discount), and our universe (15% below NAV/5.9% implied cap). On balance, we believe current levels are well-supported by robust fundamentals, a strong growth profile, solid balance sheet, and an expanding pipeline of value-add developments.