RBC Comments After Conference CallUpgdrated to outperform but slightly reduced targete price. Below is the update.
November 2, 2018
Artis Real Estate Investment Trust
Strategic initiatives should be a turning point
Our view: Artis reported in-line Q3 results, which were overshadowed
by the announcement of a new strategic plan. At a high level, we
believe these prudent initiatives provide the foundation for a stronger
financial foundation, improved NAV-resiliency and the potential to deliver
enhanced total unitholder returns. With increased confidence following
the Q3 earnings call and a 12% selloff on the news, we firmly remain
buyers. Reiterate Outperform.
Key points:
In line Q3 results overshadowed by strategic initiatives. Artis reported in
line Q3 results, with FFO/unit of $0.33, down 8% year-over-year. Quarterly
results were impacted by disposition activity, partially offset by organic
growth of 2% (on a currency neutral basis) and ~4% appreciation in the
U.S. dollar. Looking through the temporary earnings drag, Artis' IFRS NAV/
unit increased $0.37 (+3%) year-over-year to $15.11, supported by trendline
SP-NOI growth of ~1% over the past four quarters.
Tabling a three-year strategic plan. AX plans to implement a series of
actions designed to surface value for unitholders and narrow the NAV
versus unit price gap. Key elements include: 1) a 50% distribution cut to
$0.54/unit annualized; 2) a sharper focus with $800MM to $1B of asset
sales over three years; and, 3) maxing out unit repurchases units under
the NCIB. For details, please see our note entitled, "Prudent initiatives:
Upgrading to Outperform".
Moving further south... and further into industrial. As part of its strategic
plan, Artis aims to derive 40% of its NOI from the industrial sector (up
from 27% at Q3/18) and 60% of its NOI from the U.S. (up from 45%).
Management aims to achieve this principally through a combination of
industrial development in the U.S. and non-core asset sales, aided by
select acquisitions. These initiatives will further reduce Calgary office NOI
to just 5% (down from 8%), retail NOI to 15% (from 20%) and core office
to 40% (down from 45%).
Trimming forecast and PT. We are reducing our FFO/unit estimates by 4%
and 3% in 2019 and 2020, respectively, as Artis works through planned
asset sales and the subsequent re-deployment of capital. While our
forecast does not yet extend through 2021, Management sees potential
for annualized AFFO/unit growth of ~4% vs. the Q3/18 run-rate. In
addition, it sees its NAV/unit growing to $17.00 by the end of the 3-year
initiative. We think this is achievable. Our price target declines to $13.00,
from $14.50, and is based on a ~10% discount to our forward NAV. As AX
executes it plan, we see this discount narrowing and the NAV growing.
Investment summary
Our Outperform rating is primarily a function of our total return
expectations versus the broad REIT/REOC sector. Key
features of the Artis REIT story include:
U.S. exposure provides a natural hedge against oil patch
headwinds. While economic fundamentals in Alberta remain
under pressure given declining oil prices, Artis has somewhat
of a natural hedge with its U.S. exposure, as further weakness
in oil prices would likely be accompanied by additional
weakness in the Canadian dollar, a positive offsetting factor
for the REIT.
Alberta office exposure continues to decline. Management’s
efforts to reduce its Alberta exposure have been successful,
particularly for Calgary office assets. Today, Alberta accounts
for ~21% of NOI, down from 30% in Q4/16 and 35% in Q4/15.
Similarly, the Calgary office accounts for ~8% of NOI following
recent asset sales, down from 13% in Q4/16 and 15% in Q4/15.
In our view, the sale of Alberta properties are a positive for the
REIT, as it continues to reduce its exposure to the province and
the challenging Calgary office market.
Shifting focus to capital recycling. The REIT's cost of equity
capital is up, just like its peers’, which means that acquisition
growth will likely take a pause or be funded through capital
recycling. We believe Artis has ample liquidity to allow it
to carry on with its business, including the build-out of its
development pipeline and selective value-add initiatives.
Will the narrative change? Concurrent with Q3/17 results,
Artis announced intentions for Board renewal and reduced
its target retail exposure from 20% to 15%, with a focus
on everyday shopping. Should the REIT successfully execute
on its latest initiatives and, importantly, establish itself as a
thoughtful capital allocator, we believe the narrative for Artis
could see a marked improvement.
Investment risks
Beyond the "generic risks" of commercial property ownership,
we specifically note that Artis’s significant geographic
concentration renders it heavily exposed to economic
conditions in Western Canada, including potential volatility
in commodity prices such as oil, natural gas, fertilizer, and
agricultural products.