Tricon Capital Group Inc. (TCN - $7.67)
Stock Rating: Outperform One-Year Target: $11.00 Current Yield: 3.7%
Overview and business description
Tricon Capital Group Inc. (“Tricon” or “TCN”) is a diversified North American residential real estate investment company. Tricon has three main business lines, including: 1) single-family rental; 2) multi-family rental; and, to a lesser extent, 3) residential development (e.g., multifamily, land development, and homebuilding). In addition, Tricon manages third-party capital in connection with its investments, providing investors with exposure to an asset management business that generates contractual fees, carried interest, and performance fees. Tricon’s real estate investments are mostly in regions that generally have strong economic, employment, and housing dynamics such as Texas, Florida, Georgia, the Carolinas, and Arizona. Tricon was founded in 1988, went public in May 2010, and trades on the Toronto Stock Exchange under the ticker TCN.
The evolution from Tricon “Capital” to Tricon “Residential”
Since its 2010 IPO, TCN has evolved from an asset manager to an owner/operator of rental housing. Today, Tricon derives ~69% of its FFO from single-family and multi-family rental housing, up from ~49% in 2017, and less than 10% in its first five years as a public company. Looking to the future, Tricon has set an objective of increasing rental housing FFO to 75% of total by 2022.
A tech-enabled rental housing company
Since entering the single-family rental (“SFR”) business in 2012, Tricon has built a tech-enabled platform, complete with proprietary acquisition and management software, leading-edge automation/marketing tools and smart-home technology. As discussed in a comprehensive report published on February 13, 2020 (link), we also see cross-over potential to the multi- family rental (“MFR”) business, which was acquired in mid-2019.
We see Tricon as comparatively well-positioned in the current environment
The COVID-19 pandemic, mandated social distancing, business closures, and job losses are all having a dramatic impact on the North American (and global) economy. Given that Tricon is a provider of one of the most basic essential services, we see its portfolio of affordable, quality rental housing as comparatively well-positioned relative to many businesses— even if it is not immune to the effects of the current environment.
Tricon entered the 2020 downturn from a position of relative strength
In March 2020, Tricon experienced accelerating demand for its SFR homes, with record occupancy of ~97%, in the same-property portfolio, and steady demand for its MFR properties, with occupancy of ~94%. While sensibly cautioning that several weeks do not make a trend, Management cited potential sources of SFR demand, on an April 7 investor call, which included: 1) its self-showing technology (i.e., no leasing agents needed); 2) an ability to provide greater “social distance” relative to apartments; and, at the margin, 3) more affordable rental homes versus its SFR peers.
Timely rent collection highlights defensiveness of portfolio
Four business days into April, Tricon had collected 80–85% of its SFR and MFR rents, compared to a typical month where collections would stand at 85– 90% (i.e., ~500 bps below “normal”). The balance is usually collected over the course of the month as certain tenants opt to pay late fees, with collections surpassing 99% in March 2020. For tenants who are impacted by the current crisis, Tricon is offering rent deferrals. As at April 7, less than 1% of SFR tenants and ~3% of MFR tenants had requested deferral plans
Healthy liquidity, “cushion” for the dividend, and prudent capital allocation
Tricon pegged its Q4/19 liquidity at $212 million, comprised of $9 million of cash and $203 million of available credit. Relative to $3.6 billion of debt, at TCN's share, this equates to a 6% liquidity ratio. In addition, Tricon had $106 million of cash within its SFR and MFR businesses, of which $84 million is restricted. In addition, Management sees a “cushion” for the dividend, with an FFO run-rate of roughly $100 million ($0.47/share) and projected maintenance capex of less than $30 million ($0.14/share). This compares to annualized dividends of about $39 million (C$0.28 or ~US$0.20 per share) or ~$35 million net of the DRIP. With respect to capital allocation, Tricon: 1) has no significant 2020 maturities and an ability to extend most maturities by one year (or more); 2) is “pausing” acquisitions until visibility improves; and, 3) is reducing capex, where possible.
Key waypoints over the next 12–36 months
In our eyes, Tricon's evolution from asset manager to rental housing company is nearly complete. Remaining tasks, which we believe will be viewed favourably, include: 1) reducing look-through leverage from 61% currently to 50–55%; and, 2) simplifying financial reporting (expected in Q1/20). In the near-term, we believe Tricon’s MFR syndication—a meaningful deleveraging driver—has been paused. Management remains in regular dialogue with prospective investors, who have expressed an interest in resuming a potential transaction when visibility improves. Similarly, Management expects the potential expansion of its Canadian MFR development pipeline will be on the back burner, unless opportunities to acquire distressed condo projects arise (which could be converted into rental).
Estimates, price target, and rating
Tricon’s 2018 and 2019 RBC-defined FFO/share were US$0.22 and US$0.37. Our FFO per share estimates for 2020-2021 are $0.35 and $0.41, respectively. Our C$11.00 price target is based on a 5% discount to our $8.25 NAVPS one year hence at the spot FX CAD/USD rate of 1.40, which implies a 26x multiple to our 2022 AFFOPS estimate of $0.30 (C$0.42). We believe our target valuation multiple reflects Tricon’s positive long-term growth prospects, its 30+ year value-creation track record, option value in the asset management business as it gains size and scale, and the necessity-oriented nature of its rental housing portfolio. These factors are mildly tempered by near-term operating headwinds, above-average financial leverage, a high payout ratio, and what we see as complex, but improving, financial disclosures. Based on our risk- adjusted return expectations versus its peers, we rate TCN’s shares Outperform.