cibc: neutral target C$12, NAV C$14.50Waiting For The Big Reveal Our Conclusion
As we await more definitive progress on the significant components of the business transformation plan, dispositions, at a modest pace, and increased unit buybacks were in keeping with Artis’ well defined strategic initiatives. As expected, the industrial portfolio has garnered strong investor interest and we expect a transaction (or transactions) that could see a much lower cap rate than the in-place 5.6% IFRS cap rate. While the establishment of an advisory relationship between Sandpiper and Artis could be beneficial in expediting investment opportunities, we generally do prefer and lean towards unrelated third-party arrangements, however, the general alignment of interests is, we believe, sufficient as to create a symbiotic relationship between the two entities as long as the current levels of governance are maintained.
While Artis’ units are trading 20% below NAV vs. peers at 10%, we expect uncertainty around execution of the bigger transformation plan may continue to weigh on valuation in the interim, and maintain the relative valuation gap (at least for the short term). Though near-term earnings fade in relevance given the pending transformation, our estimates and NAV increase on unit buybacks. We maintain our Neutral rating and $12.00 price target, at a ~17% discount to our revised $14.50 NAV.
Key Points Q1/21 Results: FFO per unit was $0.35, ahead of our estimate of $0.32, and consensus of $0.33. COVID-19 Update: The REIT has collected 98.6% of Q1/21 contractual rents and on a proportionate share basis, the REIT has ~$4.2MM of rent deferrals. AX adjusted its allowance for doubtful accounts from ~$2MM last quarter to ~$1.8MM this quarter. Developments: The REIT continues to progress on its three development projects in process, and completed the conversion of its Dunwin Drive property into commercial condos along with ~$13.9MM of condo sales. Transactions: The REIT acquired an interest in a land parcel in Greater Phoenix, AZ, in addition to the remaining 5% in an industrial property in Greater Houston, TX. AX also sold an industrial property in Greater Denver for ~US$53.2MM. Post Q1, AX sold four retail properties in Fort McMurray and Regina for $57.2MM, and an office property in Calgary for $4.8MM. Balance Sheet: Proportionate debt to GBV improved ~30 bps sequentially to 49.9% at Q1. The REIT had liquidity of ~$423MM at Q1, in addition to ~$1.9 billion of unencumbered assets. The REIT completed the redemption of its ~$250MM Series C senior unsecured debentures upon maturity and could look to capitalize on interest rates with project-level or asset-level financing. The REIT has also been active on unit buybacks (common and preferred) having spent over $24MM during the quarter.
Looking Through The Pandemic: As we, and indeed the market, have recently focused on a narrower, short-term view of how the pandemic has effected the near-term outlook for Artis, herein we attempt to take a wider and longer-term perspective. In the bar charts in Exhibit 1 below, we review how the overall cash-flow-generating ability of the REIT has evolved since the onset of the pandemic by evaluating the difference between 2022E FFO and 2019A FFO. We note that the significant volume of dispositions in 2019 and some in 2020, offset by buyback activity, do constrain the comparability of 2022 earnings to 2019 levels as a pre/post pandemic snapshot. Nonetheless, we note that Artis’ unit price decline appears more commensurate with the decline in FFO/unit than certain other sub-sectors, affirming our Neutral rating. We expect near-term earnings to be less of a driver of returns as the REIT advances on its transformation plans, with unit price performance likely to reflect progress on meeting new strategic objectives.
Operating Performance: SPNOI declined -5.4%, with the REIT recording bad debt expense and rent abatements totaling ~$0.4MM in Q1. Overall same property occupancy declined 30 bps, with a 120 bps decline in Canada, partially offset by a 30 bps gain in the United States.
Leasing: The REIT completed ~496k sq. ft. of renewal leases during the quarter, with renewals completed at an average rent lift of +4.2%. Portfolio committed occupancy improved ~60 bps sequentially to 92.5%. The REIT currently estimates that average in-place rents across the portfolio are relatively in line with market rents (+4% mark-to-market opportunity in industrial offset by potential rent roll-downs of ~1% in office and retail). For the remainder of 2021, ~13.8% of GLA is scheduled to expire (~7% of which is industrial space, ~5.3% is office, and ~1.5% is retail).
Accelerating Dispositions: As part of its strategy to realize embedded value in assets, particularly in the industrial segment that the REIT believes is being overlooked by the market, the REIT has been focused on selling assets above IFRS value and redeploying the proceeds in either new opportunities or repurchasing units at a discounted valuation in order to drive NAV growth. In Q1, the REIT sold an industrial property in Greater Denver for US$53.2MM and post Q1, sold four retail properties in Fort McMurray, AB and Regina, SK for $57.2MM, and also sold a Calgary office property for $4.8MM.
Distribution Sustainability: The REIT currently pays an annual distribution of $0.60. Under our base-case scenario, this represents 2021E and 2022E AFFO payout ratios of ~59% and ~58%, respectively, indicating to us a low risk for a distribution cut in the near term.
Capital Allocation: During Q1, the REIT repurchased ~2.2MM common units for ~$24MM, and ~21k preferred units for ~$0.4MM. We expect the REIT to consider future unit repurchases as part of its capital allocation plans and its overall strategy and focus on growing NAV for unitholders.
Price Target Calculation Artis trades at 8.0x our 2021E FFO, a ~24% discount to our $14.50/unit NAV estimate at a 6.75% cap rate (from $14.00 at a 6.75% cap rate), and a yield of ~5.5%. Historically, REITs have traded in a relatively wide range of discounts and premiums to NAV. Artis units have traded at a long-term discount to consensus NAV of ~10%, as illustrated in the line chart in Exhibit 2 below. Our price target of $12.00 reflects a 17% discount to our NAV estimate, and equates to 8.8x 2021E FFO.