TD commentsWe are initiating coverage of PROREIT with a BUY rating and $7.50 target price. We believe PROREIT presents a unique opportunity for investors to gain significant exposure to Canadian industrial real estate at a relatively compelling valuation.
TD Investment Conclusion:
PROREIT's industrial assets account for ~70% of its asset value. However, the REIT is trading at just ~53% (12.6 multiple points below) of its pure-play Canadian industrial peers on a P/AFFO basis.
On P/NAV, PROREIT is trading at an 11% discount versus the industrial peers at a 15% premium. Further, despite increasing its industrial exposure (Q4/19: 47% of asset value), PROREIT is currently trading at discounts to its historical averages on both P/FTM FFO and P/NAV. We view both gaps as unjustified and believe that the current valuation represents a compelling entry point.
We also see meaningful earnings upside following several years of muted FFO/unit growth, as well as strong external growth prospects through acquisitions. We do not believe that PROREIT's elevated concentration in Atlantic Canada (~50% of base rents) should be a valuation impediment, and point to CRR.un and KMP.un in the retail and apartment sectors, respectively, as precedents. Additionally, given management's extensive experience operating in the region, both as leaders of PROREIT, and previously as CEO and CFO of CANMARC REIT (sold to CUF.un in 2012), we are comfortable with this exposure.
We are cautious on the REIT’s elevated payout ratio. However, we believe we have good visibility on the improvement in the metric. Looking ahead, we do not find it difficult to envision a scenario in which industrial accounts for 80%+ of the fair value of PROREIT's asset . As the REIT continues to increase its industrial exposure, we expect the stock to rerate higher and the valuation gap between its pure-play Canadian industrial peers to narrow.
We have already begun to see this phenomenon play out with Nexus REIT (NXR.un, not-rated), which we view as PROREIT's closest peer. With a 6.8% distribution yield, we believe investors are being well-compensated as they wait for the valuation to improve.
Price Company Profile PROREIT is an internally managed REIT that owns a diversified portfolio of 120 commercial properties aggregating 6.6 million square feet of GLA. The REIT's industrial portfolio represents 63% of base rents, followed by Retail, which represents 26% of base rents, and Office at 11% of base rents. The REIT derives ~50% of base rents from Atlantic Canada.