Artis Real Estate Investment Pref Shs Series E T.AX.PR.E

Scotia comments after conference

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A Couple of Positive Developments on the Margin

OUR TAKE: Slight Positive. We maintain our SP rating although AX bucks the trend of downward estimate revisions this quarter, with each of our key estimates moving higher, including our target price and NAVPU estimates (+4% and +3%, respectively; Exhibit 1). AX delivered a sizable beat in Q2 (admittedly, it was due to our slightly inaccurate treatment of Cominar FFO heading into Q2). We are pleased to hear of a material expected pick-up in dispositions ($688M of assets HFS; ~$475M net equity) expected to close by Q4 given our view that “net sellers” of direct assets have benefited from market expectations of rising private market cap rates (Exhibit 2). Timing could bode well for AX NCIB activity to resume post December 17 (expiration of this NCIB). While the substantial assets HFS (17% of IPP FV) may surface questions over a possible SIB, our sense is that AX remains committed to lowering financial leverage (Exhibit 3), prudent in the current environment in our view. So net-net, investors may have to wait until Q4 for the NCIB-related alpha to materialize (Exhibits 4-5), with AX providing a solid interim 5%+ yield (on a low payout ratio; Exhibit 7) and good valuation (Exhibits 10-11).

KEY POINTS

The relevance of NCIB to AX unit price performance. AX continues to execute on their business transformational plan of buying back units, disposing of non-core assets and investing in public securities (more than expected; $158M vs. our $90M forecast). AX fully exhausted its NCIB in Q2/22 by acquiring 3.5M units (in total, AX acquired 8.8M units since Q4/21 at an avg. $12.46/un; 7% of units o/s or closer to 16% going back to Q4/19; Exhibit 4), leaving a gap to the next one (we expect to start the week of December 19). As shown in Exhibit 5, AX has outperformed the CAD REIT Index 100% of the time by an average of 10% over six months when repurchasing 3%+ of its units o/s. With the aforementioned massive uptick in expected dispositions by Q4, we think this positions AX well in 2023. In terms of the expected ~$700M of dispositions, AX noted a majority comprises its Minneapolis Industrial assets (27 assets comprising 4.1Msf; 90.3% occupied) along with 2 Office assets in each of Denver and Phoenix (= exit from Denver). We note the U.S. Industrial IFRS cap rate = 5.30% vs. AX current implied cap of 6.70%, with AX expecting to achieve at least IFRS valuation. We’ve reflected a blended 5.5% disposition cap rate (i.e., including the U.S. Office).

What has changed since we last wrote? Our 2022E and 2023E FFOPU are +$0.08 and +$0.07, carrying forward the $0.02-$0.03 Q2/22 beat. Combined forecast modest SPNOI growth through 2023 (~1%) and substantial asset dispositions results in a forecast ~$0.36/un quarterly FFOPU run-rate through 2023. The higher NOI run-rate and inclusion of other net assets increased our NAVPU by ~$1.50, partially offset by a 20bp jump in our NAV cap rate to 6.45% (-$1.00/un), resulting in a net $0.50/un increase. Our Forward NAVPU is similarly +$0.50 to $16.00, implying 4.5% NTM NAVPU growth vs. 8% sector avg. 

Q2/22 Highlights & Developments

OUR TAKE: Slight Positive. Reported FFOPU was $0.38. Ex. $1.7M of lease termination income, we est. recurring FFOPU of $0.36 vs. $0.33 q/q and $0.342 y/y, above both our $0.33 and $0.354 consensus (range = $0.33-$0.39). The print reflected 6.1% y/y growth (Q1 = -4.6% y/y; 2021A = -6.1%). In terms of positives. AX continued to differentiate itself by completing its NCIB, which we view as a better use of capital vs. acquiring direct real estate today. We were pleased to see the U.S. Office occupancy improve q/q too. Lastly, it did deliver a $0.03 beat vs. us, driven by higher-than-expected NOI and lower-than-expected corporate expenses (Exhibit 12).

IFRS NAVPU was +$0.28 (+1.5%) q/q to $19.37 following a monster $1.72 gain in Q1, largely due to retained cash as a $19M IPP FV loss was recorded (along with equity investment losses). In terms of negatives, SPNOI was up 0.7% in CAD but down 1.5% in local currency (Q1/22 = -2.6%/-2.4%). Canada and the U.S. were -1.8% and -1.2%, respectively (Q1 = -1.2%/-3.7%). It was also a fairly light quarter, with $69M of total dispositions. That said, assets HFS are up materially q/q.

Capital recycling update. Investment in equity securities accelerated to $158M (Q1 = $66M; 2021 = $72M) bringing the total market value to $248M at quarter-end (incl. our est. $49M FV loss during Q2). AX sold a Mississauga, ON Office and Denver Industrial asset for a combined $69M, while recording $668M of assets HFS (mortgage balance = $194M), up a significant $608M q/q (YTD sales = $134M vs. 2022 minimum target of $500M). The assets HFS jumped on the inclusion of 28 Industrial properties (of its total 75) and 4 Office properties.

AX repurchased 3.5M units in Q2 (vs. 4.2M in Q1) at an avg. $12.54/un (vs. current price of $11.44), representing the full allowed amount under its NCIB that renewed on December 17, 2021. In total, AX acquired 8.8M units at an avg. $12.36 (8% above current unit price).

Solid leasing spread; nice to see occupancy tick up q/q. In-place and committed occupancy were +120bp and +40bp q/q to 90.7% and 92.0%, respectively (Q1 = +10bp q/q). In-Place CAD and U.S. were +20bp and +170bp respectively to 89.6% and 91.3% (Q1 = -70bp and +70bp), with growth predominantly driven by Minneapolis and Phoenix Office (U.S. Office was +530bp q/q to 88.6%). Avg. total portfolio rent on lease renewal was +3.7% (Q1 = +7.8%; 2021A avg. = +4.2%), almost exclusively driven by an 18% gain in Industrial. In-place rent ($13.56/sf) is now 1.5% below market (Q1 = at market). By asset class, y/y SPNOI in CAD was: Industrial (4.5%; Q1 = flat), Office (-1.4%; Q1 = -6.4%), Retail (-0.6%; Q1 = +2.9%).

Detail on q/q fair value changes. While the $19M FV loss equates to only 0.4% of IPP, we note it comprised of a $64M loss in Office, offset by a $31M and $15M gain in Industrial and Retail, respectively. Industrial = higher market rents while Retail = lower cap rates (interesting). Portfolio IFRS cap rate was +2bp q/q to 6.12% (vs. our 6.25%), with Industrial +3bp (to 5.53%), Office +7bp (6.62%) and Retail down 7bp (6.46%).

Liquidity ticks down; financial leverage moves up. Q2 liquidity fell $24M q/q to $352M (Q1 = -$414M q/q), incl. $80M in cash and $272M in available credit; = 1.8x 2022 debt maturities (Q1 = 1.6x 2022 maturities). Total debt/GBV was +300bp q/q to 46.0% (Q1 = +10bp to 43%); proportionate was n/a. Disclosed debt/EBITDA was +0.4x q/q to 8.9x (Q1 = +0.3x q/q). Variable-rate debt as a % of total debt fell 100bp q/q to 12%.