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

Scotia comments on result

[incomedreamer11]

Higher Leverage May Weigh On Sentiment, but Steps Being Taken

OUR TAKE: Mixed. SP rating intact. Key estimates fall 3%-16% on higher debt costs, higher cap rate, and lower target multiple (Exhibit 1). The 3%-16% compares to 0%-6% avg. for our universe with Q3 (Exhibit 2). AX delivered a decent Q3 but the bigger news = the USD $324M sale of 23 Industrial properties in Minneapolis (3.2M of GLA = US$102/sf; AX total U.S. Industrial IFRS = 5.5% cap rate). Although cited (on Q2 call) the Minneapolis portfolio was part of an expected ~$700M in dispositions, transacting in the current market isn’t easy, so we think AX deserves some credit on that front (stock responded on Friday aft.), with the sales price in excess of purchase price (Exhibit 3). The dispositions = ~67% of Q3/22A assets held-for-sale ($658M), with debt repayment the near-term use (AX has higher exposure to both floating rate debt + near-term debt maturities; Exhibit 4). That said, it provides flexibility to acquiring more Dream Office units (at 14% with partners) + its own units starting in December (AX completed the NCIB implemented in December/2021; Exhibit 5). Bottom line, we think the units will trade at a notable discount to NAV pending increased investor confidence on the new strategy & debt reduction.

KEY POINTS

What has changed since we last wrote? We increased our cap rate 18bp to 6.62% (AX +6bp to 6.18%), including a 37bp and 50bp increase in U.S. and CAD Office, respectively (recall, Winnipeg Office and Retail had the biggest CBRE q/q cap rate increase at 60bp-75bp; see our note). We reflected an extra 100bp of BoC rate hikes through 2023, before 175bp of cuts in 2024 (our estimates assume no reduction in floating rate debt; likely a headwind turning into a tailwind in 2024). Our 2023E FFOPU falls 10% on the higher debt cost, but also the $0.01 Q3 shortfall carryforward (~4%); we’re still 2% above 2023 consensus. In terms of capital allocation, AX interestingly noted (on the c/c) that the pricing spread between quality and other favours quality (i.e., reward/risk favours high-grading in the public markets). With respect to debt maturities, AX noted ~26% of the near-term $500M will be repaid via asset sales, ~40% is completed (refinanced) with the remaining 34% under negotiation. AX does not expect any issues refinancing near-term debt maturities.

New 2024 estimates reflect a return to growth as dispositions moderate. Our new 2024E FFOPU and AFFOPU are $1.35 and $1.02, 4% and 13% higher than consensus, respectively. Unlike consensus, we expect 2024E y/y growth (5% and 12%, respectively) as our 2024E net dispositions falls to $300M (2023E = $700M). Exhibit 6 summarizes our key assumptions. Our 2022E-2024E FFOPU and AFFOPU CAGR = -0.5% and +4.3%, respectively, below the 7.6% and 8.0% sector average to date (Exhibit 7). Our revised estimates reflect 4.5% NTM NAVPU growth (Current and Forward NAVPU of $14.25 and $15.00, respectively) vs. 7.5% sector avg. (Exhibit 8).

Q3/22 Highlights & Developments

OUR TAKE: Neutral. Reported FFOPU was $0.36. Ex. $1.9M of lease termination income, we est. recurring FFOPU of $0.35 vs. $0.364 q/q and $0.326 y/y, a bit below our and consensus $0.36 (range = $0.33-$0.38). The print reflected 6.7% y/y growth (Q2/22 = +6.1% y/y; 2021A = -6.1%).

IFRS NAVPU was down only $0.11 (-0.6%) q/q to $19.26. SPNOI was up 4.3% in CAD and +1.7% in local currency (Q2 = +0.7%/-1.5%). Canada and the U.S. were down 2% and +5.7%, respectively (Q2 = -1.8%/-1.2%). It was also a fairly light quarter, with one $24M disposition (Minneapolis Office), although AX expects to complete a number of sales in Q4 and assets HFS were still a material $658M or 16% of IPP (down $10M q/q).

Capital recycling update. Investment in equity securities decelerated to $41.5M (Q2 = $248M; 2021 = $72M) bringing the total market value to $270M at quarter-end (incl. our est. $20M FV loss during Q3 vs $49M in Q2). AX also redeemed preferred units totaling $81M. Post-Q, AX sold 6 industrial properties in Minnesota for US$75M and purchased an additional $28M of equity securities.

Solid leasing spread; flat occupancy q/q. In-place occupancy fell 20bp q/q to 90.5% (Q2 = +120bp), while committed occupancy was flat q/q at 92.0% (Q2 = +40bp q/q). In-Place CAD and U.S. were +90bp and -80bp respectively to 90.5% (Q2 = +20bp and +170bp). Avg. total portfolio rent on lease renewal was +3.0% (Q2 = +3.7%; 2021A avg. = +4.2%). In-place rent ($13.30/sf) is now 1.2% below market (Q2 = 1.5% below market). By asset class, y/y SPNOI in CAD was: Industrial (+4.4%; Q2 = +4.5%), Office (+6.1%; Q2 = -1.4%), Retail (-0.4%; Q2 = -0.6%).

Detail on q/q fair value changes. While the $74M FV loss (Q2 = -$19M) equates to 1.8% of IPP, we note it comprised of a $14M loss in Office (Q2 = -$64M), $63M loss in Industrial (Q2 = +$31M), and $2M loss in Residential (Q2 = -$1M), offset by $5M gain Retail (Q2 = +$15M), with Office and Industrial cap rates moving higher. Retail was the most stable. Portfolio IFRS cap rate was +6bp q/q to 6.18% (Q2 = 6.12%; vs. our 6.44%), with Industrial +15bp (5.68%; Q2 = 5.53%), Office +5bp (6.67%; Q2 = 6.62%) and Retail up 1bp (6.47%; Q2 = 6.46%).

Financial leverage moves up as liquidity ticks down. Q3 liquidity fell $89M q/q to $263M (Q2 = -$24M q/q), incl. $137M in cash and $127M in available credit; = 0.4x 2022-2023 debt maturities (Q2 = 1.8x 2022 maturities). Total debt/GBV was +190bp q/q to 47.9% (Q2 = +300bp); proportionate was n/a. Disclosed debt/EBITDA was +0.3x q/q to 9.2x (Q2 = +0.4x q/q). Unhedged variable-rate debt as a % of total debt was +220bp q/q to 14.2% (Q2 = 12%).