TSX:ERE.UN - Post by User
Post by
incomedreamer11on Nov 08, 2023 9:23am
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Post# 35723292
Scotia upgrade after conference
Scotia upgrade after conference
Upgrading To Sector Outperform
OUR TAKE: Positive. We are upgrading ERE to SO rating (from SP). Three reasons:
(1) Our downgrade rating thesis has now fully played out (link). In our downgrade note earlier this year, we mentioned that we expect negative FFOPU growth in 2023 and see deeply discounted valuation for European residential names. Now, as we end the year, we see positive (albeit modest) FFOPU growth in 2024E and improved valuation for European peers.
(2) Moreover, the bad news is actually the good news – on the conference call, management mentioned that they are disappointed with the pace of progress on the suite-by-suite privatization. We get a sense that one-by-one unit sale will not be the answer going forward. Now, we think, management will have to find a solution either through CBRE sale process or through CAPREIT. Either way, we think ERES unitholders will get rewarded. To us $3.50 looks like the most logical transaction price for all parties – and this implies ~60% total return to current price. Our target is now moved to $3.50 (-$0.50) which is ~10% discount to our Scotia NAVPU Of $3.85.
(3) Valuation now makes sense both on absolute and relative basis – Exhibits 1 to 5.
- ERES is an outlier on AFFO yield spread to 10-yr govt. bond yields (Exhibit 1 and 2): ERES is trading at AFFO yield spread of 670bp to 10-yr govt. bond yield vs CDN multi-family at 130bp spread and U.S. peer (BSR REIT) at 370bp. The spread is too wide for Canadian investor and or CAPREIT to ignore.
- Our NAVPU is reduced to $3.85 (-$0.15) which is now based on 4.75% cap rate on residential portfolio (vs IFRS NAV based on 4.19%) – Exhibit 3. We think our NAV is fairly reasonable even in current interest rate environment. Cost of debt financing in the Netherlands at mid-to-high 4% and 10-yr Govt. bond yield at ~3%.
- European residential names also showing signs of bottoming out: Exhibit 4 showing historical P/NAV of Vonovia – looks like the valuation bottomed out in summer of 2023 and has shown some recovery since then. E.g. Vonovia (VNA-ETR [not covered]) stock is up ~20% since Aug’23 while ERES down ~20%.
Risks to the investment rating: Strategic review process is ongoing and management provided no further update on Q3 conf call (as expected). See our recent note titled “Foreign Residential: Still Out of Favour” for details on a potential M&A transaction. Here, we mentioned that as per CoStar article, some bids were received on the portfolio but there appears a gap between buyers and sellers expectations. Continued on next page...FFOPU growth is getting slightly better and not worse due to better operational performance: We expect 2023 FFOPU to decline 2.8% y/y and modest growth in 2024 with +1.4% y/y growth. This is despite higher interest rate on debt refinancing. We think ERES should be one of the beneficiaries from a potential rate cut environment.
While balance sheet issues are not getting worse anymore (higher leverage), we are seeing acceleration in operational performance. SPNOI growth was +7.8% y/y this quarter (+7.6% in Q2/23). Acceleration on SPNOI growth was driven by higher revenues from increased SP rents and largely flat operating expenses. SP rents grew a solid +7.1% y/y in Q3/23. The higher growth is also a function of higher indexation rate of 4.0% (effective 1st July 2023) versus 3.0% last year. In addition, suite conversions and capturing mark-to-market uplifts on turnover played an important role here. Needless to say, portfolio is performing very well on operation side.