Analysts update Believing its “near-term upside is limited,” Desjardins Securities analyst Kyle Stanley downgraded Canadian Net Real Estate Investment Trust (NET.UN-X) to “hold” from “buy,” believing lower interest rates are necessary before a resumption in transaction activity emerges.
“In the current high-cost-of-capital environment, NET’s external growth program, which generates the bulk of its cash flow growth, has been sidelined — our 2024 FFOPU [funds from operations per unit] outlook calls for 1.5-per-cent growth,” he said.
On Wednesday after the bell, the Montreal-based REIT, which focuses on triple net and management-free commercial properties, reported third-quarter results that fell narrowly below expectations. FFOPU fell 4.7 per cent year-over-year to 15.5 cents, missing the 16-cent projection of both Mr. Stanley and the Street. The variance was attributed to weaker-than-anticipated net operating income and interest expenses, while total occupancy remained unchanged at 100 per cent.
“We expect the portfolio to remain fully occupied through 4Q23 as remaining 2023 lease maturities have all been addressed,” the analyst said. “Management made solid progress on 2024 lease maturities in 3Q23 and has now addressed approximately 74 per cent of maturities (vs 40 per cent at 2Q23). Moreover, tenants representing 24 per cent of 2024 lease maturities that have not yet been renewed are actively undergoing renovations. Leasing spreads achieved on 2024 renewals are in the 10–15-per-cent range.”
“Transaction activity remains muted given the persistently wide bid–ask spreads. However, NET completed the previously announced sale of a single-tenant QSR property in Trois-Rivires, Quebec, for $1.3-million in 3Q23, representing a 5.6-per-cent cap rate and 26-per-cent premium above IFRS value. Assets held for sale at quarter-end totalled $4.8-million (with $2.8-million of associated debt) and represented the last properties to be sold under the REIT’s asset recycling program. Post-quarter, NET closed on the sale of one of these properties in Dartmouth, Nova Scotia, for $1.7-million.”
While he pointed to limited near-term FFO growth, access to capital and trading liquidity for his rating change, Mr. Stanley acknowledged further downside could be limited, pointing to the REIT’s “stable cash flow profile, healthy 7-per-cent distribution yield and cheap relative valuation (7.6 times 2024 FFO vs the retail average of 10.2 times).”
With reductions to his FFO projections through 2025, Mr. Stanley trimmed his target for Canadian Net units to $5.25 from $5.50. The average on the Street is $5.65.
Elsewhere, Echelon Partners analyst David Chrystal lowered his target to $6 from $6.25, reaffirming a “buy” recommendation.
“While the outlook for external growth remains challenging given continued debt market volatility, a wide transaction market bid-ask spread and the REIT’s NAV [net asset value] discount, CNET continues to make progress on its accretive capital recycling program,” said Mr. Chrystal. Though interest rate headwinds are expected to persist, reduction of variable rate debt (approximately 8-per-cent rate) from asset sale proceeds and up-financing activity should provide savings. Operationally, the REIT’s portfolio continues to perform as expected, with modest organic growth to be driven by solid rent lifts on 2024 lease expiries (10-15 per cent on renewals, less than 10 per cent on new leasing) and from high-return property-level capex (9-per-cent unlevered return, $0.8-million aggregate spend).”