TD comment on updateTHE TD COWEN INSIGHT
We believe the market largely expected the downgrade (yield spreads were out only 10-20bps following the news). Although it does not change our forecasts/outlook, at the margin, the downgrade adds somewhat to the bear-case argument for a distribution cut. Management is adamant that the current distribution level remains secure (link). Our forecast has Allied maintaining its current distribution.
Impact: SLIGHTLY NEGATIVE
Moody's downgrade lowers Allied's bond rating to Baa1 (highest junk rating) from Baa3 (lowest investment-grade rating), with the negative outlook maintained.
This compares with the current DBRS IG rating of BBB. Although the removal from the IG bond index may increase investor concerns that Allied may need to cut its distribution on higher funding costs, the bonds were already trading at "junk" status, and we do not expect debt funding costs to change materially. Near-term maturities include a $200mm bond coming due in April 2025 (3.64% interest rate), a $400mm term loan in October 2025 (4.87%), and a $600mm bond in February 2026 (1.73%). Although we estimate current bond market costs for Allied in the low-7% range, management is exploring alternatives to bond issuance, including CMHC-insured mortgages (on its multi-res properties), traditional mortgages, and mortgage bonds, all of which we believe would result in interest rates lower than what could be achieved in the bond market (currently ~4.5% to low-6% range).
Q1/24 reported Debt/EBITDA was 9.4x. We estimate it rose further in Q2/24 following the closing of the Westbank transactions (link), but should improve through Q4/25 as Allied completes $200mm in non-core asset sales and EBITDA from developments comes online. We estimate Debt/EBITDA at 9.9x by Q4/25 (management believes it could be a full turn lower).
We forecast AFFO payout ratios of 97%/102% for 2024/2025, which, given current leverage, represents the high end of our comfort zone for the distribution. That said, liquidity is solid, with $540mm available on its line of credit (Q2/24E) and north of $8bln in unencumbered properties (IFRS value), which we view as ample to temporarily fund an over-distribution.
Valuation. Allied is trading at 8.7x our 2024E P/AFFO multiple, 2.8 multiple points below its U.S. peers, which we believe is unwarranted, given Allied's relatively favourable (i.e. minimal) near-term leasing maturity profile. Although sentiment towards the office sector remains negative, we believe H2/24 could be an inflection point for Allied, and see potential occupancy gains as a positive catalyst for the unit price.