Comments from RBCAugust 16, 2024
Nexus Industrial REIT
Getting back on track
Target Price Increased from 8.00 to 8.50.
Our View: After two quarters of sequentially declining FFO/unit, Nexus Industrial (“NXR”) posted results that look to be back on track. We expect H2 to get progressively better with vacancies backfilled and developments coming on line. Moreover, we expect a healthy pace of growth in 2025 given renewal spreads, more developments and its largest market, London, holding strong. With forecast payout ratio <100% in 2025, an 8%+ yield, we could see near term positive momentum in the stock. NXR is trading slightly tighter than LTA vs. industrial peers. TP $8.50 (+6%). Maintain SP
Key points:
SP NOI growth was +3.3% driven primarily by the inclusion of the Belvedere Club lease in Richmond BC (the rental income more than replacing the vendor rent obligation). Industrial occupancy was 97% (-100 bps q/q). Retail & office occupancies were flat at 88% & 73%, respectively. Next quarter, we expect further improvement in the y/y SP NOI growth.
H2 should get progressively better with 1) the vacancies at two sites in London & Calgary backfilled in Q3, 2) full impact of Richmond BC lease, 3) Hubrey Road development coming on line. In 2025, we are modeling a healthy pace of growth driven primarily by rent growth on renewals, further two developments (St Thomas & Hamilton) coming on line and new tenant at its Regina recent development. MTM rent opportunity stands at 25%. NXR noted that 75% of 2024 renewals was completed at +24% rent growth, and 50% of 2025 at +10%, with a large 264K SF below market lease in London (HCL Logistics) that could drive $2M of annualized NOI lift. In the context of broader slowing industrial market, London, its largest market, seems to be holding strong with the tightest availability in Canada at 1.5% and market rents in the $12 range.
Capital Allocation activity: 1) Acquisitions: NXR acquired (post quarter) a newly-built industrial property in Sherbrooke QC for $16.6M ($268 PSF, 6% cap rate), funded partly with 0.46M Class B units at $10; 2) Asset Sales: NXR sold an office property in Blainville QC for $5.1M ($150 PSF). It now expects to sell $110M (vs. $200M previously) in H2/24 comprising office and retail (valued at 7.1% cap) and does not expect to sell the non-core industrial Westcan portfolio.
Valuation: While timing of leases and developments impacts near term estimates, there appears to be a good line of sight of below 100% payout in 2025. Its high yield of 8.3% and improving payout could see momentum near term. We estimate NXR’s NAV/unit at $9.50 (+6%), based on a 6.4% cap (+5 bps) vs reported NAV of $13.20 (+0.8% q/q) based on a 5.8% (-4 bps q/q). Our target of $8.50 (+6%) is based on a 15% discount to one-year forward NAV, discount in line with LTA. NXR trades at an implied cap of 6.9% (~55bps wide to peers), 11.6x 2025 AFFO, 2.6x lower than peers, which is slightly tighter than 3x historical average. Maintain SP
Valuation
Our $8.50 price target is based on units trading at a 15% discount to our $10.00 NAVPU one year hence, which implies a 13x multiple to our 2025E AFFOPU. We believe our target valuation multiple reflects: 1) strong fundamentals relative to other property classes; 2) limited means through which to gain exposure to industrial real estate; and 3) the composition of secondary market assets compared to industrial peers. Based on relative risk-adjusted return expectations, we rate the REIT’s units Sector Perform.
Upside scenario
Our $11.50 upside scenario assumes that NOI growth exceeds our forecast by ~2%, cap rates compress by 25 bps, and units trade at parity to our NAV per unit one year hence. In this scenario where cap rates are compressing and NOI is exceeding our forecast, we think a higher P/NAV multiple would be warranted.
Downside scenario
Our $5.75 downside scenario assumes that NOI growth falls short of our forecast by ~2%, capitalization rates increase by 25 bps, and units trade at a 35% discount to our NAV per unit one year hence. In this scenario where cap rates are expanding and NOI is falling short of our forecast, we think a lower P/NAV multiple would be warranted.
Investment summary
Our Sector Perform rating is primarily a function of our risk[1]adjusted total return expectations compared with the broader REIT/REOC sector. Key elements of the Nexus Industrial REIT investment case are the following:
An industrial play on Canadian secondary markets
Nexus Industrial REIT has focused its efforts on acquiring industrial assets in secondary markets within Canada, differing from its industrial REIT peers. At the end of Q2/24, Alberta, Quebec, and Ontario composed over 75% of the REIT's NOI. Going in cap rates that can be achieved in its target markets are typically higher than larger urban markets given lower long term growth profiles and lower competition for assets.
Industrial sector tailwinds to drive future earnings growth
The strength of the industrial sector is well known and market rent growth has been breaking records in many markets. Ecommerce adoption, retail sales, just-in-time to just-in[1]case inventory have been major demand drivers and likely will continue to be. Despite concerns on slowing consumer demand and a potential recession, we expect a favourable demand/supply picture given low market availability rate and construction activity in NXR's key markets.
Multiple re-rating driven by well-bought assets
We believe that CEO Kelly Hanczyk’s capital allocation has been fairly disciplined. After years of modest growth as a diversified small cap REIT, the 1.2m sf London portfolio transaction in April 2021 enabled the adjustment to an industrial REIT. It was well-timed as London has seen significant rent and sales growth since the acquisition. We believe multiple re-rating is possible with increased scale, further well-priced acquisitions, better than expected organic growth, lower relative leverage and broader sector recovery.
Risks to rating and price target
Risks to our rating and price target primarily relate to the risks associated with the ownership of real estate property, which include but are not limited to general economic conditions, local real estate markets, credit risk of tenants, supply and demand for leased premises, competition from other industrial landlords, and the depth/duration of job losses and GDP contraction stemming from the COVID-19 pandemic. Beyond the generic risks of commercial property ownership, we highlight the REIT’s geographic concentration in secondary markets within Canada during downturns, the inability to grow organically and over reliance on capital markets, and growing pains of transitioning to a pure-play industrial REIT