Near-term weakness looks more 'transitory' to us; revenue set-up positive
Our view: Canadian Apartment REIT (“CAPREIT”) reported a slightly weaker quarter. Q1/22 could be impacted by snow. But the revenue story is positive, with turnover spreads gaining steam. There’s nothing new on the regulatory front to report. We see any weakness in the stock as a good buying opportunity.
Key points:
Some inflationary pressure perhaps, but not main culprit this quarter:
SP NOI growth -2.0% (SP-Rev +1.2%; SP-Exp +7.6%). Management cited increased ‘catch-up’ R&M was primary reason. For 2022, natural gas costs are mostly hedged, insurance costs may turn out to be a positive story, property taxes are in line, but we could see some wage pressures. Moreover, Q1/22 could see weather-related softness given amount of snow days. We think some inflation pressures are to be expected but its impact is likely exaggerated in the quarter.
Revenue trends are positive with turnover spreads gaining steam: Rent growth on CDN suite turnovers is approaching ~10% in 2022, was +8.6% in Q4 vs. +6.0% in Q3, +4.9% in Q2, +3.4% in Q1. Recall in 2018/2019, with leasing spreads in the low-double-digit range, CAPREIT traded at a double- digit premium to NAV. Effective Jan 1, 2022, 44% of its tenants were served with a +1.3% renewal rent increase with guideline increases for ON/BC set at 1.2%/1.5% in 2022 (0% in 2021). Occupancies in its key markets are now close to 99% setting the stage for pricing power and lower incentives, currently running at ~70 bps of revenue.
Capital allocation: In Q4/21, CAPREIT acquired 988 (net owned) suites for $426m in West Kelowna, Toronto and Quebec City, bringing 2021 acquisitions to 2,851 suites for $805m (~$280k/suite) in Canada. Post Q4, CAPREIT acquired a 59-suite apartment in Kelowna for $29.5m ($500k/ suite). 2022 capex budget is $311m ($84m non-discretionary / $227m discretionary).
Estimate changes. Our 2022 FFO estimate is reduced to $2.37 from $2.43, reflecting a weaker Q1 and slightly higher operating cost. Our 2023 FFO estimate is largely unchanged.
Maintain Outperform rating. Our NAV/unit estimate is unchanged at $59. Our target is based on a 7.5% premium to our 1Y forward NAV. Our thesis on CAPREIT is based on fundamentals in Canada inflecting with revenue growth exceeding expense growth (albeit with lag). While timing is tougher to predict, we believe the pre-conditions to get to higher than pre-Covid levels are here: Occupancy is high. Immigration targets and housing prices are at record highs. And then there is the positive impact of unbundling of households, which management highlighted this quarter. We would take advantage of any weakness in the stock to accumulate.