Our view: Set against a slowing economy, we believe FCR’s essential needs portfolio is well-equipped to deliver healthy organic growth. While activism has created a distraction, we remain supportive of FCR’s strategic plan and are encouraged by progress made to date, particularly the reduction in leverage. In our view, Sandpiper’s plan misses the mark by failing to address a primary pushback among investors. In short, we see an attractive entry, with drivers to support a positive re-rating. Outperform, $21 PT (+$1.50).
Key points:
From our lens, Sandpiper’s (SP) proposed plan misses the mark. Over the past several years, among the most frequent pushbacks we’ve encountered from investors on FCR is its above average leverage, particularly on debt/EBITDA. Accordingly, as outlined last September, we believe FCR’s strategic plan sets the wheels in motion to support a higher valuation by monetizing value created (much of which is not reflected in the unit price) and materially reducing leverage, while simultaneously driving stronger earnings growth and still leaving ample drivers to support long-term NAV upside. Encouraging signs of progress surfaced with Q4 results. In contrast, SP’s plan to recycle asset sale proceeds principally into unit buybacks and maintain debt levels does little to address investor preference for lower leverage or reduce FCR’s risk profile. Furthermore, 1) we do not view the assets identified to date as sale candidates as the “crown jewels”, but rather typical of FCR’s high quality portfolio, and 2) considering the majority of properties to be sold are low-yielding density plays, we expect minimal impact on its operating metrics, portfolio quality, or platform capabilities.
Good insulation as economy cools. SP-stable NOI rose 8.5% YoY (+5.2% YTD), or +0.8% (+1.8%) excl. lease termination fees and bad debts. Notably, renewal leasing spreads remain solid at ~10%, while occupancy edged up to 95.8%. Looking ahead, we expect occupancy to remain reasonably steady as solid demand from FCR’s core “everyday needs” tenants should offset anticipated vacancy, incl. a Walmart store in AB. Layering on strength in leasing spreads, our forecasts reflect ~2-3% annual organic NOI growth.
Earnings and NAV estimates raised. We increased our 2023E/2024E FFOPU to $1.18 (+$0.02)/$1.21 (+$0.01), with revisions mainly for higher NOI and lower net interest costs. Our 2021A-24E CAGR (excluding other gains/ losses) is 4%, in line with FCR’s target. Our NAVPU rose to $21.50 (+$0.50), with our $23 (+$0.50) one-year forward NAVPU reflecting 7% YoY growth.
Outperform, PT raised to $21 (+$1.50) on our higher forward NAV and a higher target multiple (10% discount to FWD NAV vs. prior -13%) for strategic progress, including lower leverage. FCR is trading at 16% below NAV (6% implied cap rate/18x 2023E AFFO), well below its retail peers (6% NAV discount) and the sector (-13%). In short, we see an attractive entry to a name with superior quality assets, reasonable growth, a major pipeline of value-add opportunities, and levers to support multiple expansion.