RO Real Estate Investment Trust (PRV.UN-T) possesses a “defensive asset base with re-rate potential,” according to National Bank Financial analyst Matt Kornack.
He initiated coverage of the Montreal-based REIT with a “sector perform” recommendation on Wednesday.
“The portfolio has expanded but remains smaller in size, although management has a stated goal of scaling to $2-billion in asset value (as they view $1-billion of market cap as a threshold for greater institutional interest),” said Mr. Kornack. “At Q3/22, 68.2 per cent of the REIT’s base rents were derived from industrial properties followed by retail at 21.9 per cent and office at 9.9 per cent with $1 billion in assets owned. Additionally, the REIT owns Compass Commercial Realty, a real estate property manager with $1.6-billion in AUM [assets under management]. PRO has been the beneficiary of significant transaction-driven growth in recent years, particularly in Halifax’s Burnside Industrial Park, where through a joint venture with Crestpoint Real Estate Investments Ltd. (Crestpoint) it enhanced its exposure to the Atlantic Canada industrial market, now owning on a proportionate basis 1.5 million square feet of space (3.0 million sq. ft. at 100 per cent, accounting for 23 per cent of the entire Halifax industrial market GLA [gross leasable area] and 40 per cent of the Burnside Industrial Park).”
Mr. Kornack thinks the private equity partnership with Crestpoint “speaks to the quality of the portfolio and reputation of the REIT’s management team,” which led CANMARC REIT through to its eventual sale to Cominar REIT in March of 2012.
“CANMARC was a successful story with many parallels in asset class and geographic footprint,” he said.
“PRO’s management team has been pursuing a proactive de-leveraging program. Our forecast shows a minimal cash drag related to the ongoing operations of the portfolio, including all capex. This speaks to distribution sustainability, a plus given the high tax-efficient yield to investors.”
While Mr. Kornack likes “the trajectory of fundamentals in the REIT’s industrial segment” and think that “solid” earnings growth is approaching as it moves beyond the recent deleveraging trend, he set a “sector perform” rating based on market volatility and its relative valuation.
“Cost of capital challenges will remain an impediment to growth given size and liquidity concerns and a still diversified offering,” he said. “These are not insurmountable challenges and a re-rating is probable as the portfolio grows and asset exposure becomes more concentrated.”
Mr. Kornack set a target of $6.75 per unit. The current average on the Street is $7.21.
“PRO trades around where we would expect it to in the context of public market comparables on both a discount to NAV and P/FFO multiple basis,” he added. “While a modest re-rating opportunity exists upon achieving pureplay industrial status there isn’t a ton of room between it and Nexus, which would be the closest comp in that segment, whereas the REIT trades at a premium to its high-quality diversified peer (H&R REIT). Given the scale of their offering and strong portfolio attributes for the U.S. apartment and Canadian industrial segments it remains a more interesting value play. Balance sheet, scale and portfolio attributes/geographic concentrations justify a wider spread between PRO and Dream Industrial/Granite. Needless to say, the return to target is modest in light of the relative positioning and the bulk of this comes in the form of the distribution (which we view as sustainable). To truly bridge the gap we would need to see an improvement in the scale and portfolio concentration.”