Echelon Partners analyst David Chrystal thinks the outlook for Canadian Net Real Estate Investment Trust’s (NET.UN-X) external growth “remains challenging,” citing “continued volatility in the debt markets, limited cap rate expansion and the REIT’s discounted unit price.”
After the bell on Wednesday, the Montreal-based REIT reported second-quarter funds from operations of 16.1 cents per unit, up 0.6 per cent year-over-year and in line with both the analyst’s 15.8-cent forecast and the consensus expectation of 16 cents.
“Interest expense headwinds remain, though savings are expected to be generated from the repayment of expensive variable rate debt (effective rate of 8 per cent) using proceeds from assets held for sale and up-financing activity. The REIT’s portfolio continues to generate a steady stream of cash flows, with modest organic growth expected from positive leasing spreads on 2024 lease expiries (5.5 per cent of GLA, 8 per cent of net rent) and from high-return property level capex (9-per-cent unlevered return, $1-million aggregate spend).”
Touting its “healthy” balance sheet, which he thinks “provides ample capacity to weather a higher rate environment while maintaining stable cash flow,” Mr. Chrystal expects the REIT to also continue to benefit from dispositions.
“During the quarter, the REIT sold a single-tenant asset located in Timmins, Ontario for gross proceeds of $1.3-million, equating to a cap rate of 6.2 per cent (19-per-cent premium to IFRS value). The REIT is currently marketing two additional properties with a carrying value of $4.8-million. While the timing of the sale and pricing for these assets are uncertain given continued volatility in the debt markets, we expect these dispositions to be accretive as they are backed by variable rate debt ($2.8-million) which bears interest at approximately 8 per cent, and net proceeds will likely be used to reduce outstanding debt on the REIT’s credit facility.”
“CNET’s mortgage maturity schedule is well-staggered, with just 28-per-cent maturing through year-end 2026. We expect that near-term debt maturities should result in up-financing opportunities ($2-million for balance of 2023), which should allow the REIT to reduce the $16.4-million credit facility balance. While maturing mortgages will see higher rates on renewal, the interest expense headwind should be somewhat offset by repayment of higher-cost floating rate debt.”
Predicting a net asset value discount will persist until transaction activity continues, Mr. Chrystal cut his target to $6.25 from $7, maintaining a “buy” rating based on a “significant” valuation discount to peers and “an attractive (7 per cent) and sustainable (55-60-per cent payout ratio) distribution. The average target on the Street is $6.54.
Elsewhere, Desjardins Securities’ Kyle Stanley trimmed his target to $5.75 from $6 with a “buy” rating.
“We are reducing our target ... to reflect updated NAV work and a decreased target multiple,” he said. “The latter largely reflects (1) the impact that the elevated rate as well as broader economic environment are having on transaction volumes; (2) its limited organic growth profile; (3) its higher leverage profile; and (4) its lack of trading liquidity.”