Cominar (OTCPK:CMLEF) is a Canadian diversified REIT, which owns and manages office, commercial and industrial buildings mainly in Quebec and Montreal. With CAD 8.2bn of assets and 538 properties, Cominar is one of the largest REITs in Canada.
About Canadian Real Estate Market
A study from CBRE published earlier this year described "Canadian Commercial Real Estate fundamentals as some of the healthiest in the world." However, the demise of Target (NYSE:TGT) in Canada impacted Cominar significantly. Cominar indicated that the impact of Target explained the 2.6% decline in the occupancy rate in the retail sector.
In Montreal more specifically, one of the main markets of Cominar, the study mentioned the increasing vacancy rate for office buildings. Completion of several development projects in 2016 will increase pressure on landlords to maintain prices during leasing renewal.
Cominar has a quite high leverage, with a debt ratio of 54.4%. The interest coverage reached 2.67 at the end of June. Most of the other Canadian REITs have interests coverage above 3.
On this part, the management indicated that the objective is to reduce the leverage to 50%. By the end of 2016, the debt ratio should decrease to 53%. This objective was supposed to be reached thanks to sales of assets (CAD 150m of properties held for sale are identified). However, something changed and Cominar announced an equity raise in September.
Capital Increase and DRIP reinstatement
At the beginning of the year, Cominar announced the suspension of its Distribution Reinvestment Plan. At that time, the management argued that "the market value of the units does not reflect the intrinsic value of the REIT." On January 20, date of the announcement, Cominar's stock was quoting 14.5 CAD. Simultaneously, the company launched a plan to sell some assets to deleverage its balance sheet and to start a buyback program.
I really welcomed that news, as I believed it would really create value for unitholders. However, looking at the evolution of the AFFO during the past years, I would have also expected the management to announce a dividend cut at the same time, in order to get more flexibility. Buying back stock at low price would have created much more value than paying dividend. But the management decided to maintain its dividend.
In the past months, Cominar executed the strategy as announced and the number of units declined from 175.7 million at the end of June 2015 to 169.1 million at the end of June 2016. So, 6.6 million of units have been bought back on the market.
Two weeks ago, with a stock price not much higher than what it was in January, the management decided to raise equity and to reinstate the DRP. This was really a surprising move. Cominar issued 12.78 million of units, nearly 2 times what was acquired on the market during the past year. The number of units will increase by more than 7%. The proceeds of the capital increase will mostly be allocated to pay down some debts.
On top of that, Cominar announced simultaneously the reinstatement of its DRP plan, which will add some dilution in the coming months. The DRP will reduce the cash out for dividends, but will increase the number of units while the stock is still trading at quite a low price.
While the AFFO per unit was already decreasing before this equity raise, these sudden announcements will lead to a further decrease.
These unexpected changes in the strategy make me feel Cominar was facing some cash issue. Few weeks before, during the Q2 earnings call, the management stated the deleveraging target of the year would be reached with the sale of assets. I haven't seen any sign in Cominar's communication or in the previous earnings calls of any potential cash issue.
Looking at the current situation, the next move should be a reduction of the dividend.
Dividend at risk
Cominar is currently paying a dividend of 0.1225 CAD per unit every month. At the current price (15.50 CAD at the time of writing), we have a dividend yield of 9.5%.
Since incorporation in 1998, Cominar has been paying dividends without any decrease or interruption. However, since 2008, the increase has been very modest (CAGR of 0.5%!).
The current dividend is not supported by the AFFO, with a payout above 100% for the 1st semester 2016.
With the newly issued units and the reinstatement of the DRP, I expect the AFFO to further decrease. The payout ratio should continue to grow to unsustainable levels. In that frame, I would expect a dividend cut in 2017, by at least 25%. With such a reduction, Cominar would keep some flexibility to come back to growth.
Even after a 30% decrease in the stock price in the past 3 years, Cominar is not that cheap, with a price to AFFO at 10.6 times. As mentioned previously, I would expect the AFFO to continue decreasing in the short term.
The Net Assets Value per unit is estimated at 19.2 CAD. That means a discount to NAV of 20%. However, I have a limited confidence in this NAV. I still have in mind Dream Office which cut its NAV by 28% last month. I know the situations are not really comparable, as the problems for Dream Office were mostly related to its activities in Alberta. But, I keep in mind there are two ways to close the gap to NAV.
The news published two weeks ago really reduced my confidence in the management. Even with a 9%+ dividend yield, I will stay on the sideline.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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