Artis: Distribution Sustainability Analysis
Summary
- Artis REIT reported Q4 2017 results.
- Payout ratio remained elevated.
- We explain why this ratio is elevated and why it will likely move lower in 2020.
Artis REIT (ARESF) announced Q4 2017 results and this quarter marked the fourth consecutive quarter of worsening adjusted funds from operations (AFFO) payout ratio. For the quarter and the year, the AFFO payout ratio went past 100%.
Source: Artis 10-K 2017
We had previously pointed out our cautious stance on this one, thanks mainly due to the big drop in leasing spreads in the Calgary office market. Is the distribution safe? Here are few things to consider in that regard.
Calgary beginning to lose impact
Artis was able to sell 5 Calgary office buildings at or above NAV in 2017. This has definitely lessened the impact of further lease turnovers in this segment. Excluding the impact of currency movements, same property NOI increased in 2017 and the increase was strongest in Q4 2017 (+1.7%) for the fiscal year 2017.
In fact, the overall Canadian office segment, despite of the weight of Calgary office, showed a remarkable 3.5% NOI growth in Q4 2017.
2018 NOI
2 redevelopments were completed in Q4 2017 and those should help boost 2018 NOI. Still, overall rents are below market rents and there will be a drag in 2018 and 2019.
With approximately a $3 million decrease over 2 years projected and 150 million units outstanding, funds from operations (FFO) would drop by about 2 cents/year. Not huge and likely something that can be offset by redevelopments and capital recycling.
FFO to AFFO
A key reason we see the risks as less than projected by AFFO is because we have examined the ratio of FFO to AFFO over the last few years.
Source: Author's calculations from Artis 2014-2017 10-Ks
Historically, AFFO has been in the range of around 85% of FFO. The extraordinary vacancies in the Calgary office space have had tenants demanding extremely crazy inducements, pushing that percentage significantly lower. With dispositions in this space by Artis and a stabilizing Calgary office market, we are forecasting this ratio to gradually move up to the 80-84% range over the next 3 years. Our forecast for 2018 is a FFO of $1.40 and an AFFO of $1.08, representing a 77% conversion of FFO to AFFO. That would also represent a 100% payout ratio for Artis for 2018, an improvement over 2017 numbers.
Conclusion
US REITs use the very generous NAREIT definition of AFFO and regularly pay out more than what would be 100% of the Canadian version of AFFO. Artis comfortably covers its distribution via FFO, but the coverage via AFFO will be tight in 2018. Artis does also have some interest rate headwinds as refinancings come up and growth will be hard over the next two years. There is no runway strip here barring a sudden move to $100 oil which has the Calgary office market screaming higher.
Artis is on our list of good performers over the last 9 months and we still own it, but we are not adding here. We also looked at some additional indicators that we shared in our newly developed Marketplace partnership, The Wheel Of Fortune, with The Fortune Teller, that we think will significantly impact stock market leadership going forward. Those indicators also have influenced our overall stance here.
Disclaimer: Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.
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Analyst’s Disclosure: I am/we are long ARESF. 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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