Artis REIT: Industrial Portfolio Is Exceptionally Undervalued
Summary
- Artis REIT currently yields 4.5%.
- The diversified portfolio and low payout ratio make it one of the safest 4% plus yields out there.
- The industrial portfolio is likely being drastically undervalued by Artis on the books and the company could be bought out at a price in excess of $16.00/share.
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Note: All amounts presented are in Canadian dollars.
Artis REIT (OTC:ARESF) is a smaller REIT where we have been rather bullish. While we sold out of most positions in the Canadian REIT space, Artis is one where we chose to hang on. The last time we covered it, we left with the message that the real estate company has decent upside alongside its modest yield.
Our 12-month target price for this is $15.00/share as we believe the stock deserves to trade at no more than a 5% discount to its NAV. This discount we believe should be there due to the high vacancies in the Calgary office portfolio. We have reduced our discount to NAV from previous levels as Artis has whittled down Calgary portfolio to under 6% of NOI and also because we believe inflationary trends should help this REIT's portfolio. We like the shares here, and although the yield is small, the potential upside is rather high.
Source: Seeking Alpha
Although the stock has since produced a small alpha versus the broader indices and the Canadian real estate ETF (XRE:TSX), it has still underperformed our expectations.
Data by YCharts
With Q4-2019 results out, we decided to see if this was still worth playing or whether the freshly battered Canadian REIT landscape offered better values.
Q4-2019
Artis had lower revenues and lower Net Operating Income for this quarter. That was expected as it had been actively pruning its portfolio. However, the combination of its dispositions and large buybacks at a big discount to NAV produced a very strong increase in funds from operations (FFO) and adjusted funds from operations (AFFO).
Source: Artis Q4-2019 Financials Press Release
AFFO this quarter was at 27 cents, a rate that matched its old distribution rate of 27 cents a quarter. Artis rapidly achieved its objectives of enhancing its AFFO via buybacks, which were partly facilitated by a distribution cut. For investors who are not aware, Canadian AFFO is a far superior metric to the one shown by U.S. REITs, as it deducts leasing commissions and maintenance capex from FFO. As a result, this AFFO distribution coverage of about 2X is the best in the North American REIT landscape today.
Looking closer at the NOI, we see that same property performance was driven mainly by its industrial portfolio.
Source: Artis Q4-2019 Financials Press Release
US office turned in a strong performance as well, but Canadian office and retail were slightly weak. Canadian office is still under pressure from the Alberta vacancies. However, the impact is declining as Artis has reduced its Calgary presence significantly via dispositions.
Source: Artis Q4-2019 Financials Press Release
Why we like it here
As a diversified REIT with both US and Canadian exposure, Artis is well balanced to handle diverse economic climates.
Source: Artis Q4-2019 Presentation
Its lease maturity schedule is very manageable and the impact from the big drop in Calgary rents is finally ending.
Source: Artis Q4-2019 financials
The company guided investors that it was on track to whittle Calgary office to negligible levels.
It's important to note of course that our financial metrics improved so as our portfolio properties and it's about real estate. We're reducing our office and retail, increasing our ownership of industrial properties, also reducing the number of secondary markets win with diversifying, if you will. Our Calgary office exposure is consistently shrinking, it will be 2% at the end of Q1 and by the end of this year it'll be down to zero. Our remaining retail investments will be open air service sector properties in Western Canada only, which we feel is a very good focus for us.
Source: Artis Q4-2019 transcript
A key attraction for Artis is not only that it trades at a decent discount to its NAV, but its NAV is likely understated based on the cap rates it is using for its industrial portfolio.
Source: Artis Q4-2019 Presentation
In this low rate environment, industrial assets are highly prized. Cap rates even in the "sub fives" are not uncommon. Colony Capital (CLNY) sold its entire industrial portfolio at a 4.3% cap rate. Those assets had an annualized NOI of $249 million and Blackstone (BX) bought it for $5.9 billion. Based on this, if we extrapolate another year of strong NOI growth and use a 5% cap rate, we can value the industrial portfolio closer to $2.3 billion or $500 million over where Artis currently has it. Artis has about 138 million units outstanding. Therefore, if we are right about the fair value of this portfolio one year out, this alone adds $3.62 to the NAV per unit.
Source: Artis Q4-2019 Presentation
Artis also has plans to grow in this segment in the years ahead.
Jonathan Kelcher
But I'm assuming that would entail either buying or like if you're going to sell $200 million to $300 million, you'd be looking to put that into either development or new acquisitions?
Armin Martens
So primarily debt reduction, we've got to get our debt down that’s -- we can promise much higher price multiple when we do that, and it would get that debt down to 45% and then selectively growing and we would be growing in the industrial sectors primarily.
Jonathan Kelcher
How high a percentage would you like to, are you -- like industrial is around 30 right now? How high would you want to get that?
Armin Martens
At least up to 40, and after 40 we'll take a second look and may be get it up to 50.
Source: Artis Q4-2019 transcript
Equally, if not more importantly, Artis is developing these rather than buying expensive industrial properties.
Source: Artis Q4-2019 financials
In our opinion, this is a very positive direction and the NAV buffer alongside the rapidly growing AFFO, presents a good opportunity in Artis today.
Conclusion
After we ran our numbers on the industrial portfolio, we saw that Artis did bring up similar thoughts on the conference call about the potential value growth there.
Jenny Ma
Turning to industrial, I know you've mentioned in past quarter conference call that you've gotten a lot of unsolicited inbound interest on industrial, just given markets this week aside, just given the strength of the demand for industrial assets and versus your desire to grow that asset class. I'm just wondering for a good portion of industrial assets, is there a price that you would be willing to sell it at, or are you more committed to expanding the strategy that you'd want to hang onto all of it?
Armin Martens
Well, it becomes a question of how much it means on the table, 28% percent growth right now, if we bring it down to 4% or 5% and you look at our portfolio of 1.8 [billion], it goes up to about 2.3 Billion in the five year period, creating NAV increasing the assets, $3 per unit that's just our industrial portfolio, if you just manage it optimally and grow in a conservative manner in the next two years and building more industrial and then in the next five years rather. So then what's that growth that you like give all that away now, let's move to today what’s the present value of that. So I don't know if somebody gave us a four cap of all of our industrial, I guess we'd look at but let’s say next five and all the industrial, we’re going to say well we can do a lot better by holding and managing ourselves that we'll give you a better view on our retail if you want retail.
Source: Artis Q4-2019 transcript
The key difference in our position though is that Artis Industrial Portfolio is dramatically undervalued today. If the company tried selling it, we think a $2.3 billion plus number is reachable in 2020. Combining the information here with the 8X FFO multiple and the well-covered dividend yield, we see Artis as a safe buy in this market turbulence. The odds are high that it gets sold for $16 or higher in 2020.
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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.
TIPRANKS: Buy.
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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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Comments (19)
A so-called INDUSTRIAL Reit does NOT hold office and retail properties. I read as far as the word 'office' and stopped to just write this short comment. Thanks.
Where did you see me mention those two words together?
