CA - Artis REIT: Now 8.5% Yield And 60% Discount To NAV

2023-07-11 10:00:00 ET

Summary

• Artis REIT had a strong quarter from a NOI perspective.
• Occupancies remained strong, even in the office segment.
• The numbers in the title look compelling, but we show you why we are still not biting.

All values are in CAD unless noted otherwise.

Based in Canada, Artis Real Estate Investment Trust ( ARESF ) ( AX.UN:CA ) has a 15.6 million square feet, 135 property portfolio comprising industrial, office, and retail properties.

The properties are located in the REIT's home country and the United States.

The above data reflect the properties wholly owned and operated by Artis. Artis also holds partial ownership in 11 properties, primarily industrial, one parcel of land development, and a 32.64% interest in the common equity and with preferred units in the entity that acquired the now defunct ticker Cominar Real Estate Investment Trust. Rounding it all up, the REIT has a portfolio of equity securities, which includes Dream Office Real Estate Investment Trust ( DRETF ) ( D.UN:CA ) and First Capital Real Estate Investment Trust ( FCXXF ) ( FCR.UN:CA ). All of the above appear under the following three asset categories on the financial statements.

Artis reduced its investment in Dream Office last month when the latter had a substantial issuer bid , buying back shares at a price of $15.50. This transaction was not accretive to our protagonist, who bought the shares over a year ago for an average price of $24.54. We have not been a fan of this REIT funneling cash to buy equity securities of other real estate companies, which brings us to the next section, our prior coverage.

Prior Coverage

We were not a buyer of this diversified REIT when we covered it in February of this year. The 50% discount to NAV it traded at then looked juicy, and the solid 6.4% dividend yield was well covered. There were still a few negatives, which we felt overshadowed the positives, and we moved to the sidelines.

For us the biggest negative here is the strategy of using cash to buy other REIT stocks at this time.

Based on this wrinkle we are taking a backseat in this story. The company will still have challenges as the weighted average debt maturity even after this recent extension is about 2 years. Rents remain strong for now but we think a recession will test the company's mettle. Debt to EBITDA was still over 9.0X and we just cannot pull the trigger. We are neutral on this REIT for now and think a long case could have some merit at these depressed prices if done via covered calls.

Source: 6.4% Yield With A 50% Discount To NAV

Artis has underperformed other diversified REITs like H&R ( HRUFF ) ( HR.UN:CA ) and Morguard REIT ( MGRUF ) ( MRT.UN:CA ) since that coverage piece. The iShares S&P/TSX Capped REIT ETF ( XRE:CA ) has also beat this REIT quite comfortably.

Q1-2023

With around 410 thousand square feet of new leases, the overall occupancy levels were slightly higher year over year. Even the black sheep aka the office properties came out ahead of the March 2022 levels. ( Q1 2023 )

Artis renewed around 316 thousand square feet of space in Q1, with a weighted average increase of 4.8% in rental rates.

The same property NOI in CAD was higher by 8.4% year over year, however, the 2022 and Q1-2023 dispositions resulted in a decline in the rental revenue and net operating income or NOI. That despite the offset from the positive impact of a stronger USD compared to the same three months in the prior year.

While the net income received a boost from the income earned on the preferred and equity securities portfolio, it could not begin to offset the rise in year-over-year interest expenses, resulting in an over 20% decline in the year-over-year funds from operations or FFO.

The weighted average interest effective interest rate on property loans and mortgages increased from 3.22% in Q1-2022 to 5.24% in Q1-2023. The interest coverage ratio shrunk year over year from 3.90 to 2.28. This coverage ratio will go lower in Q2 and Q3 as the majority of the debt is floating rate. With most of its loans maturing this year and the next, things are going to get decidedly less than rosy for the next little while.

Coming back to the Q1 results, the per unit decline in the FFO was less severe than the total since Artis used some of the liquidity created from selling equity securities to buy back its own units, both common and preferred.

Given its intimidating debt maturity schedule, we are not too happy with the allocation of cash toward the unit buybacks. Management though is very comfortable and confident about this move and intends to keep this option active.

It's both of the factors you've noted, Fred. If we were concerned about the go-forward liquidity and the balance sheet, we would not be active with our NCIB. We are very comfortable with where we are today and directionally where we're heading. And then based on that, have that comfort in seeing our NCIB continue to be active.

Source: Q1-2023 Earnings Call Transcript

There were further buybacks subsequent to the quarter, which will help alleviate the hits from the higher interest expense to the FFO/unit in the subsequent quarters.

Liquidity

As of the end of Q1, Artis had around $37 million of cash on hand, around $107 million available on its credit facilities, and unencumbered properties with fair value of around $2 billion. The elephant in the room is the debt maturity schedule, and this was addressed during the earnings call.

Today, our top priority is strengthening the balance sheet and more specifically, reducing leverage and increasing liquidity. Fortunately, we have a number of levers available to us to achieve this, including selling assets, refinancing mortgages, establishing new mortgage financing and monetizing public securities.

Source: Q1-2023 Earnings Call Transcript

Artis has been busy on the asset disposition front and is on course to shed $400 million worth of properties in 2023. The REIT also unloaded $39 million of equity securities in Q1, in addition to the aforementioned units of Dream Office that were sold in June. On March 31, Artis had over $700 million in debt maturing for the balance of the year. It repaid the $50 million facility that matured in April and plans to do the same with the $250 million debenture issue that matures in Q3.

We recognize that a key component of our 2023 debt maturities is the $250 million debenture that is maturing at the end of Q3. We are on track to have the flexibility to simply repay this full amount if the prevailing terms for issuing a new debenture by that time are not in the best interest of our unitholders.

Source: Q1-2023 Earnings Call Transcript

Verdict

Management has been very explicit in their priorities and their efforts towards achieving lower leverage, higher liquidity, and having a stronger balance sheet. While concrete steps were taken in Q1 to improve liquidity, it was but a drop in the bucket as far as the market was concerned. Case in point is the deeper discount to NAV compared to earlier this year.

The consensus NAV is closer to $13 with one brave soul thinking this is actually worth $16.80. We think there is likely more pain ahead as Artis tries to address the ultra-short debt maturity schedule. We are staying out.

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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