- Artis REIT’s recent unit price (around C$9.15) is a 39% discount to IFRS Net Asset Value of $15.11/share.
- Artis trades at 9X 2018 AFFO, well below the 16X average for Canadian REITs and 19X average for US REITs.
- Artis’ new strategic plan has similarities to the path followed by Dream Office which provided a total shareholder return over 65% since early 2016.
- Artis is aggressively repurchasing shares and insiders are buying
- Activist shareholder (Sandpiper) and strong independent shareholder (Ron Joyce) are both represented on the board.
Artis REIT (TSX:AX/UN)(ARESF) units have fallen 35% in 2018 and are down 20% since the 11/1/18 announcement of “New Initiatives To Deliver Improved Value to Shareholders“. Investors reacted more strongly to the dividend cut than the long-term value creation potential from asset sales, development projects, and accretive share buybacks.
The company’s projection of Year3 Net Asset Value of $17.50 could be easily achieved and likely exceeded through development projects ($3.80/unit) retained cash flow (about $1.50/unit) and accretive share buyback (about $1/unit).
A significant risk is that the company could continue to trade at a large discount to Net Asset Value that might not be eliminated without more aggressive reorganization. Dream Office (TSX:D/UN.TO)(DRETF) provides an example of how this could be accomplished.
- Operating Performance and NAV
- Relative Multiples
- Projects Under Development
- I’ve Had this Dream Before
- Share Buyback and Insider Buying
- Board Representation And Governance
- Investment Considerations
Background: Artis is a diversified Canadian REIT with Office (53%) Industrial (27%) and Retail (20%) assets in Canada (55%) and the United States (45%). Additional information is available at the company website, investor presentation, financial reports, and conference call transcripts.
OPERATING PERFORMANCE & NAV
Artis results have deteriorated due to high Alberta exposure where the end of an oil and gas boom caused severe office oversupply with a market vacancy rate of 27% (including 42% for Class B space). Other sectors experienced some softness but conditions are not dire: the Calgary industrial vacancy rate is 4.7% and retail is 3.5%.
Softer rents led to falling FFO and rising accruals for lease renewal expenses causing a widening gap between Artis FFO and AFFO. Falling rent projections caused IFRS asset values to drop. Artis 2014 annual report projected Calgary office 2018 market rents averaging $23/sf while three years later the projection dropped to $11/sf.
Since 12/31/14 Artis has sold $1.1Bn of property, primarily in Western Canada, and raised its exposure to US markets (Arizona, Wisconsin, and Minnesota). Prices realized from sales of Calgary offices have fallen to extremely low levels (C$132/sf for the vacant Class B downtown building shown below). Recognition of a small gain on this sale package suggests that balance sheet carrying values fairly reflect current market conditions.
Prices have fallen to a point where alternative uses become viable. Artis is converting its Sierra Place tower into residential condos.
Calgary office is a shrinking part of Artis (8% of 3Q18 NOI), but dismal news there has overshadowed good performance of the US office and industrial assets where same property revenues are rising and the company is adding new properties.
Some brokerage analysts conservatively estimate Artis NAV is a little bit over $13, lower than the company’s estimate but still well above the current share price. The company has been executing sales at or above carrying values and expressed confidence that it could continue to do so.
Artis trades at a large discount to the valuation of REITs in every sector where it owns assets:
The large valuation gap shows that Artis valuation is held back by the excessively diversified scope of Artis business.
PROJECTS UNDER DEVELOPMENT
Artis has several multi-phase development projects (such as Park Lucero in Phoenix described here) where it estimates it will earn an average unlevered rental yield of 7.6%. Artis estimates that it can create $570mm of value ($3.80/unit) from completion and leasing of these sites when IFRS fair values are calculated at cap rates of 5.5-6%.
CBRE estimates of current cap rates for industrial real estate in Artis’ markets suggest that the projected returns are realistic.
I’VE HAD THIS DREAM BEFORE
Key points of the three-year plan announced by Artis in November:
- Cut unsustainably high dividend in order to retain cash (payout ratio drops from 109% of AFFO to 53%)
- Aggressively repurchase shares ($270mm)
- Sell $800mm to $1Bn of “non-core” assets from non-strategic sectors (e.g. US Retail) non-strategic markets (e.g. Nanaimo BC) and where Artis lacks operating scale (e.g. Ottawa and enclosed malls)
- Fund development and intensification projects
It has strong similarities to the plan announced by Dream Office in February 2016 that has generated an excellent shareholder return:
Dream initially projected sale of $1.2Bn of assets, but ultimately sold $3.4Bn and used the proceeds to reduce unit outstanding by 43%. Dream began with a diverse portfolio including underperforming assets that caused its units to be valued in the market at a 40% discount to NAV. Dream now has a concentrated portfolio of higher quality assets and a unit price close to NAV. It’s highly likely that Artis Board of Directors and key independent shareholders would like to see similar success in execution of their plan and delivery of returns to investors. The announced sale target of $800mm-$1Bn could just be the beginning.
SHARE BUYBACK AND INSIDER BUYING
Artis projects that net proceeds of $600mm from asset sales will fund a $270mm Share buyback over three years. The 3Q18 conference call explained that the company expected to buy a little over $130mm per year which hints that the total repurchase amount could exceed the target. If the company were able to buy $270mm of units at $10 then NAV accretion would be about $1.08/unit.
Unit purchases since the strategic plan was announced on 11/1 to 12/19:
Other officers and directors
Artis renewed its buyback plan this month and the maximum daily purchase increased to 83,938 units (prior 59,138) plus additional amounts that may be acquired through block purchases. The company has been buying the maximum amount every day:
BOARD REPRESENTATION AND GOVERNANCE
The undervaluation of Artis units resulting from excessive diversification attracted attention from two significant independent shareholders who were granted board representation in the past year.
- Sandpiper Group disclosed ownership of 4.5% of Artis and the company agreed to appoint a board director selected by Sandpiper who has an extensive background in international real estate private equity. Sandpiper has launched proxy campaigns at two other Canadian REITs (Granite and Agellan). Under Canadian regulations Sandpiper is not required to disclose changes in ownership until its stake reaches 10%.
- Ron Joyce, the billionaire who built the Tim Horton chain and sold it to Wendys in the 1990s, controls 11% of Artis and Steven Joyce was appointed to the Board of Directors in March. A Joyce controlled company purchased 900,000 Artis units in November.
Artis has been internally managed since 2012 and company operating expenses are running at a modest rate of about 0.6%/year. When management was internalized the CEO and CFO were given 10 year employment contracts. With just over 3 years remaining the payout on a “changer of control” would not pose a significant financial obstacle to a strategic transaction.
Insiders and directors (excluding Steven Joyce mentioned above) own about 1.3mm units. It’s meaningful to those individuals, but not enough to affect the outcome of a potential proxy contest.
Artis units recently dropped to their lowest level since 2009 and below where Artis raised money many times through secondary offerings.
Almost every investor has a loss on his position so the unit price is likely to be depressed by tax selling pressures in December. Canadian taxable capital gains/losses are calculated on a settlement date basis so the last day of 2018 tax selling should be December 24th (25&26 are holidays).
As happened at Dream Office, it may take some time for Artis to demonstrate the value creation potential of its new strategic plan. Below average distribution yield will inhibit retail investor interest. Excessive diversification will inhibit institutional investor interest. Artis may continue to trade at a valuation multiple lower than the average of competitors in each of its operating segments, but this discount could be captured over time through more aggressive corporate actions.
Dream was able to eliminate the discount of its unit price to NAV by shrinking to a point where it holds a concentrated portfolio of high quality assets that are appealing to long-term institutional investors or potential strategic acquirors. Artis has some exposure to attractive markets, but does not offer any rationale for holding all these assets within a single entity.
If the unit price remains significantly below NAV then further review of corporate strategic alternatives is appropriate. Artis could split the US/Canada operations, or sell its prime assets such as Toronto and US industrial, or retain the prime assets and sell everything else. If the company fails to take such actions then the valuation may remain depressed.
Investors punished Artis for reducing its dividend rate, but dividends simply transfer value rather than creating value. Any change in the dividend does not affect the underlying value of the company and its assets so this article does not offer any detailed commentary about past present or future dividends. The distribution (currently C$0.54/year) gradually returns a portion of the full NAV which we can now acquire in the market at a discount.
The author is a shareholder of Artis REIT. The author does not make any recommendation regarding any investment in any company mentioned in this article. Investors are encouraged to check all of the key facts cited here from SEDAR filings and other sources prior to making their own investment decisions.
Valuation numbers get stale quickly in this volatile market, but the relative performance gap of Artis vs a Canadian REIT ETF (TSX:XRE) remains wide (LINK to current chart)