Artis REIT: Delivering Value Faster Than Expected

  • Artis 5/10 unit price is a 28% discount to IFRS Net Asset Value of $15.55/unit
  • Artis trades at 8.5 X 2019 FFO, well below the 14X average for Canadian REITs and 19X average for US REITs
  • The strategic initiatives announced in November 2018 have been aggressively implemented and a new Special Committee will consider further actions

AX Banner May 2019 Picasso

Artis REIT units have risen 24.1% in 2019, but are still slightly below where they traded prior to the 11/1/18 announcement of “New Initiatives To Deliver Improved Value to Shareholders“.  The company’s satisfactory 1Q19 results featured aggressive unit repurchases and marketing of assets for divestiture.

The company’s projection of Year3 Net Asset Value of $17.50 can be easily achieved and likely exceeded through development projects (long-term company target of $3.80/unit in value creation) retained cash flow (about $1.50/unit) and share buyback (accretion of about $1/unit).

AX Appreication Potential May 2019

A significant risk has been that the company could continue to trade at a large discount to Net Asset Value that might not be eliminated without more aggressive reorganization, but the formation of a new Special Committee, management support, and activist investor involvement should increase confidence that steps will be taken to deliver fair value to unitholders.

Topics:

  • 1Q19 Operating Results
  • Relative Multiples
  • Strategic Initiative 1: Divestitures
  • Strategic Initiative 2: Buyback
  • Strategic Initiative 3: Development
  • Special Committee & Activist Involvement
  • 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 websiteinvestor presentationfinancial reportsconference call transcripts and prior Koneko articles (12/31/18 and 03/19/19).

1Q19 OPERATING RESULTS

Artis 1Q19 results (press release, MD&A, conference call transcript ) were slightly ahead of expectations and largely overshadowed by the strategic initiatives.  Key data:

AX 1Q19 Operating Results

Artis has substantially reduced its exposure to the weak Calgary office market.  Same property results benefited from increased occupancy in Canada (BC SK MB) and the US (AZ MN).

AX 1Q19 Same property NOI

Net Asset Value was adversely impacted by appreciation of the CAD from US$0.728 at 12/31/18 to US$0.749 at 3/31/19, but benefited from significant accretion from unit repurchase.

AX 1Q19 NAV Bridge

RELATIVE MULTIPLES

Artis trades at a large discount to the valuation of REITs in every sector where it owns assets:

AX 1Q19 FFO Multiples

The large valuation gap shows that Artis valuation is held back by the excessively diversified scope of its business.

STRATEGIC INITIATIVE 1: DIVESTITURES

Artis is aggressively executing its plan to sell $800-1000mm of property within three years.  As of 5/9/19:

  • $63mm completed sales
  • $135mm unconditional sale contracts
  • $328mm conditional sale contracts
  • $398mm properties offered for sale

During the conference call Artis said it hoped to complete $600mm in sales this year (vs $400mm target mentioned in prior call) and further suggested: “nobody should be surprised if we do even better and finish it all in — by the end of this year“.  Some individual properties have sold above IFRS carrying value and some below, but the average is in line.

STRATEGIC INITIATIVE 2: BUYBACK

Artis intends to repurchase $270mm of units within three years at an estimated average cost of $11.50.  The REIT bought 3.5mm units in 4Q18 at an average price of $9.77 and has repurchased an additional 7.8mm units in 2019 (to 5/3) at an average price of $10.62.  The company has also acquired a total of 138200 preferred shares at an average price of $20.85.

Total purchases of $120mm in just over 6 months put the company well ahead of the promised pace of execution and at better than projected cost.  At the current pace Artis will complete the 13.2mm unit purchases permitted by its Normal Course Issuer Bid within 3 months.  CEO Armin Martens strongly stated: “after that an SIB is not off  the table.”  A Substantial Issuer Bid (SIB) enables a Canadian company to purchase a larger amount of its units than the 10% of float permitted by a Normal Course Issuer Bid.  Dream Office and Brookfield Property Partners both completed SIBs that rewarded selling unitholders through a premium to market prices and continuing unitholders through accretion resulting from purchases below NAV.  The rapid pace of Artis divestitures will put it in place for an SIB in 2H19 that could be at a fixed price or possibly dutch auction pricing in a range of $12-$13.

STRATEGIC INITIATIVE 3: DEVELOPMENT

Artis plans to invest about $200mm over the next three years in multi-phase new industrial developments in the US:

AX 1Q19 New Development

Phased construction allows Artis to defer capital investment to match tenant commitments for the completed space and limits exposure to the risk of a market downturn.  The company expects to achieve rental yields about 150-200bps above market cap rates which could improve IFRS Net Asset Value by at least $0.37/unit.

AX Development Capex accretion

Artis will earn additional profits by preparing certain existing properties for residential conversion and then selling to third parties after zoning approvals have been received (1Q19 MD&A excerpt).

“Artis is exploring opportunities for a densification project at 415 Yonge Street in Toronto, Ontario. 415 Yonge Street is in a prime location in downtown Toronto, across from the College Station subway stop and in close proximity to the University of Toronto and Ryerson University. Preliminary plans to build 375 apartment units above this 19-storey office building are underway.

Artis is exploring opportunities for a densification project at Concorde Corporate Centre in the Greater Toronto Area, Ontario. The site provides direct access to Don Valley Parkway and convenient access to other major thoroughfares in the Greater Toronto Area. Preliminary plans are underway to build approximately 600 apartment units on the site.

Artis is exploring opportunities for a densification project at Poco Place in Port Coquitlam, British Columbia. The site provides access to major transportation routes and frontage on four streets, including Lougheed Highway, an east-west arterial corridor. Preliminary plans to build 600 to 900 apartment units are underway.

Stampede Station II development land on Macleod Trail in Calgary, Alberta, has been rezoned from office to multi-residential. The original plan for a 300,000 square foot office project has been changed to a 30-storey multi-family project with 300 suites.
This land has been classified as held for sale at March 31, 2019.”

The IFRS carrying values of these redevelopment properties are based on current usage and rents so sales after successful rezoning with increased density should result in significant gains.  1Q reporting did not have any new disclosures or discussion of these projects.

SPECIAL COMMITTEE & ACTIVIST INVOLVEMENT

Artis has a clear path to increasing asset value over time through development, however its diversified business model is unpopular with investors.  There has been a risk that the strategic initiatives announced last fall would be insufficient to improve the company’s appeal and that units would continue to trade at a discount to fair value.  Prior Koneko articles suggested that Artis could be pushed towards further strategic actions by an activist investor (Sandpiper Group) who has a successfully pushed for changes other companies including Agellan Commercial REIT and Granite REIT (see 03/19/19 article for background on Sandpiper’s record) .  However institutional analysts have not been willing to look beyond the plan announced last fall so they conservatively estimated Artis’ NAV and then conservatively set price targets at a further discount.

Formation of a “Special Committee of Independent Trustees to review and evaluate additional strategic alternatives that may arise” should increase confidence that the current Board and management are committed to delivering value for unitholders.  CEO Armin Martens explained:

“So the Board has formed a special committee of 5 independent trustees to review and consider strategic alternatives in addition to the initiatives that we’re implementing now. Again, it’s all about maximizing unitholder value”

If you look at these sectors, we’re trading at a multiple of 10 to 11x AFFO compared to industrial REITs trading at 16; office, 17; retail, 14. So we’re not even close to a multiple of one of the asset classes that we own. So this mispricing is not only silly, it’s also annoying, and the Board is going to work hard and the management team, of course, will work hard to narrow the gap between our current price and our true value.

“there have been some inbound calls and interest expressed in the REIT and so it did boost the Board to be proactive and stay in front of that kind of activity”

“If we’ll go into that process, that will take 30 to 60 days. And I think at Q2, you’ll hear a lot more about the steps being taken, but we are not negotiating with anybody right now.”

These comments suggest that something significant, possibly a sale of the company, could occur this year.

INVESTMENT CONSIDERATIONS

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.

Artis unitholders will be rewarded if corporate actions succeed in narrowing the NAV discount so investors should be attuned to board membership, the unitholder roster, and developments at peer companies that may hint at the path that Artis will follow.

Disclosures

The author is a unitholder 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 any investment decisions.

 

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