Artis REIT: High Rent Collection, Valuable Industrial Assets, And Low Price

• Artis 5/12 unit price is a 51% discount to IFRS Net Asset Value of $15.52/unit
• Artis trades at 6X 2020 FFO, well below the 12X average for all Canadian REITs
• Artis price has underperformed the sector since 2/28 despite an improved business mix and strong rent collections
• The company’s Strategic Review concluded without a transaction, but conference call comments suggest that value enhancing initiatives will continue.

Artis REIT (TSX:AX/UN)(ARESF) units have fallen sharply since my last article (Artis REIT: Liquidation Sale?).  A financial market crash and an economic recession made it untimely for the Special Committee to proceed with sale of the company or significant parts in the near-term, but the strategic initiatives executed over the past year leave Artis well positioned to weather the storm and deliver an attractive return from their current price.  The company substantially divested from the weak Calgary office market while adding more US industrial assets which are performing well and should be highly valued.  Artis collected 93% of April rents and indicated that May receipts have been better.

Topics:

• Peer Returns
• 1Q20 Operating Results
• Relative Multiples
• Strategic Initiatives
• Investment Considerations

Background: Artis is a diversified Canadian REIT with Office (47%) Industrial (35%) and Retail (18%) assets in Canada (51%) and the United States (49%).  Additional information is available at the company website, investor presentation, financial reports, conference call transcripts and prior Koneko articles.

Peer Returns

Artis diversified business model should protect it from weakness in particular sectors and markets, but since February Artis units have underperformed broad US & Canadian indices and also sector returns weighted according to the sources of Artis 1Q20 NOI.

Artis return has been similar to several diversified Canadian REITs (H&R, Morguard, and Brookfield) that have high retail exposure.  Investors are not recognizing the stability provided by Artis Industrial assets which are performing well in the current ecommerce boom.

1Q20 OPERATING RESULTS

Artis 1Q20 results (press release, MD&A, conference call transcript) were slightly lower than expectations due to the cumulative impact of completed asset sales.  Gross revenues were 11% lower than a year ago while units outstanding were reduced by 5% through repurchases.

Artis recognized a $141mm fair value loss in 1Q of which $88mm was attributable to retail properties and $18mm on the remaining Calgary office.  This was offset by the benefit from the 8% appreciation of the US Dollar during the quarter.

Artis has substantially reduced its exposure to the weak Calgary office market (only 2% of 1Q20 NOI).  Results benefited from increased revenue at industrial properties which reported same property NOI +6% yoy in Canada and +3% in the US.  Total NOI from US Industrial properties rose from $10.1mm in 1Q19 to $12.7mm in 1Q20 (+25% yoy) due to a 29% increase in GLA.

Artis reported that it collected 93% of April rents and during the conference call mentioned that May has been running ahead of April.

RELATIVE MULTIPLES

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

The valuation gap shows that Artis valuation is held back by the excessively diversified scope of its business.  The current multiple is extremely low despite the limited remaining exposure to the most stressed sectors/markets.  Artis has only one enclosed mall (Victoria Square in Regina – currently open) and six remaining Calgary office buildings which provide 2% of NOI and probably account for the same portion of NAV.

STRATEGIC INITIATIVES

Artis largely delivered the goals of the 3 year strategic plan announced in November of 2018:

• Repurchased/Redeemed $264mm of common and preferred units
• Sold $743mm of property through 3/31/20 nearly meeting the target of $800-1000mm.  The 5/9 conference call said $850mm has been completed with another $50mm under conditional contract and hopes to sell an additional $100-200mm by year end.
• Invested $125mm in industrial properties under development generating a yield on cost of approximately 7%

In May 2019 Artis formed a Special Committee of Independent Directors to review further initiatives including potential sale of the company.  A BNN-Bloomberg report earlier this year suggested that negotiations were underway with several parties including Slate Realty, Morguard, and CEO Armin Martens.  This month the committee announced:

“in light of the current market conditions and global uncertainty, it is not in the best interests of the REIT to pursue a strategic transaction at this time. The Board will remain open to considering strategic opportunities for the REIT in the future.”

It would be difficult to realize fair value in this market when property revenues are uncertain and buyer financing might be difficult.  Units and shares of Morguard, Morguard REIT, Slate Office, and Slate Retail have been as weak as Artis so those companies are not well positioned for a deal right now.

However a couple of overlooked comments during the recent Artis conference call provide a strong signal that the company will pursue further value enhancing actions:

… we expect to have a pristine balance sheet and a really conservative payout ratio when we’re finished selling away, another $800 million of properties. We want to target $200 million this year and $600 million in next year.

we see ourselves being 50% industrial in the future as well, if not higher, and getting retail down to 10%, maybe 5%, maybe 0 of our total NOI”

These comments are the first time that management has suggested potential asset sales substantially beyond the original target and potential exit from the Retail sector.  Retail assets are unlikely to fetch their optimal value in 2021, but sales proceeds could be applied to repurchase of Artis units at discounted prices.  If Artis derived a majority of its revenue and asset value from the Industrial sector then it would narrow or eliminate the discount attributable to the current diversified business model.

Development projects continue and should deliver increases in fair value over the next year:

• Sierra Place office tower in Calgary is marketed for sale as a residential conversion
• Dunwin Drive in Mississauga (adjacent to Toronto) is being sold as commercial condo units
• 300 Main in Winnipeg will be a “best-in-class amenity-rich apartment building with main floor commercial space”
• 330 Mainwill be a state-of-the-art multi-tenant retail property approximately 90% pre-leased to a national tenant
• Park 8Ninety Phase IV in Houston is a 100,000 square foot build-to-suit development for a multinational tenant

INVESTMENT CONSIDERATIONS

Investors punished Artis in 2018 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 distribution is amply covered by AFFO and strong rent collection so it is very unlikely to be cut.

Artis Debt/(Gross Book Value) of 53% is above the company’s long-term target of 45%.  The company has $191mm of liquidity (cash + available credit facility) and $1.9Bn of unencumbered assets so solvency is good, however further economic weakness could lead to lower rents, lower asset values, and an Artis credit downgrade.  For the time being it is prudent for management to allocate free cash flow to debt reduction rather than share repurchase despite the low current unit price.

Artis unit price has been overly punished in the epidemic sell-off.   Sector weighting suggests it should be closer to C$9.50 right now.  An economic recovery in late 2020 or 2021 could see Artis return to its prior discount of 20% to NAV, a unit price around C$12.40.  If the company achieves further asset sales and simplification in 2021 then the price should rise near NAV (C$15.52).

CEO Armin Martens purchased 10000 units on 5/11, 5/12, and again on 5/13.

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.