Artis REIT: Not For Sale, But Not Forsaken

• Artis 8/10 unit price is a 45% discount to IFRS Net Asset Value of C$15.40/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 a favorable business mix and strong rent collections
• The company’s Strategic Review concluded without a transaction, but value enhancing initiatives will continue.

Artis REIT (TSX:AX/UN)(ARESF) units have underperformed the real estate sector after its strategic review concluded without announcement of a major transaction, however investors should realize benefits over time from the company’s ongoing initiatives.  The company has minimal exposure to stressed sectors (malls and Calgary office) and growing revenues from industrial properties.  Activities were disrupted by the COVID epidemic, but earnings and asset value have not been impaired.  Peer comparisons suggest the unit price should be at least C$11.

Topics:

• Peer Returns
• 2Q20 Operating Results
• Relative Multiples
• Strategic Initiatives
• Investment Considerations

Background: Artis is a diversified Canadian REIT with Office (48%) Industrial (35%) and Open-Air Retail (17%) assets in Canada (47%) and the United States (53%).  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 2Q20 NOI.

Investors are not recognizing the stability provided by Artis Industrial assets which are performing well in the current ecommerce boom.  Artis return has been similar to several diversified Canadian REITs (H&R, Morguard, and Brookfield) that have high retail mall exposure. Rent collection demonstrates that Artis open-air retail assets were less affected by COVID restrictions:

2Q20 OPERATING RESULTS

Artis 2Q20 results (press release, MD&A, conference call transcript) were ahead of expectations due to lower overhead, lower interest expense, fewer shares outstanding, and a small fair value gain.

Year-to date corporate overhead of $3.5mm has been 1.5% of revenue and is running at an annualized rate of just 0.3% of equity.

RELATIVE MULTIPLES

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

Artis has reduced exposure to the disastrous Calgary office market to just 2% of NOI.  Investors are concerned about all retail businesses but Artis rent collections were high due to its predominantly “essential” tenant base.

Canadian governments and citizens have done a good job of bringing the COVID epidemic under control.  As of 8/9 Canada had 6,742 active cases (0.018% of population) compared to 2,478,168 active cases in the United States (0.748% of population). Canada is getting back to work.  Stores are open.  Workers are returning to offices.

Artis management indicated during the 2Q20 conference call that property sales would probably further reduce Canadian retail exposure to just 10% of NOI by 12/31/21.

STRATEGIC INITIATIVES

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

• Repurchased $199mm of common and preferred units.  Redeemed an additional $78.5mm of preferred.  Artis has been saying that further asset sales will be used to pay down debt, but did continue repurchases at a modest rate in 2Q20 ($14mm) while insiders also purchased $0.8mm.
• Sold $743mm of property through 6/30/20, nearly meeting the target of $800-1000mm.  The company reported an additional $136mm as “held for sale” at 6/30.  During the 2Q20 conference call management said $20mm is currently under contract or LOI and active negotiations are underway for an additional $100mm.  In addition: “we anticipate selling at least another CAD200 million of property by year-end and another CAD200 million during the first half of next year. So CAD400 million of properties during the next 12 months, all retail and office properties.”
• Investing in industrial properties under development generating a yield on cost of approximately 7%.  Management mentioned: “as a little fun fact, we don’t disclose it as well as we could or should, but in the past five years, Artis has, in fact, developed over $300 million of new generation industrial properties that are generating an average IRR of over 30%.

Artis disclosed a new initiative to launch a $100mm institutional fund that would bring outside investors to participate in its US industrial development pipeline.  Artis will contribute 10% of the equity and earn fees based on leasing revenues and project profits.  With regard to the investors the company promised: “you will recognize the names“.  That could be a catalyst for reassessment of the fair value for Artis shares.  Fund investors will be paying full NAV plus fees while equity investors pay 55% of NAV, no fees, and low overhead.

The Board of Directors is likely to continue initiatives to improve shareholder value due to the participation of an activist investor (Sandpiper Group), and a large independent investor (Jetport).  If the units remain undervalued after currently planned divestitures then the company could consider spinning off the industrial assets into a separate company as happened with the separation of Dream Industrial from Dream Office in 2012.

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 46%.  The company has $201mm of liquidity (cash + available credit facility) and $2.0Bn 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$11.21 right now (based on a 7% drop from the 2/28 price).  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$12.32.  If the company achieves further asset sales and simplification in 2021 then the price should rise near NAV (C$15.40).

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.