Description
How often do you find real
estate companies trading at 8x 2007 funds from operations (FFO) and 10x 2007
adjusted funds from operations (AFFO)? We have found one for you, Revenue
Properties Company Limited (RPC).
RPC invests in Canadian and US
retail, residential and office properties. The Company is 68% owned by Morguard
Corporation, which manages over $7 billion of real estate, and the management
teams of the two companies overlap. Because RPC trades on the Toronto exchange, does not do conference
calls, and has no Wall Street research coverage, it has been overlooked by
investors. RPC trades at a significant discount to its peers – a 9.2% cap rate
for 2007 net operating income (NOI) (vs. peers under 6.6%) and 7.9x 2007 FFO
(vs. peers over 15.3x). We value the Company at over $37 per share, more than a
100% premium to the current price, based upon an average of the high end of
2007 peer cap rates and the low end of FFO and AFFO multiples. As RPC realizes
the benefits of its recent acquisition of Sizeler Property Investors, we see
potential for an even higher valuation.
(Please note: All numbers are
in Canadian $ unless otherwise noted.)
Sizeler Acquisition
RPC operated primarily in Canada until
the acquisition of Sizeler Property Investors in November 2006. Sizeler now
makes up the majority of the Company’s assets and revenues. The acquisition of
Sizeler by RPC was objected to by some of Sizeler’s major shareholders for not
adequately compensating them. However, RPC made the best offer for a poorly
managed company that needed a change of management. With many opportunities to
improve Sizeler’s results, RPC was able to purchase Sizeler for a great price
(an 8.5% cap rate on June 30, 2006 LQA NOI while almost all US REITs trade with
less than a 7% cap rate).
Property Portfolio
Following the Sizeler
acquisition, RPC’s property portfolio breaks down as follows:
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GLA
Sq. Ft. (mm) / Apartments
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Commercial
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Community Enclosed Malls
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5
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2.1
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2/3
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140.8
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6.9
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Retail Shopping Centers
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16
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1.5
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13/3
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145.2
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5.4
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Office/Mixed-Use
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1/5
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Total Commercial
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27
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4.5
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368.7
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14.1
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Apartment
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15
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3,414
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15/0
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216.2
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4.2
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Land for Development
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Total
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42
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602.5
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18.2
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(1) Reported NOI. Not adjusted for $1.5 million of amortization
of below market rents.
The historical Sizeler portfolio, which is all US malls, shopping centers and
apartments, is as follows:
·
2
malls, 5 shopping centers, and 7 apartment complexes in Louisiana
·
8
shopping centers and 4 apartment complexes in Florida; and
·
4
apartment complexes in Alabama
Many of these properties are
on higher ground and are benefiting from people relocating after Hurricane
Katrina. Rents at these properties have been rising quickly as shown by the
$30+ million of below market leases accounted for in RPC’s acquisition of Sizeler.
In addition, RPC can take advantage of accelerated depreciation for tax
purposes (another consequence of Katrina) on most capital expenditures at these
properties making development activities more attractive. Given these dynamics,
one could argue that the historical Sizeler portfolio should trade with a lower
cap rate than its peers, which makes RPC’s deal look like even more of a steal.
Morguard may use RPC as a platform to acquire or develop more properties in the
US
in the future.
The remaining US commercial property, a warehouse in Danville, Virginia
leased to a textile company beginning in 2006 as part of a sale-leaseback
transaction, has an attractive double-digit free cash flow yield. The lease has
a 10-year term. The income from this property is recorded as other income on
the income statement, and the asset is listed as an investment in a direct
financing lease on the balance sheet. This property was owned by RPC prior to
the Sizeler acquisition.
The Canadian commercial properties,
RPC’s historical portfolio, consist of 3 office properties (2 in Ontario, 1 in
New Brunswick) leased to single credit-worthy tenants, a mixed-use (retail,
office and residential) property in a prime area of Toronto (Bloor Street), 3
malls (2 in Toronto, 1 in Alberta), and 3 shopping centers (all in the Toronto
Area). RPC’s historical portfolio has organically grown revenues and net
operating income at a steady rate over the past 3 years (5.1% and 5.9% annual
growth rates, respectively). This level of organic growth places RPC squarely
in the range of other Canadian property companies. The Company’s largest tenant
accounts for only 8% of its 2006 revenue and its top 3 tenants account for only
13% of 2006 revenue. This solid performance from a diversified tenant base
makes RPC’s historical portfolio deserving of a cap rate or FFO multiple
similar to its peers.
RPC also owns 108 acres of
developable land, including 56 acres from the Sizeler transaction in Florida, Alabama and Louisiana that are all
adjacent to rental properties. The land in Canada (primarily in Guelph,
Ontario) is likely to be sold off as lots for houses or condos while the land
in the US is likely to be used for new projects or additions to current
properties. We use the book value of these properties in our enterprise value
calculation.
Current Enterprise
Value (EV)
| Shares Out |
10,827 |
| Share Price |
$ 17.75 |
| Equity
Value |
192,179 |
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| Debt |
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Mortgages |
401,835 |
|
Loans Payable |
199,956 |
|
Construction Financing |
- |
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Converts |
- |
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Bank Debt |
15,923 |
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| Total Debt |
617,714 |
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| Cash |
$ 2,098 |
| Mortgage
and Loan Receivables |
12,929 |
| Land for
Development and Sale |
17,511 |
| Investment
in Direct Financing Lease |
8,194 |
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| Enterprise
Value |
769,161 |
Projections
As RPC is able to raise rents
on the Sizeler portfolio, NOI, FFO, and AFFO should grow significantly during
2007. Our numbers are summarized below. We would expect RPC’s reported revenues,
NOI, FFO, and AFFO will be significantly higher as we exclude amortization of
below market rents (a non-cash item representing $1.5 million of non-cash
revenue in Q1) from revenues. We think our methodology is more conservative,
but appropriate for valuation purposes.
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Pro Forma Q1 2007 |
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Q2 2007E |
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Q3 2007E |
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Q4 2007E |
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FY 2007E |
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Assumptions |
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| Revenues |
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Income from Properties - Canada |
14,934 |
|
15,046 |
|
15,159 |
|
15,273 |
|
60,411 |
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3.0% Annual Revenue Growth (1) |
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Income from Properties - US |
15,934 |
|
16,450 |
|
17,228 |
|
17,786 |
|
67,399 |
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13.0% Annual Rev Growth (2)(3)(4) |
| Total
Revenues |
30,868 |
|
31,496 |
|
32,387 |
|
33,059 |
|
127,810 |
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| Property
Operating Expenses |
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Property Operating - Canada |
(7,357) |
|
(7,403) |
|
(7,449) |
|
(7,496) |
|
(29,705) |
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2.5% Annual Growth (5) |
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Property Operating - US |
(6,755) |
|
(6,806) |
|
(6,753) |
|
(6,803) |
|
(27,116) |
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3.0% Annual Growth (3)(6) |
|
| Total
Property Operating Expenses |
(14,112) |
|
(14,209) |
|
(14,202) |
|
(14,299) |
|
(56,822) |
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| Net
Operating Income |
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Net Operating Income - Canada |
7,577 |
|
7,643 |
|
7,710 |
|
7,777 |
|
30,706 |
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Net Operating Income - US |
9,179 |
|
9,645 |
|
10,476 |
|
10,983 |
|
40,282 |
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| Total Net
Operating Income |
16,756 |
|
17,288 |
|
18,185 |
|
18,760 |
|
70,989 |
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| G&A
Expenses |
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G&A - Canada |
(566) |
|
(570) |
|
(573) |
|
(577) |
|
(2,285) |
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2.5% Annual Growth (5) |
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G&A - US |
(1,059) |
|
(1,067) |
|
(1,075) |
|
(1,083) |
|
(4,284) |
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3.0% Annual Growth (6)(7) |
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| Total
G&A Expenses |
(1,625) |
|
(1,636) |
|
(1,648) |
|
(1,660) |
|
(6,569) |
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| EBITDA |
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Property EBITDA - Canada |
7,011 |
|
7,073 |
|
7,137 |
|
7,200 |
|
28,421 |
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Property EBITDA - US |
8,120 |
|
8,578 |
|
9,401 |
|
9,900 |
|
35,999 |
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| Total
EBITDA |
15,131 |
|
15,651 |
|
16,537 |
|
17,100 |
|
64,420 |
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| D&A |
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D&A - Canada |
(2,020) |
|
(2,020) |
|
(2,020) |
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(2,020) |
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(8,080) |
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Flat |
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D&A - US |
(11,366) |
|
(11,366) |
|
(11,366) |
|
(8,183) |
|
(42,281) |
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Flat Through Q3; Apartment Intangibles Will Be Fully Amortized in Nov 2007 (8) |
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| Total
D&A |
(13,386) |
|
(13,386) |
|
(13,386) |
|
(10,203) |
|
(50,361) |
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| EBIT |
1,745 |
|
2,265 |
|
3,151 |
|
6,898 |
|
14,059 |
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| Interest |
(9,718) |
|
(9,275) |
|
(8,850) |
|
(8,850) |
|
(36,694) |
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Flat Less Savings from Refinancings
(9) |
| EBT and
Other |
(7,973) |
|
(7,010) |
|
(5,699) |
|
(1,953) |
|
(22,635) |
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| Other |
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Dividend Income and Other |
467 |
|
467 |
|
467 |
|
467 |
|
1,868 |
|
Flat (10) |
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Other |
- |
|
- |
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- |
|
- |
|
- |
|
Excludes Early Extinguishment of Debt |
|
| Total Other |
467 |
|
467 |
|
467 |
|
467 |
|
1,868 |
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| EBT |
(7,506) |
|
(6,543) |
|
(5,232) |
|
(1,486) |
|
(20,767) |
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| Current
Taxes |
(1,287) |
|
(1,303) |
|
(1,319) |
|
(1,336) |
|
(5,245) |
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Flat % of Canadian EBIT |
|
| Future
Taxes |
- |
|
- |
|
- |
|
- |
|
- |
|
Assume No Tax Benefit Recognized |
|
| Net Income |
(8,793) |
|
(7,846) |
|
(6,552) |
|
(2,822) |
|
(26,013) |
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| Maintenance
CapEx |
1,130 |
|
1,138 |
|
1,146 |
|
1,154 |
|
4,567 |
|
2.9% Annual Growth (11) |
|
| Straight-Line
Rents |
286 |
|
292 |
|
298 |
|
304 |
|
1,180 |
|
8.3% Annual Growth (12) |
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| EV/EBITDA |
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11.9x |
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| Implied Cap
Rate |
|
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9.23% |
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| FFO |
4,593 |
|
5,540 |
|
6,834 |
|
7,381 |
|
24,348 |
|
(13) |
|
| FFO/Share |
|
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$
2.25 |
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| FFO
Multiple |
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7.9x |
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| AFFO |
3,177 |
|
4,110 |
|
5,391 |
|
5,923 |
|
18,601 |
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| AFFO/Share |
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$
1.72 |
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| AFFO
Multiple |
|
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10.3x |
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Notes:
- Q1 2007 Income from Properties – Canada is
a reported number. 3.0% annual growth is divided into 0.75% per quarter sequential
growth from Q2 2007 to Q4 2007. 3.0% annual revenue growth consistent with
growth from 2005 to 2006.
- Income from Properties – US excludes amortization
of below market leases.
- RPC is completing the redevelopment of a Kmart
property in Florida
in the second quarter. The cost of the project was $7 million. Assuming an
8% yield, the property should do $0.2 million of revenue and $0.1 million
of NOI per quarter beginning in Q3 2007.
- Q1 2007 Income from Properties – US is a reported
number less amortization of below market leases. 13.0% annual revenue
growth derived from 3.3% sequential revenue growth from Q4 2006 to Q1 2007
annualized. We assume this sequential growth continues from Q2 2007 to Q4
2007. Further evidence of the potential for strong 2007 revenue growth
comes from the $26.3 million of net below market leases (below market
leases less above market leases) as accounted for in RPC’s acquisition of
Sizeler. From a discussion with management, 25% of below market leases are
from apartments and 75% are from retail. The average apartment lease is 1
year while the average retail lease is 5 to 7 years, and the below market
leases are to be marked to market over this period. If all leases were
marked to market as amortized, revenues would grow over $1 million per
quarter each of the next 3 quarters, more than double the $ growth rate we
have assumed.
- Expense growth consistent with rate of Canadian inflation.
- Expense growth consistent with rate of US
inflation.
- G&A – US excludes $1.1 million of mortgage
origination costs in Q1 2007.
- D&A – US is high because of the amortization
of in-place leases costs that were over $100 million at the time of the
Sizeler acquisition. Apartment in-place lease costs will be fully
amortized at the beginning of November 2007 leading to reduction in Q4
2007 amortization.
- Interest Expense excludes amortization of loan origination
($0.6 million in Q1 2007). The Company priced US$150 million of new
mortgages at 5.6% in January 2007. This debt took out debt with rates from
7.13% to 8.25%, saving $2.8 million in interest expense annually. The
Company expects to place additional mortgages in May 2007 to take out the
rest of the 7.13% acquisition financing. We assume a 5.75% average rate
for these mortgages, saving RPC $2.5 million annually.
- Income from the Danville, Virginia
property is accounted for as Dividend and Other Income. Dividend and Other
Income excludes a reserve for mortgages receivable of $0.6 million in Q1
2007. It includes $0.1 million of interest quarterly on these receivables
that will be included going forward according to management.
- Estimates of maintenance capital expenditures. Q1
2007 capital expenditures are based on 0.8% of assets, the midpoint of the
range to which management has guided. Capital expenditure growth is based
on a weighted average of US and Canadian expense growth. Q1 2007 total
capital expenditures were higher owing to redevelopment of the Kmart
property in Florida.
- Blended rate of US and Canadian revenue growth.
- Pro Forma Q1 2007 FFO reconciliation to reported
FFO:
| Reported FFO |
|
2.9 |
| Below Market Lease Amortization |
- |
1.5 |
| Mortgage Transaction Costs |
+ |
1.1 |
| Amortization of Loan Origination Costs |
+ |
0.6 |
| Accounting Reserve for Mortgages
Receivable |
+ |
0.6 |
| Interest on Mortgages Receivable |
+ |
0.1 |
| Debt Defeasance Costs |
+ |
0.8 |
| Pro Forma FFO |
|
4.6 |
Valuation
We believe the best way to
value RPC is using comparable company analysis. We include Canadian diversified
REITs, US apartment REITs,
and US
shopping center REITs as comparable companies. Using the average of the minimum
multiple of each group, we arrive at a price of $37.34 using 2007 numbers. We
think this is conservative as we are using minimum multiples given RPC’s
relatively small size and float.
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FFO Multiple
2007 |
AFFO Multiple
2007 |
Cap Rate
2007 |
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| RPC
Multiples |
7.9x |
10.3x |
9.23% |
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| Canadian
Diversified |
|
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| Averages |
|
15.0x |
18.1x |
6.40% |
| Min |
|
14.0x |
16.9x |
6.80% |
| Max |
|
17.2x |
18.8x |
5.80% |
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| US
Apartment |
|
|
|
| Averages |
|
16.9x |
20.7x |
6.32% |
| Min |
|
15.9x |
18.6x |
6.71% |
| Max |
|
18.1x |
21.8x |
5.97% |
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| US
Shopping Center |
|
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|
| Averages |
|
17.9x |
20.8x |
5.62% |
| Min |
|
16.1x |
18.4x |
6.17% |
| Max |
|
19.6x |
24.6x |
5.19% |
|
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|
| Average of
Peer Min |
15.3x |
18.0x |
6.56% |
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|
|
| Revenue
Properties Data |
$ 2.25 |
$ 1.72 |
70,989 |
|
|
|
|
|
| Implied
Prices |
$34.48 |
$30.87 |
$46.66 |
|
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|
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|
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| Average
Valuation - 2007 |
$ 37.34 |
|
|
Sources: Merrill Lynch and RBC
Even if you think that RPC’s
current trailing (i.e. LQA) multiples are somehow warranted, our projected
operational improvement from Q1 2007 to Q4 2007 would imply a price target of
$26 to $33 a year from now.
Issues
- Taxes.
RPC is not a REIT; it pays corporate level taxes. As a result, making
comparisons with REITs is complicated. We realize that accounting for
taxes should mean that our valuation be discounted. Any discount would
have to make assumptions concerning when (or if) taxes would be paid (e.g.
RPC does not expect to pay US taxes in 2007 because of high levels of
interest expense and amortization) and the tax considerations of the
investor.
- Liquidity.
RPC’s shares trade rather infrequently. We think the discount to fair
value on the shares more than makes up for this.
- Morguard Corporation Ownership. As a 68% owner, Morguard could push actions
detrimental to minority shareholders. In addition, the overlap of
management between the two companies creates a conflict of interest as to
where they spend their time and allocate capital.
- Weather. The
Sizeler portfolio is located on the Gulf Coast,
which is susceptible to hurricanes. While most of the properties are on
high ground, further hurricane damage in the region may cause more people
to leave the area and may raise insurance rates further.
Bottom Line
The market does not know that
this company exists based upon its massively discounted valuation as compared
to peers. RPC has produced solid results in the past, and there is no reason to
believe they will not continue to do so in the future. They take a disciplined
approach to acquisitions and dispositions to their portfolio. We recommend
potential investors visit
www.morguard.com
to see the extensive market-by-market and sector-by-sector forecasts and
overviews put out by the management team. More importantly, the Company
completed the Sizeler acquisition at a very good price, and has many
opportunities to add value there. We believe this value will become apparent in
2007 results.
Catalyst
- Reporting solid results in line with our 2007 expectations
- Increased Wall Street attention