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Equity Research Model

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Canadian Apartment Properties Real Estate Investment Trust (Q4/19) (Update)

Riding the Wave of Success - Target Price: C$62.86; Recommendation: Buy; Risk: Low

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(all currencies are in CAD$ unless otherwise noted)

EventCanadian Apartment Properties Real Estate Investment Trust (“CAPREIT” or “CAR.UN”) reported Q4/19 results on Feb 27, 2019.

Highlight: NOI of $135.70 million and FFO of $87.86 million ($0.54 per share) were slightly below Modelyze Investments forecast of $142.20 and $93.07 ($0.56 per share) in Q4/19. This represents an FFO decrease of 1.12% relative to Q3/19 and increase of 28.5% relative to Q4/18. On an annual basis, FFO increased by 17.32% and NOI grew by 15.74% with respect to 2018. Total suites Net AMR grew by 1% relative to Q3/19, occupancy remained stable at 98.2% and operating revenues grew by 16.44% with respect to Q3/19. CAPREIT ended the year with 60,713 rental units and properties, an increase of 9,185 units relative to 2018. Q4 was the largest quarter of acquisitions historically with $1,327 million acquisition of investment properties and with CAPREIT raising $1.12 billion gross equity in 2019.  As of Q4/19 CAPREIT holds 66% majority ownership in ERES and 18.3% minority interest in IRES. Q4/19 was a strong quarter from earnings, cash flows, operational efficiency and balance sheet perspectives with higher cash flow return on invested capital and interest coverage ratios, stable NOI margin and increasing net margin, lower debt to GBV of 35% and higher liquidity. Strategic use of local euro third party mortgages at favorable rates, euro  acquisitions and operating credit facilities and cross currency swaps led to significant interest rate savings by borrowing at a blended rate of 1.1% in Euro rather than 3.4% in CAD and further hedging the portfolio’s European exposure. As of Q4/19 CAPREIT has $1.2 billion of euro denominated debt.

Details: Q4/19 was a strong quarter with accretive portfolio growth and increases in operating and financial performance. CAPREIT acquired 9,241 residential suites and MHC sites in Canada and the Netherlands in 2019 and sold 2,710 of Netherlands suites to ERES, bringing the majority ownership in ERES to 66%. In Q4/19, CAPREIT announced an agreement for acquisition of 1,503 rental properties in Halifax, NS which was closed after year end. Revenues and NOI continued to grow due to higher monthly rates compared to last year and further rent increase on turnovers; NOI margin was 65.3% in 2019 with respect to 63.78% in 2018. Net AMR increased by 1.4% relative to Q3/19 due to strong turnovers in BC, Ontario and NS. Fair value of invested properties increased by $892.2 million in 2019, significantly contributing to increased net margins; this progress is mainly due to compressed cap rates across the whole portfolio, rental increases on turnovers and renewals, and CAPREIT's strategy to buyout and convert operating leasehold interests to traditional fee simple property interests. CAPREIT has been shifting focus to modernizing its asset base in order to reduce the average age of the portfolio by targeting the purchase of brand new properties in key growth markets such as Toronto, attracting stronger residence, and generating sustainable rents with much lower capital spending. In Q4/19 CAPREIT financial position continued to improve with debt to GBV of 35% and net debt to capitalization of 33% (compared to 37% and 35% in Q3/19), $477.3 million of cash and cash equivalent and $8.4 billion of available liquidity relative to $7.5 billion in Q3/19. With continued emphasis on ESG integration in the real estate market, CAPREIT continued its efforts for initiating ESG related policies and programs and released its 2019 corporate ESG report along with its annual report in February. CAPREIT is looking ahead at inaugural submission into global real estate sustainability benchmark by the end of 2020. Through continued implementation of corporate strategy, purchasing properties at significantly below replacement costs, maintaining stable cost structure and margins and playing to its key strength in large Canadian urbanized reals estate markets, CAPREIT has maintained its elite position as Canada’s largest residential landlord.


Valuation: Modelyze Investments considered the last twelve months (“LTM”) NOI, 2020F NOI and 2021F NOI and the average cap rate of CAPREIT portfolio of assets across Canada and Europe in an Asset Based Valuation of the REIT. Value of rent generating operating assets is derived by dividing the NOI by a cap rate of 4.11% as of Q4/19. Averaging out the FY1 and FY2 net asset value per share in today’s dollar given a cost of equity of 4.74%, Modelyze Investments arrived at a price of C$62.86 per share. It is expected that cap rates in certain regions of Canada decrease in 2020 as real estate bubble continue to expand. Looking at comparable REITs across the sector, the median 2020F P/FFO mean estimates is 20.83 x and median 2021F P/FFO is 19.64 x (mean estimates are sourced from Refinitiv). Based on Modelyze Investments forecast, CAPREIT is trading at 2020F P/FFO of 23.11 x and 2021F P/FFO of 20.40 x as of the analysis date. Modelyze Investments assigns a BUY recommendation with a LOW risk rating at a target price of C$62.86 and an annualized return to target of 57% as of the date of the analysis.

Risk to Target Price: Risks associated with investing in CAPREIT includes but not limited to interest rate risk, commodity price volatility risk, cyclicality nature of the operating expenses (higher utility expenses and commodity exposure in Q1 and Q4), bad debt expense of tenants, rent control and regulations, taxation related risks, inability to refinance mortgages and senior debt at favorable terms, foreign currency and exchange rate risk, fair value adjustments and appraisal risk, illiquidity risk, operating and asset management risks, and climate related risks. From a risk management perspective, CAPREIT has managed the interest risk exposure of the mortgage portfolio by reducing average interest rates and mitigated refinancing risk by managing the average term to maturity of the portfolio and staggering the maturity dates. It has managed the European exposure through cross currency swaps and borrowing in local currency. With primary focus in Canadian multi-unit residential real estate, CAPREIT is eligible for government-backed insurance for mortgages administered by CMHC.

Conclusion: Modelyze Investments believes CAPREIT is a stable, dividend paying stock with bond like characteristics. CAPREIT has strong financials and a growing, diversified portfolio of assets. Modelyze Investments assigns a BUY recommendation with a LOW risk rating at a target price of C$62.86 and an annualized return to target of 57% as of the date of the analysis.

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