Artis REIT: My Top Real Estate Play for 2023
It's dirt cheap, pays a decent dividend, and an upcoming catalyst could unlock some value
I’ve owned Artis REIT (TSX:AX.UN) for the better part of a decade now, and the stock has been pretty much flat. Excluding the dividend, at least.
I bought in for a few pretty simple reasons. It traded at a steep discount to book value. The yield was decent. The balance sheet was improving after a big foray into the U.S. And there were a couple of big shareholders I hoped would put pressure on management.
Fast forward to today and Artis offers much the same investing thesis. It trades at an even bigger discount to book value. The yield is up to 6.7%, and that’s after a 50% reduction in the distribution in 2018. The balance sheet has improved after selling off assets to private buyers. And the C-Suite has been transformed after an activist campaign ousted the previous management team.
Let’s start with the change in management. Sandpiper Group first got involved with Artis in 2017, amassing a big enough position to get a representative named to the board. They were mostly patient until 2020, when Artis floated a plan to spin off its struggling retail assets into a separate REIT. Convinced the company was selling at the bottom, Sandpiper went ape shit and started a big activist campaign.
Among other things, Sandpiper alleged:
Then-CEO Armin Martens was putting his family’s interests ahead of Artis’s interests, including naming relatives to management and board positions. There were also allegations a family-owned company was overcharging Artis for various services. Despite this, Martens did not hold a material position in the stock
Much of senior management (especially Martens) was overpaid and very comfortable in their positions
The big gap between NAV and the current share price was largely a reflection of the market’s feelings towards current management
The final nail in Martens’ coffin was when large shareholder Jetport Inc. (the holding company of longtime Tim Horton’s head Ron Joyce) came out and said it would be voting against the retail spin-out. Knowing he was beat, Martens stepped down shortly after and Sandpiper head Samir Manji became Artis’s CEO.
Under Manji, Artis has been trying to close the persistent gap between its unit price and fair value in a couple fairly predictable ways. Firstly, the company pledged to sell off non-core office and retail assets to private buyers, taking advantage of the elevated prices private companies are willing to offer. The company also started buying back shares like crazy. Take a look at how many shares Artis has repurchased in the last few years:
That chart only covers to the end of last year, too. The current number of shares outstanding is approximately 115 million, and Artis has renewed its buyback program for 2023. It has also been busy buying back shares over the last couple weeks, retiring approximately 300,000 of a total of 8M shares authorized for 2023. This is a serious share buyback, and a no-brainer use of excess company capital.
Asset sales have been happening at a brisk pace, too. Martens started the process, but Manji has taken it to a whole new level since announcing a grand new vision for Artis in March, 2021. The company has sold 48 industrial, 10 office, and 6 retail properties, for a grand total of 64 properties sold. That was about 35% of its portfolio. These days, the company owns 135 properties spanning some 15.6 million square feet of gross leasable space.
(A picture of Artis’ residential tower, currently under construction in Winnipeg)
It’s not that hard to see where the money from the property sales has been spent. Artis has used it primarily in three ways — to pay down debt, to pay some special distributions to shareholders, and, as mentioned, to buyback shares. I’ve already talked about the buybacks, so we’ll touch on the debt. Artis’s debt-to-assets ratio went from close to 50% to 47%. It’s not much, but it’s a start. Artis also increased its monthly distribution to $0.05 per unit each month, and has paid special distributions in both 2021 and 2022.
Despite all this, Artis’s share price has remained weak. Shares currently trade at $9 as I write this, falling by more than 20% in 2022. Some of this is because higher interest rates have hurt the overall REIT market, but some of it is also Artis doesn’t really seem to have a strategy beyond selling that they determine to be overvalued assets and buying stuff they think is cheap.
Take the Cominar transaction. In 2021 a group of investors announced they were taking Cominar REIT private. The Quebec-based REIT had traded at a discount to its NAV for years as it made mistakes like overpaying for assets, having a retail-heavy portfolio through the pandemic, and various distribution cuts. After the dust settled Artis owns approximately 30% of the new Cominar, along with $100 million worth of preferred shares with an 18% dividend (emphasis mine).
(I’ve racked my brain for a solid 10 minutes and I can’t figure out why such a preferred share series would even exist)
There’s more. Artis also announced it holds a big position in Dream Office REIT. It, along with various Sandpiper-controlled partnerships, owns some 14% of Dream Office, shares acquired in the low-$20 range. Dream Office shares currently trade at $14.90 each.
Here lies the problem. It sure looks like Artis is selling off physical real estate in exchange for a combination of share buybacks, a little bit of debt repayment, and a whole lot of positions in other publicly traded REITs. Why should investors bother with it? Why not simply wait until Sandpiper/Artis announce they’re in a stock and join them for the ride?
Why 2023 will be the year Artis wins
My thesis is simple. 2023 will be a good year for Artis because it’s the classic heads I win tails I don’t lose much scenario.
Artis trades for a mere 40% of its $19+ per share NAV. It owns a bunch of cheap real estate and publicly traded entities that also own a bunch of cheap real estate. It’s actively gobbling up all the undervalued shares it possibly can, too.
Sandpiper and its allies already own more than 30% of Artis’s shares. With every share repurchased, their ownership stake gets a little bigger. If they really believe Artis has a $19 per share NAV, why wouldn’t Sandpiper just take Artis private?
That’s the easy win, and I think Sandpiper does it in 2023 or sometime in 2024 if the price-to-NAV discount remains this elevated.
However, I don’t think an outright sale is the only way Artis wins. Management should continue to sell off non-core assets at prices that should more closely reflect their current market values. If they put that cash back into share buybacks it will eventually be reflected in the unit price.
I also believe interest rates come down in 2023 as central banks first pause rate increases and then quickly realize they raised rates too quickly. Canadian inflation has largely been in check over the last few months, and a likely recession in 2023 will necessitate rate cuts. This will be good for every REIT, and Artis will ride this rising wave.
(Yes, I realize the folly of making macro predictions. There’s a reason why this is so close to the end…)
I also wouldn’t be surprised to see another distribution hike in 2023. The current payout ratio is comfortably below 50% of FFO. The share buyback and retirement of preferred shares means there’s less cash going out the door than a year ago. And Artis has consistently told investors it plans to hike distributions as part of its quest to transform the company. The current yield is 6.7%.
A hike from the current $0.05 per month distribution to a $0.055 increases the yield to 7.3%. It isn’t very often we talk about stocks with such high current yields that have the potential to increase the payout.
Artis is dirt-cheap from an earnings perspective, too. According to analyst projections, Artis should earn approximately $215M in EBITDA in 2023 after accounting for known dispositions. To do some quick and easy math, we’ll assume Artis will be able to convert EBITDA to FFO at the same rate it did in 2021, meaning $215M in EBITDA will translate into approximately $150M in FFO. Divide that by 115 million shares outstanding (which assumes zero share repurchases for 2023, an overly conservative measure) and Artis has a price-to-FFO ratio of approximately 7x.
There may very well be some errors in my assumptions in the last paragraph, but overall I think I was fairly conservative. Even if I’m off by a little, the fact remains Artis is dirt cheap on both an NAV and on an earnings perspective.
Finally, there’s the company’s big Winnipeg residential project. 300 Main is a 42-story apartment building spanning 580,000 square feet, currently accepting deposits for its first 20 stories. It will start contributing to earnings in 2023 and, more importantly, will give Artis a foothold into a sector of real estate that’s viewed as more stable.
The bottom line
Artis has some warts; there’s no doubt about that. But there comes a point where the stock is just too damn cheap, and I think we’re there with Artis today.
Management isn’t perfect, but they’re much improved from the previous regime. Most importantly, they’re obviously very interested in selling off anything that will help create value. If that means crummier office assets remain, so be it. I’m happy as a shareholder to let them continue to cash out.
As mentioned, I think 2023 is the year Sandpiper starts getting impatient and really starts trying to extract value from Artis. I still think Sandpiper taking it private is extremely possible and if not, the share buyback is good enough. Good things tend to happen to companies that gobble up undervalued shares, and I’m happy to go along for the ride.
Disclosure: Author is long Artis and is actively buying more in the market
Interesting Perspective. Thanks for the article.
In both this article and the Algonquin Power one, you mention PE and EBITDA. In both cases, I think i'd be interesting to discuss of the interest expense as well. 2021 to 2023 corporate rates have more than doubled, is there a bottom line and cash impact due to rising rate ? Stable Funds from operating & increased interest expense means less cash.
Thanks, what about leverage on a net debt /ebitda basis, any risk here? Thanks