Mainstreet Equity: Canada's Forgotten Compounder

One of the reasons why I started the Canadian Dividend Investing newsletter was to give myself a reason to dive into interesting stocks that are somewhat off the beaten path.

Don’t get me wrong; I still think a portfolio full of large Canadian companies like Royal Bank (TSX:RY), Enbridge (TSX:ENB), and Brookfield Corporation (TSX:BN) does just fine over time. These companies have clear moats and limited competition. They have sharp managers and able directors. And they all still have growth opportunities, even if their size would make that seem unlikely at first glance.

But I also think investors are limiting themselves if they’re just looking at the usual suspects. Hiding among the masses of non-S&P 500 companies are all sorts of interesting names, stocks that I periodically feature for free subscribers (and feature weekly for premium subscribers).

For instance, a little less than a year ago, I wrote about Monarch Cement (OTCPK:MCEM), a boring cement supplier out of Kansas. That stock is up 24.59%, assuming you reinvested your dividends. That’s beating the S&P 500 by about 13%.

A few months before that, I wrote about Murphy USA (NYSE:MUSA), a collection of gas stations in the South and Midwest parts of the United States. Murphy was (and continues to be) a share buyback machine, repurchasing 58% of shares outstanding between 2013 and 2023. Up until about a month ago Murphy was outperforming the S&P 500 too, but shares took a sharp turn lower on weaker than expected earnings. I think this downturn represents a terrific buying opportunity.

Today I’m writing about another under-the-radar stock, a company that has quietly returned more than 5,300% since its 2000 IPO. As you’ll see, growth potential is still strong. It has also accomplished this despite barely issuing any shares. All growth has been self-funded via one of the most ingenious business models out there. Oh, and the CEO holds about 50% of shares outstanding.

That stock is Mainstreet Equity (TSX:MEQ), and needless to say, I’m a fan. Here’s why.

The skinny

Led by CEO Bob Dhillon, Mainstreet Equity debuted on the Toronto Stock Exchange in 2000 with a different vision of a real estate company.

Rather than pay out a large chunk of profits back to shareholders — as virtually every other publicly-traded real estate company does — Dhillon had a different vision. His profits would be reinvested back into additional apartments.

Like any good investor, Dhillon set out to maximize the return on his investment while using the least amount of capital possible. And so he settled on a business model that’s simple and virtually limitless.

Essentially, it goes like this:

What Mainstreet discovered is mid-market apartments have a bunch of qualities that made them attractive investments. They tend to trade for far below replacement costs. They offer better cap rates than new builds. Rents are low, which is something tenants always find attractive. Supply is ample. These properties could easily be fixed up at a relatively low cost. And banks will lend against them at attractive interest rates, buying into the mantra that people are always going to need a place to live.

Put it all together, and we have the Mainstreet Value Creation flywheel — a powerful business model that virtually anybody can understand.

It all begins with the acquisition. Mainstreet targets properties owned by individual investors who either couldn’t afford to upgrade units, or simply milked the property a little too long. It focuses on buildings without expensive amenities like parking garages or elevators, which minimizes long-term maintenance costs.

Next up is the renovation process. The company uses its own full-time contractors and buys supplies in bulk, saving money compared most other renos. It focuses on kitchens, bathrooms, and new flooring. Quite often a $20,000 investment can increase the value of a unit by $30,000, and result in a few hundred dollars per month in extra rent.

The company also implements various operational improvements. It brings in its own managers, keeping costs down by putting one person in charge of several buildings. It puts in energy and water-saving equipment. And it uses technology to help with all parts of the rental application process.

Once the reno is completed and the property is back on the market and fully rented, this is when the real magic starts to happen. Mainstreet will then approach a lender and finance the building, pulling out equity as it does. In fact, in many situations, Mainstreet is able to pull out enough equity in the building that it has zero of its own capital invested.

Let’s look at an example. Say Mainstreet buys a 10-unit apartment building for $1.2M. It spends $200,000 on renovations ($20,000 per unit) and raises rent from $1,100 to $1,400 per location. Based on the improvements made, a lender values the property at $1.75M. Mainstreet gets a mortgage for $1.5M, when then frees up all of its invested capital (and then some) to do another deal. Meanwhile, the tenants pay off the mortgage slowly over the next 25 years, and Mainstreet continues to grow.

The company started in Calgary back in the 1990s, and eventually moved into Edmonton, Red Deer, and Lethbridge. Approximately 40% of its portfolio today is in Alberta. It then expanded into British Columbia, Saskatchewan, and, most recently, Manitoba. These days, the company owns 18,653 units across Canada’s four westernmost provinces.

That seems like a lot of units, but in reality Mainstreet is still a small player in a big pond. The number of mid-market apartment units in the cities where it currently operates is vast, with nearly a quarter million units. That puts Mainstreet at about an 8% market share in Western Canada alone, and that assumes it’ll never expand outside of the area.

Demographics are also helping here. Baby boomers own many of the apartments Mainstreet is interested in acquiring, and these guys will need exit liquidity in the next 1-15 years.

Mainstreet has kept up this business model for some 25 years, and results have been wonderful. It has grown from under 1,400 units in 2000 to nearly 19,000 units today, and has done so while keeping shares outstanding virtually unchanged. The growth has all been internally funded.

The lag between stabilized and unstabilized units also creates a nice little near-term growth runway. As it stands today, Mainstreet has 16,259 stabilized units. That leaves more than 2,000 units (or more than 10% of the total portfolio) that are in various stages of renovations. Once these properties are fixed and put back on the market, Mainstreet will maximize cash flows from the asset. That translates into earnings growth.

Combine that with annual rental increases to existing tenants, and the company being able to bring underperforming suites back up to market rents when someone moves out, and it’s a powerful growth combination.

Mainstreet has another advantage many don’t often talk about. The Canadian Government is motivated to rein in unaffordable housing prices throughout the country. One of the ways they do so is by offering special CMHC-backed financing terms to apartment operators. Mainstreet taps into that program, and gets funding at a lower rate than even the best-qualified mortgage borrowers.

The opportunity

In its 25-year history on the TSX, Mainstreet has delivered some very impressive gains.

In that time, it has:

• Grown FFO/share by 18% annually

• Increased the IFRS value of its portfolio by 16% annually

• Grown revenue by 16% annually

• Grown the share price by 17.3% annually

That’s enough to turn a $10,000 investment into one worth $541,015 — and no, that’s not a typo.

Some might scoff and declare Mainstreet finished after such a move. The law of large numbers has to apply at some point, right?

Sure, eventually. But I still think this compounder has loads of room to keep compounding.

As mentioned above, it has just an 8% market share in the communities it already operates. Even if it doesn’t expand outside of Western Canada, the potential is still strong.

Mainstreet also has a long-term opportunity to expand into the rest of Canada. I’ve heard bears disagree, saying that the company won’t move into Ontario or Quebec because of rent control. But it has operated in BC for years now, and it has rent control. Its latest foray into Manitoba also features a market that has rent control. These guys are not afraid to enter markets where the government limits rental increases.

I believe the company will also eventually expand into the United States. The Midwest part of the United States has a ton in common compared to Alberta and Saskatchewan, and that part of the country is filled with the kind of apartments Mainstreet likes. Plus, there’s no other investor of size that’s doing what these guys are doing — or at least none that I can find.

Mainstreet trades for about 18x FFO today, but the bottom line is expected to grow by 15%+ annually for at least the next two years. That puts shares at a very reasonable 15× 2026’s expected FFO, and just over 13× 2027’s expected FFO.

Dividends and buybacks

Mainstreet recently started to pay a very small dividend, partially to get the attention of dividend investors like me.

The quarterly payout is $0.04 per share, which is good enough for a 0.1% yield. The payout ratio is approximately 1% of FFO.

Many of you want more yield than that, which I understand. But Mainstreet is poised to be a massive long-term dividend grower as it continues to grow the bottom line.

The initial dividend, which was first declared in 2024, was $0.0275 per share. That’s 45% annual growth, and I believe the company can maintain that for a long time.

Say it grows the dividend by 25% annually, and it keeps it up over 15 years. That works out to a $4.55 per share dividend in 2040 — plus plenty of growth in the meantime.

Based on the $194 share price today, that works out to a 2.4% yield on cost.

As mentioned, this isn’t really a dividend story. But the payout helps, and it gives those of us who insist on dividends (like your author 👋) the permission needed to buy shares.

The bottom line

Mainstreet is a special company that I believe has tons of growth potential left.

The company’s business plan is as simple as it is powerful. It’s something that it can easily repeat no matter what market it enters, and reinvesting most of its profits really accelerates growth. Plus, there isn’t a single large company copying the business plan, which bodes well for future acquisitions.

Plus, the CEO continues to own approximately 50% of shares. Other insiders are among the company’s largest shareholders as well.

I believe Mainstreet will eventually grow into Canada’s largest landlord by using the same simple business model it executes so well today. It’s an impressive operator, one that should demand more attention.

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