Cominar REIT (OTC:OTC:CMLEF or TSE: CUF.UN) is a diversified Canadian Real Estate Investment Trust, and the largest operator in the province of Quebec, Canada. With 566 properties and $8.2B in assets, it is one of the largest REIT operators in Canada, using a highly disciplined approach that has allowed Cominar to increase its dividend's paid every year since becoming a publicly-traded entity. Note that this is cumulative dividends, and the per-share increases have been irregular over time, with the most recent in August of 2014.
As one of the largest operators in Canada it enjoys a big scale, well-diversified portfolio of assets and has impressive insider ownership of approximately 7.2% of outstanding shares. With one of the largest dividends in the industry we are left wondering provided this REIT is undervalued.
Any company with 51.4% of its operating income from one city may have outsized geographic risks. Combine that with a complete of 73.7% coming from the province of Quebec and suddenly we have a company with some serious provincial risks associated with it. They have been making some serious entries into other markets to further diversify, but the risks remain.
The diversified nature of its income by market segment is more promising, though they are office focused with some manageable parlays into other areas, such as the higher cap-rate industrial section. I enjoy a higher margin "kicker", and I prefer they are less than 25% of NOI, which sits Cominar comfortably under that level.
Cominar "suffers" from its own success. Its competitive advantages in its home market, the province of Quebec, give it the ability to purchase properties at very competitive rates. It can also manage them at a cost advantage, combined with the provinces government and people's preference to deal with native institutions. This leads to some concentration risk that other REITs do not need to deal with.
The two largest markets for Cominar are Montreal and Quebec City, the two largest cities in the Canadian province of Quebec. The province is largely French speaking (~78%) and the only province where French is the sole official language. As the second most populous province and second largest in economic output, the province has long been an anomaly, politically speaking, in Canadian history. As a especially influential province, with a particularly strong historical proclivity to protectionism and a desire to maintain its culture against a largely English-speaking federal government, it has been a major force in Canadian politics and economic life.
As two of Canada's largest cities, ranking 11th (Quebec City) and 2nd (Montreal) they are economic powerhouses within the province. The province itself has numerous strong industries supported by the federal and provincial governments, combined with new immigrant populations and increased presence of native companies growing on the world stage. On the downside, increasing regulations designed to protect the French-speaking population, and the French language requirement for immigrants is limiting the strength of candidates companies are able to draw from. The aging infrastructure does not line well with the new age of high-tech cities.
The protectionist policies of the local government, in their try to protect the dominant French-language in Quebec, have put a damper on growth prospects in the province. Although Montreal and Quebec City are large and growing there are issues stemming from some of the political issues in the province. All of the province-specific issues are fixable, but it will be a long-term process.
Quebec-based companies often trade at a discount to their Canadian peers, who tend to trade at a discount to their US-based peers. As the liquidity of the Quebec-Non Quebec companies is the alike (TSE), this discount stems from perception rather than a liquidity issue. This means that on top of concerns about the Canadian Real-Estate market, there is also an underlying Quebec discount that is largely unnecessary.
As an investor I believe this discount stems from a few sources. The leading one is difficulty analyzing these companies properly. Their investor presentations and main websites are sometimes in French, though most major companies will produce all information in English on the English-language site (Cominar defaults to French, but you can select to view the website in English).
The second stems from lack of analyst following, most Quebec companies who have eliminated traces of their discount (BMO (NYSE:BMO), Alimentation Couche-Tard Inc (OTCPK:ANCUF), BCE Inc (NYSE: BCE), Valeant Pharmaceuticals (NYSE: VRX), etc) are exceptionally large and there is no reason to view them as Quebec-based. They have also grown to the point that analysts begin to cover them as a global company. Growing their scale and re-orienting their websites help eliminate any discount, regardless of where they are headquartered.
The third is an undervaluation of Quebec itself, as investors are simply less familiar with it. There are different laws and regulations for those based in Quebec that do not impact their ability to grow (as illustrated in the aforementioned companies) but that investors seem to automatically attach to Quebec, a stigma if you will, due to investor unfamiliarity.
Due to investors misunderstanding/under-rating of Quebec-based businesses there is an ability to accumulate assets based in that province with a higher than usual level of safety. It also allows businesses like Cominar, who deal actively in Quebec to get the best of both worlds. Low-cost leverage in the alike vein of every other credit worthy institution, better cap-rates as sellers are more likely to prefer a native company and lower competition for properties as other major players are not as active in the Quebec market. These three advantages over other competitors in its home market allow for solid returns for investors at a discounted price.
As a diversified REIT there is already a discount associated with this type of investment vehicle. As Brad Thomas, the king of REIT contributors on Seeking Alpha, puts it in his article on Investors REIT (NYSE:IRET) which you can read here he states:
"I'll admit I've never been a big fan of Diversified REITs and neither has Mr. Market. One of the primary reasons that I like REITs is because I can hand pick REIT sectors with management teams that have a "core of competence". Coined as "pure play" REITs..."
This is Brad's preamble to an analysis of a diversified US-listed REIT, one of numerous I researched whose business models and asset mixes were simply too different from the Canadian equivalent to use in the comparisons (IRET for example trades at a 13 P/AFFO, is very little to trade at that level, but has appreciable healthcare and multi-family buildings exposure, both sectors none of the Canadian REITs have exposure to).
This discount to peer groups of the more focused-REIT businesses allows for purchasing the assets of the REIT at a discount that I feel is largely unnecessary. At one time diversified companies, in the vein of General Electric (NYSE: GE), were all the rage. This turned out to be temporary, but "diversification as a strength" is a viable strategy in the authors opinion, and a change in investor sentiment is very possible in the future.
Comparable companies include Artis REIT (TSE: AX.UN), H&R REIT (TSE:HR.UN), Melcor REIT (TSE: MR.UN), Canadian REIT (TSE: REF.UN), and Morguard REIT (TSE: MRT.UN) in Canada. All the companies chosen operate a diversified REIT charter with the majority of earnings coming from Retail/Office, with most having an industrial component, much like Cominar.
As we evaluate the REITs we can see that there is a theme. The smallest REITs, and thereby least diversified, are valued very closely to how Cominar REIT is currently valued. The larger REITs are valued much higher, depending on their individual diversification.
As we can see from the information above, there is quite a bit of diversity within the valuations and sizes for diversified REITs, who themselves usually trade at a discount to US listed diversified REITs. This unlocks tremendous value for shareholders who have the possibility to purchase at very reasonable multiples.
Cominar REIT, H&R REIT and Canadian REIT are the closest comparables of the Canadian REIT world. Cominar REIT and Canadian REIT in particular symbolize the sibling REITs in Canada, as they both began operating at a similar time and have produced some impressive returns for shareholders. In this graphic you can see the three REITs capital returns, and notice in particular Cominar and Canadian REIT diverging from their early life as concentrated REITs. There are two main reasons for this divergence of return, in the author's opinion. The first is that Canadian REIT was never particularly Quebec focused, allowing it to trade without that overhang. The second is Canadian REIT started diversifying across Canada more quickly. These two features allowed Canadian REIT to trade at a persistent premium, which gives it a competitive advantage in issuing new shares (higher price, more funds to reinvest, smaller dividend per share hurdle for investment).
Where Cominar has been trading with an aggressive dividend its entire life, Canadian REIT has been able to pay around 4% dividend (compared to Cominar's 8%) since about 2010, and occasionally before that, including between 2006 and 2008 (up to the crash). H&R REIT has been paying a distribution since late 2008 (interesting time to start), and has consistently paid around 5-6% its entire life. Cominar, on the other hand, has been grappling with a distribution in the 8-10% range since inception, trading at a yield below that for a short time late 2006 to early 2007 and again in late 2011 to 2012 (in both instances the distribution was still well above the REIT average at the time).
Accounting for this dividend discrepancy the return difference between the three narrows considerably, but there is still a gap. I would argue this hole stems from the advantage of better prices for equity issuances, coupled with greater exposure to the very hot (and currently struggling) Alberta market for the other two REITs.
As per my table above we can see that Cominar trades at a P/AFFO discount to both HR and Canadian REIT (CREIT), trading more in line with much smaller counterparts. Both HR and CREIT have increased exposure to struggling markets in Western Canada, which has hurt H&R more than Canadian. One of the stand-outs is the weightings for Retail-Office-Industrial buildings between H&R and Cominar, making H&R the basis of comparison for our base case.
H&R has a large exposure to Ontario, a market I consider very comparable to Quebec in terms of risk weighting. They are both touchy to manufacturing and immigrant numbers, though Quebec has outsized government agency (less risky) and Ontario is growing marginally faster (less risky), I consider the comparison a wash.
H&R has increased exposure to commodity volatility (NYSEARCA:OIL) due to its increased investment in Western Canada, notably Alberta. Canadian REIT still trades at a hefty premium despite similar weightings, but I still feel there is a justifiable risk that needs to be accounted for. Cominar has increased geographic exposure to Quebec, which in itself is less risky, but the sheer volume of its properties being located there adds an element of geographic risk. Again, I will consider the two as canceling each other out, compensating investors adequately for the risk at H&R's P/AFFO value.
In our base case, we presume that Cominar will trade more in line with H&R's P/AFFO multiple over time. This will start to eliminate the equity issuing gap between the three and allow for strong growth in the future. In this case Cominar is worth $23.99 per share, a complete return amount of 39.3% to this one-year price target.
In our best case, we presume Cominar will trade more in line with Canadian REITs P/AFFO, allowing outsized future growth through strong equity issuance pricing. If this were to occur, Cominar would be worth $28.08 per share, a total return potential of 61.65%, though this return would take considerable amounts of time, strong growth in Quebec (stronger than Ontario, similar to Alberta's growth rate before the crash) and policy changes in Quebec itself. Assuming any of the discount is because of the property mix, Cominar would also need to increase its exposure to Retail buildings considerably.
In our worst case, we presume that a crash in Quebec affecting Montreal and Quebec City (and not the rest of Canada) push Cominar to a P/AFFO multiple of 10, among the lowest I have seen in Canada, rarely applied to such a high-quality REIT. At this multiple we have a price of $16.10 for a total return of negative 3.88%, and would require some very aggressive miss-pricing (or lowered AFFO) from a downturn in Quebec where national renters are struggling. An event I find extremely unlikely, even in a real-estate market downturn.
Canadian Real Estate Market - The Canadian Real Estate market is at one of the highest levels in history, and shows signs of finding the top of the cycle. Many analysts are calling for a "soft landing" that would not affect REITs to the extent that is priced in, but there is always a risk of a "hard landing" where real estate values fall rapidly.
Quebec Real Estate Market - The Quebec market is usually less touchy to the Canadian market due to different political and legislative differences making the markets less correlated (generally Quebec grows slower, and slows down less, than a commensurate change in the Canadian market, due to higher government intervention - Note: This is the authors opinion only). An unusual event that disproportionately affects the province of Quebec, would affect Cominar much more than other Canadian REITs.
Interest Rate Risk - All REITs are sensitive to interest rate changes. The recent cut to the Bank of Canada rate (two recently) is bullish for Cominar and other similar REITs, but interest rate increases will be forthcoming as Canada generally follows in the footsteps of the United States, which is widely expected to begin raising rates later this year, or early next year.
High Payout Ratio - Cominar commonly distributes a large portion of its income to investors each year (~90% of AFFO). This relatively aggressive payout ratio leaves less room than a comparable REIT should events affect the REIT's earnings. Cominar's long history and strong/diversified tenant base help mitigate this risk, but it is a consideration in evaluating the company.
Diversification Potential - Cominar, due to its weightings in other jurisdictions in Canada, has been relatively unaffected by the turbulent oil price issues that most other REITs have been dealing with. This lack of exposure might allow Cominar to invest in the Alberta market at solid cap rates should other REITs need to shore up their capital amounts. The market would also likely reward Cominar for diversifying out of Quebec.
Large-Scale Merger - Cominar's strong asset base in a market that many lack proper exposure to, and experience in, allows for some opportunity for mergers in the space between Cominar and other REITs, within and outside Canada. Due to its large mispricing, strong properties and lack of overlap, a merger with H&R REIT or Canadian REIT would allow each to add valuable assets at below-market prices, and diversify each out of troubled markets. They would also enjoy the revaluation of Cominar to their own AFFO multiples, unlocking tremendous value for their shareholders.
Discount to Peers Dissipates - Cominar trades at an unnecessary discount due to its Quebec presence, its diversified nature, and being Canadian listed. It also has a necessary discount due to it being overweight in key Quebec cities. The discount will dissipate over time due to three main changes. The first is Cominar grows its asset based outside of Quebec, a stated strategy for the company. The second is an eventual dual-listing (not stated but a natural step for larger REITs in Canada), adding the liquidity of a large US exchange will lower any liquidity discount. The third is a growing realization by the Quebec government that to remain competitive their legislative and regulatory surroundings will need to change, a change that should come as the economic competitiveness issues begin to arise. All of these will happen with time, and all lead to a strong valuation for Cominar.
With a strong asset-base, dividend and operating history, Cominar represents one of the strongest, yet perennially under-appreciated of the Canadian REIT sector. With its unique combination of several unnecessary discounts, investors will be (and have been over its history) able to buy an impressive array of assets with a margin of safety. Should any of these overhangs eventually dissipate, the return potential is very impressive. If they do not, investors can continue to accumulate some great assets at great prices well into the future, and enjoy the increasing distributions and high current income.
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in CUF.UN over the next 72 hours. (More...)I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose inventory is mentioned in this article.
Additional disclosure: For investors considering a purchase of Cominar REIT it is strongly recommended investors twosome the company with a similar REIT that invests in the lacking markets in Canada. Either Artis REIT or H&R REIT make an interesting twosome with Cominar REIT, depending on the investor?s belief about the future of Alberta and the oil market (Artis is more heavily exposed and at a better price; H&R is more larger and less exposed to Alberta in particular). The author is not a financial advisor, please conduct your own due diligence and consult with a trust financial advisor before making any investment decision. The listed REIT trades with narrower spreads/more liquidity on the Toronto Stock Exchange (TSE) under the symbol CUF.UN. If the author initiates a position, and if readers are considering purchase, this is the preferred method to do so if permitted by your brokerage firm.
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