Canadian Apartment Properties REIT: A Good Defensive Play In A Post-Coronavirus World (OTCMKTS:CDPYF)

Investment Thesis

Canadian Apartment Properties REIT (OTC:CDPYF) (TSX: “CAR.UN”) delivered another strong quarter in Q1 2020 despite the outbreak of COVID-19. Its rents collected and occupancy ratio remain elevated. However, the REIT may see a slowdown in its rent growth due to fewer than expected immigrants coming to Canada in 2020 and 2021 caused by COVID-19. Fortunately, the company has a solid balance sheet with ample liquidity to handle this healthcare crisis. Canadian Apartment currently pays a safe 2.8%-yielding dividend and is trading at a discount to its valuation before the outbreak of COVID-19. Therefore, we think this is a relatively defensive stock for investors seeking some exposure to the REIT sector.

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Recent Developments: Q1 2020 Highlights

Canadian Apartment delivered another quarter of positive growth in Q1 2020. As can be seen from the table below, its stabilized occupancy for residential and multi-family housing remained solid at 99.1% and 95.9% respectively. The company also saw average rent growth of 2.2% and 13.5% on rent renewals and turnovers respectively. Its same property net operating income also increased by 5.7% year over year.

Source: Q1 2020 Investor Presentation

Earnings And Growth Analysis

Impact of COVID-19 on its occupancy ratio and rent collected is limited

Despite the outbreak of COVID-19, Canadian Apartment’s quality portfolio located in strong markets has helped it to maintain its high occupancy ratio. As can be seen from the table below, its overall occupancy ratio of 98.1% at the end of April 2020 was only a decline of 0.1 percentage point. The company has collected 98% of its rent in April. Although it has not yet released its rent collection statistics for the month of May, management indicated in its Q1 2020 conference call that they expect rent collection to be similar to the trend in April.

Source: Q1 2020 Investor Presentation

Demand will likely be weak in 2020 and 2021

As we have indicated in our previous article, rental demand in Canadian Apartment’s largest market has been largely driven by Canada’s annual immigration. However, COVID-19 changed this trend. In April, the number of immigrants admitted declined by 80% from last year. It might take several years for the number of immigrants coming to Canada to return to the pre-pandemic world. Since immigrants account for most of Canada’s population growth, this decline in immigrants will inevitably change the outlook of the residential rental market in Canada and impact Canadian Apartment’s growth outlook in 2020 and 2021. Therefore, we expect rent growth to slow down in 2020 and 2021.

Ample liquidity to go through this crisis

Canadian Apartment has a strong balance sheet with total debt to gross book value ratio of 36.1% at the end of Q1 2020. This was better than last year’s 37.7%. Similarly, the company’s weighted average mortgage interest rate of 2.74% was also lower than last year’s 3.02%. We expect this weighted average mortgage interest rate to continue to trend downward as the current 10-year rate is only about 1.8%. Therefore, Canadian Apartment should be able to reduce its interest expense further as it renews its mortgages in the future. The company has taken steps to preserve cash and limited its capital expenditures to emergency repairs. With a liquidity of C$280 million, Canadian Apartment is in a good position to manage the interruption caused by COVID-19.

Source: Q1 2020 Investor Presentation

Valuation Analysis

Canadian Apartment has shown consistent growth in the past few years. The company generated adjusted funds from operations of C$1.81 per share in 2019 and we expect growth to be limited in 2020 and 2021. In fact, it is likely that growth will remain lackluster at about 3% in 2020 and 4% in 2021. Using these growth rates, we believe Canadian Apartment will deliver AFFO of C$1.86 per share in 2020 and C$1.94 in 2021. This means that it is currently trading at a price to 2020 AFFO and 2021 AFFO ratios of 26.4x and 25.3x respectively. We noted that the REIT has been trading at a P/AFFO ratio closer to 30x before the COVID-19 outbreak. Therefore, the REIT is currently trading at a significant discount and has the potential for multiple expansion once the economy recovers.

A 2.8%-yielding dividend

Canadian Apartment currently pays a monthly dividend of C$0.115 per unit. This is equivalent to an annual dividend yield of 2.8%. The company’s dividend is safe with a dividend payout ratio of 63.3% in Q1 2020.

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Risks And Challenges

Multiple waves of the pandemic

While we expect demand for residential rental units to gradually recover, multiple waves of the pandemic may cause significant damage to Canada’s economy. As many people are out of a job for longer, many tenants may not be able to pay their rents in time. This will negatively impact Canadian Apartment’s revenue.

Investor Takeaway

Canadian Apartment has shown resilience in this pandemic so far and we are still optimistic about its outlook. Although growth will likely be slower in 2020 and 2021, its long-term outlook remains intact unless Canada changes its immigration policy. Therefore, this is still a good defensive stock to consider for investors seeking some exposure in the REIT sector.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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 stock is mentioned in this article.

Additional disclosure: This is not financial advice and that all financial investments carry risks. Investors are expected to seek financial advice from professionals before making any investment.

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