All values are in CAD unless noted otherwise
Dream Industrial REIT (OTC:DREUF) owns and operates industrial properties across Canada, US and Europe. We got bullish on this one around the onset of the pandemic in March, and thought it was best to take our profits when it reached close to our fair value in June:
Overall, Dream is in a position to navigate this turbulence and we see its key assets as being worth significantly more down the line. That said the stock is moving closer to our fair value since we last wrote on it and we have lowered what we would like to pay across the spectrum.
The run up in price from March combined with the distributions till we changed our stance in June, provided a total return of approximately 20%.
Granted, those that continued to hold on to the shares, were rewarded with a higher return.
However, we are happy with the tidy sum we made while staying within our comfort zone vis-à-vis a risk-reward standpoint. The Q1 distribution payout ratio had breached 100% [102.3%] and based on the Dream team history, we rated the chances of a distribution cut in the next 12 months as high.
We examine the recent results and provide an update on our thesis.
Dream Industrial had a sound second quarter with funds from operations (FFO) per share remaining relatively steady versus last year.
Source: Dream Industrial Press Release
The FFO payout ratio once again breached 100% though. Notable was that the interest coverage ratio reached 4.1X on lower debt levels.
Dream bolstered liquidity by replacing its 150 million dollar secured credit facility from Q1 with a US$250 unsecured credit facility [$341 million CAD equivalent noted in table below]. The new credit facility, unlike the old one, enables it to borrow in all three currencies it currently does business in, CAD, USD and EUR. The facility matures in January 2022.
With this move, the REIT also increased its unencumbered assets from $843 million to $1.1 billion or about 40% of the value of the investment properties at the end of Q2. Dream aims to use its well placed liquidity and reduced leverage to expand its portfolio. In addition, the ample liquidity will also assist it in refinancing hiccups it could face in the next 12 months.
Dream began 2020 with 209 properties. All the acquisition activity in the first six months was completed in Q1.
Source: Q2-2020 Financial Report
In addition to the above, Dream expects to close on two properties purchases in Germany in Q3. The cap rate on the properties is 6.1%. The REIT is also in negotiations to add 4 properties across Netherlands and Canada with cap rate of 5.5%. At present, cap rates are very low for industrial properties. Dream would have to be very selective in ensuring that they do not overpay in this environment.
As of August 4, the REIT had collected approx. 92% of the rent for Q2. They expected another 5.0% from the CECRA government program and deferral arrangements in place with tenants. July had similarly proportioned cash collections of 92% and another 2.4% expected from the CECRA government program.
Source: Q2-2020 Financial Report
We think the ultimate cash rent collections for these periods will be around 97%-98%. That is not bad for a REIT that is still building its portfolio. This is one of the highest in our REIT universe, where the collections have ranged from an abysmal 18% for EPR Properties (EPR) to about 98% plus for Granite Real Estate Investment Trust (GRP.U) and W. P. Carey Inc. (WPC).
For the remainder of the year, Dream has only 3% of its leases up for renewal that it has not secured any commitments on as of June 30.
Source: Q2-2020 Financial Report
With the expansion in e-commerce we see strong lease renewals for Dream Industrial and until the economy is running normally again, Dream will have no issues filling its assets with tenants.
Dream is trading at close to 16X its FFO and at a slight discount to its own NAV of $11.75. It appears fairly valued on both metrics, although we see the possibility that someone could step in and buy this as high as $13.00/share. The biggest problem with valuation currently is the very high payout ratio. That said, Dream Industrial’s leverage is very low and it could pay the current distribution for 1-2 years while waiting for rent escalators to improve payout ratio. It could also leverage up a bit. Certainly, there is still a spread between cap rates and financing rates and adding properties could also improve the payout ratio. Based on all the information, Dream Industrial has a “High” level of danger of a dividend cut on our proprietary Kenny Loggins Scale.
This rating signifies a 33-50% probability of dividend cut in the next 12 months.
The asset base is in high demand today and if Dream Unlimited (OTC:DRUNF) which manages Dream Industrial, decided it wanted to exit, we believe a deal could be struck before the end of August. In an era of cheap money, quality industrial assets will likely fetch a premium. Dream Unlimited also exited Dream Global some time back at a massive premium and they could look to repeat that process for Industrial assets. But that alone does not entice us to go long. We are staying committed to neutral side on overall valuation metrics and a dip below $10 would get us strongly bullish.
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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: Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.