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Praveen Chawla
Praveen Chawla
Articles (33) 

Great Canadian Value: Boardwalk REIT

The well-managed REIT is selling for 50% below tangible book value

June 26, 2020 | About:

Boardwalk Real Estate Investment Trust (TSX:BEI.UN) has fallen a lot more than its cash flow from operations, or "free cash flow," would justify from the start of the Covid-19 crisis in February. While the stock has bounced back strongly from the bottom, there is still a good opportunity to acquire shares. After plateauing in 2018, cash flow has been rising and Covid-19 has not affected the rental apartment sector as much as other REIT businesses such as retail.

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Boardwalk is a REIT that owns and operates residential buildings in the Canadian provinces of Alberta, Saskatchewan, Ontario and Quebec. It owns over 200 buildings with 33,000 apartments. The majority of its properties are in the western Canadian province of Alberta, but it has been making an effort to diversify out to eastern Canada and other undersupplied markets like the greater Toronto and Vancouver areas. It is trading at less than half its tangible book value. While Alberta and Saskatchewan are suffering from the oil slump and an oversupply of rental apartments, they are economically strong provinces, rich in natural resources, that will recover in due course.

Control

Boardwalk in controlled by brothers Sam and Van Kolias. They control the company through voting shares called " LP Class, B Units," which are recorded as liability of the balance sheet. These are non-transferable, except under certain circumstances, but are exchangeable, on a one-for-one basis, into Boardwalk REIT Units at any time at the option of the holder and entitled to distributions as the same rate as the REIT units. As of Dec. 31, 2019 there were 4,475,000 LP Class, B Units and 46,461,293 REIT units outstanding.

Financing

Boardwalk's buildings are financed with mortgages insured by Canada Mortgage & Housing Corp. (a government-backed entity). These insured mortgages are transferable between lenders upon maturity and amortized over 30 years. Lenders compete with each other for the opportunity to finance. Maturities are staggered to manage interest rate risk.

Distributions

Boardwalk distributes payments on a monthly basis to its unitholders. In 2017, the company cut its distribution by over 50% in an attempt to fund a geographical diversification strategy. In 2019, it had a distribution to FFO payout ratio of 38.9%, compared to 45.4% for the prior year. Currently, the distribution yield is around 3.5%.

Valuation

Two methods of Valuation are presented below. Both methods indicate that the REIT is substantially undervalued at the present time.

DCF valuation

A discounted cash flow calculation using GuruFocus' two-stage DCF calculator showed a value of 118 Canadian dollars ($86.32) per share, which equates to a margin of safety of 75%. The following was assumed for the calculation: I used a discount rate of 6% (as of Dec.31, 2019, the REIT’s weighted average cost of capital was reported to be 3.58%). I assume the free cash flow will grow 6% a year for the next 10 years, which is consistent with recent results. I also assume that in the following 10 years, the company will grow at a reduced rate of 4%, after which it will be sold for at least the current tangible book value.

Book value justified valuation

Boardwalk REIT is trading well below tangible book value. Note that the trust follows Canadian IFRS accounting, so property values are adjusted on an annual basis to reflect market value. Unlike U.S. GAAP, IFRS uses "mark-to-market" values for REITs. These values are 'Level 3" (i.e., they are based on indirect appraisal models so there is lot of judgment involved).

Boardwalk's median price-book ratio over the past five years was 0.76. Currently (following the Covid slump), it is only 0.46. The median price-book justified stock price is around $48 (current stock price multiplied by the median ratio divided by the current price-book ratio), which is a 40% margin of safety.

In closing

Boardwalk appears to be undervalued with a large margin of safety. It is selling at a steep discount to its tangible book value and its net asset value while generating free cash flow. I estimate the cap rate (net operating income divided by enterprise value) to be about 6%. While the recession caused by the pandemic as well as the oil price slump weighs on the Canadian economy, apartment rentals should hold up well. Shelter is a basic need. People have to live somewhere and emergency orders against eviction for non-payment of rent will expire by the end of August 2020. As the economy recovers in the years ahead, the gap between net asset value and the stock price should close. Meanwhile, we can earn a 3.5% dividend for waiting.

Disclosure: The author is long Boardwalk via options.

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