The MoneyLetter recently featured analysts’ reports on two real-estate stocks—one focused on residential real estate services and one on residential and commercial mortgage lending.
With what appears to be a turn in the Alberta market coupled with the ability to grow through acquisition, AltaCorp Capital analyst Chris Murray maintains a positive outlook for real estate services company Mainstreet Equity Corp. (TSX—MEQ).
The Calgary-based residential real estate services stock announced second-quarter fiscal 2019 results for the period ending March 2019. Mainstreet reported revenue, net operating income (NOI) and diluted funds from operation (FFO) per share of $33.7 million, $20.2 million and $0.92, respectively, as compared to the analyst’s estimates of $31.9 million, $18.9 million and $0.79.
The analyst views the results positively, given the strong NOI and FFO performance, noting that the second quarter 2019 results saw continued strong rental performance in BC and a surprisingly strong three per cent increase in average rent in Calgary alongside stable vacancy rates, indicating that we may be reaching an inflection point for Alberta.
Mr. Murray gives the stock an ‘Outperform’ rating and $68 target share price.
FFO up 28 per cent year-over-year
With regards to further details regarding the fiscal results the analyst notes: “The company reported a 28 per cent year-over-year increase in FFO from $6.5 million in second quarter of 2018 to $8.3 million in the second quarter of 2019, largely attributable to an increase in rental revenue.
“The company’s vacancy rate decreased significantly to 6.5 per cent in the second quarter of 2019, as compared to a vacancy rate of 11.3 per cent in the previous year, while the average monthly rental rate increased to $920 per unit, as compared to $842 a year prior.
“Correspondingly, rental revenue and ancillary rental income increased 19 per cent year-over-year to $33.7 million in the second quarter of 2019, as compared to $28.3 million in the second quarter of 2018, largely attributable to the improvement in the vacancy rate and growth in the Company’s portfolio, with the weighted average number of units owned increasing nine per cent year-over-year to 12,227 driven by a 141 per cent year-over-year increase in acquisitions.
Record-high acquisitions growth to continue
“Management noted that the Company’s record-high volume of acquisitions in recent years causes higher rates of unstabilized properties which, in turn, puts pressure on NOI, FFO and margins, however it expects to lower the imbalance in second half of 2019. With a liquidity position of approximately $100 million, management expects to continue to acquire new assets in addition to ongoing repurchases of its shares, which it believes continue to trade below net asset value (NAV).
“Our estimates for 2019 and 2020 net operating income revise to $83.8 million and $86.1 million from $79.9 million and $80.2 million, respectively. Correspondingly, our estimates for 2019 and 2020 FFO per share revise to $3.98 and $4.03 from $3.58 and $3.48, previously. While our forecasts do not account for new acquisitions given the unpredictability both in terms of timing and cost, we highlight the acquisition of new properties as a key growth driver for Mainstreet and a potential upside to our fair value estimate.
“We also believe recent share price performance is reflective of our position with Price to Book multiples beginning to retrace.
Residential rental market growing
“Citing immigration growth, a slower-than-expected rise in interest rates and the expectation that stricter stress tests for mortgages will push more people into the rental market, management is confident in the potential for more opportunistic acquisitions in 2019.
“Management noted that in the fourth quarter of 2018, migration into Alberta nearly doubled year-over-year, while migration into Saskatchewan doubled year-over-year. The labour market has accommodated strong population growth, with Alberta’s unemployment rate falling to 6.4 per cent in the first quarter of 2019 from seven per cent a year earlier and Saskatchewan’s falling to 5.6 per cent from 6.5 per cent year-over-year.”
Mainstreet Equity is a real estate services company focused on the acquisition, redevelopment, repositioning, and management of mid-market rental apartment buildings in western Canadian markets.
Home Capital making solid progress
Toronto-headquartered Home Capital Group’s (TSX—HCG) problems have been well documented, but the company has been making some solid progress, too, says Toronto-based Raymond James equity research analyst Brenna Phelan.
Home Capital Group Inc. is a specialty finance company that offers residential and commercial mortgage lending, consumer lending, and credit card services. The company also offers deposits through brokers, financial planners and its direct-to-consumer deposit brand, Oaken Financial.
Home Capital’s mortgage lending focuses on homeowners who typically do not meet all the lending criteria of traditional financial institutions. Its consumer lending includes an equity-line program that allows customers to access the equity they have built in their homes.
HCG trending well but analyst still says “show me”
Ms. Phelan continues: “We think Home Capital has done a good job of returning its operations to business as usual and key earnings drivers such as traditional mortgage growth (17 per cent year-over-year) and net interest margin (two basis points quarter-over-quarter) continue to trend well. However, we believe this remains a show-me story, and against the backdrop of ongoing concerns about both the housing market and late-cycle credit risk, any blip in results—particularly within credit—results in a negative reaction in the stock.
“Trading at 0.67 times book value per share, we see upside from a market valuation re-rate, particularly as earnings grow and return on equity expands. Nearer-term, we think that there is little room for error in any earnings driver and so remain more cautious since it appears that volatility may persist within the consumer loan portfolio,” she notes.
Q1 results close to analyst’s projections
For the first quarter, Home Capital announced adjusted earnings per share (EPS) of $0.49, which was just ahead of the analyst’s estimate of $0.48. The company’s interest income was in line with the analyst’s projection. Its higher deposit cost and deposit balance contributed to a lower net interest margin of 2.01 per cent compared to the analyst’s estimate of 2.02 per cent.
Ms. Phelan continues: “Non-interest income was approximately $3 million light of our forecast and approximately $3 million below last year. Secularization income of $1.6 million was down from 2018’s average approximately $2.6 million due to a lower volume of multi-unit residential mortgages derecognized. We expect this to revert to more normal levels. The fee-based component of $10.3 million was down from an average of approximately $12 million in 2018. We have revised our estimates to reflect approximately $11 million going forward.
“Operating expenditure was $57 million on an adjusted basis, but guidance calls for a run-rate of approximately $60 million going forward, which is in-line with our estimates. This yields a 2020 efficiency ratio of 52.4 per cent for 2020 in our model, an improvement versus 54.5 per cent in 2018. To provide context, HCG’s efficiency ratio was 32.4 per cent as recently as 2015. We think the regulatory environment has changed too much to ever return to that level of efficiency or the associated approximately 19 per cent return on equity.”
While Ms. Phelan reiterates her ‘Market Perform’ recommendation, she increases her 12-month target share price to $19.50 from $19.
This is an edited version of an article that was originally published for subscribers in the July 2019/First Report of The MoneyLetter. You can profit from the award-winning advice subscribers receive regularly in The MoneyLetter.
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