Value Investors Club / Boardwalk Real Estate Investment Trust (BEI-U)

Description

Investment Thesis – Short Boardwalk

Boardwalk Real Estate Investment Trust (“BEI-U CN” or “Boardwalk”) is the largest owner of apartment rental

units in Canada with significant exposure (71% on a weighted unit basis, 79% on a “stabilized property” NOI

basis) to Canada’s oil producing regions.

Boardwalk is an ‘easy’ to borrow REIT short with short interest under 1%, a dividend yield of 3.4%, a large

$C3.1bn market cap, trading at the highest valuation of all Canadian REIT peers (on any metrics, but on a

P/AFFO basis: 20x 2014 P/AFFO, 19x 2015 E Mgt’s P/AFFO) and above the sector’s 15 year average (~16x

P/AFFO). Boardwalk is down only ~15% from its all time peak in October of $70 and faces numerous

headwinds driven by a weakening Alberta economy.

Boardwalk’s large Alberta exposure will be a drag on earnings in 2015 due to impact from the recent

commodity correction. This impacts Boardwalk in several ways, most importantly: 1) reduced oil and gas prices

will result in a recession in Alberta with local energy companies having layoffs, less work for energy service

companies (more layoffs), as well as less revenue for the province (energy drives Alberta’s GDP, so less work

for infrastructure projects, more layoffs, etc…), and 2) a reduction of in-migration to Alberta from other

provinces seeking commodity related jobs. In-migration has been the growth driver in Alberta’s population (and

thus apartment rental rates) pre-commodity correction.

Simply put, Boardwalk has large Alberta exposure, is valued above peers, trades near its historic stock high just

as Alberta enters a recession. We see Boardwalk worth the mid $40s (similar levels to where the stock traded in

2010/2011), a 30% return from the current $60 price with limited risk against the short thesis.

Company

Founded in 1984 by Sam Kolias (chairman and CEO of Boardwalk REIT) and his brother Van Kolias (Senior

VP of Quality Control of Boardwalk) the brothers got their start via a $50,000 loan from their father. The loan

was used to buy apartment real estate in Alberta and Saskatchewan. Currently Sam and his brother Van Kolias

are at #81 of the top 100 richest people in Canada, via Canadian Business 2006.

As of 12/31/14 58% of Boardwalk’s portfolio in terms of weighted average apartment units was located in

Alberta (16% in Calgary, 36% in Edmonton, 1% in Fort McMurray, 2% in Grande Prairie, and 3% in Red Deer)

with an additional 14.1% in Saskatchewan, another oil rich province.

Among the entire apartment REIT industry in Canada, Boardwalk has the highest amount of exposure to

Alberta. The trade is based on Boardwalk’s Alberta exposure, as we see Alberta entering a recession in 2015

and Boardwalk undergoing a similar scenario to previous recessions in Alberta.

Alberta

Alberta is Canada’s energy province. Alberta accounts for 78% of Canada’s oil production (2013, 80% of which

are oil sands projects) and 69% of Canada’s natural gas production (2013). The energy sector (which includes

mining as well as oil and gas) accounted for 22.1% of Albert’s GDP in 2012 and 72% of the province’s exports.

In terms of investment projects, oil sands alone accounted for 53% ($C 110bn, many of which are having their

growth initiatives scaled back as oil sands on average require a break even oil price of $65/bbl) of all major

investment projects in Alberta. Oil and gas is easily the economic driver in Alberta.

In terms of people, according to StatCan Alberta has a population of 4.1MM (estimated as of 10/1/14), or 11.6%

of Canada’s total population. In 2014, mining, quarrying, and oil and gas extraction employed 175,300 people,

considering Alberta in 2014 had a 72.7% Labour Force Participation Rates, it suggests 5.9% of the labor force

was involved in the mining, quarrying, and oil and gas extraction segment. This is misleading as it omits related

industries (servicers, linked construction, etc…etc…).

A thorough review of how energy impacts Alberta was completed via the Alberta Competitiveness Review in

20102 and stated that the oil and gas industry impacts 50% of the Alberta economy and directly or indirectly

employs one out of seven (14%) people in Alberta, with a substantially greater impact in sectors such as

hospitality, transportation, food services, construction, and real estate. Every one dollar invested in oil and gas

provides three for Albertans in economic activity. The drop off in oil / gas prices has guided Alberta’s 2015

budget to forecast a $C4.991bn deficit in 2015 and only to return to surplus in 2017, based on WTI of

$54.84/bbl in 2015-2016 and $62.80/bbl in 2016-207, and just under $84 by 2019-2020.

The current drop off in commodity prices has driven Alberta unemployment to 5.5% for March 2015 (the

highest since September 2011), up from 4.5% in January 2015, with 20,000 natural resource jobs cut in the past

6 months. ³

The unemployment rate in Alberta will continue to rise in 2015, with continued losses from the

energy space (the highest paid sector in Alberta).

WTI vs Alberta Unemployment Rate

1 Boisvert, David and Contreras, Guido” Economic Impacts and Labour Market Trends 2015.” Research, Policy and Strategic Partnerships Jan 1, 2015: Electronic.

2 Canadian Association of Petroleum Producers. “Alberta Competitiveness Review 2010.” Mar. 11, 2010:. Electronic.

3 BNN. “Just how bad were the job losses in Alberta.” March 13, 2015: Electronic

WCS vs Alberta Unemployment Rate

The mining, quarrying, and oil/gas extraction sector has the highest earnings among all professions in Alberta.⁴

Alberta’s economic growth, directly and indirectly relates to investments in the oil and gas industry and has

played a key role in attracting Canadian workers from other provinces.⁵

During the 2009 / 2010 recession, all ofAlberta’s regions experienced zero to negative migration with the exception of moderate gains in two divisions

(Division No. 16 (Wood Buffalo) and Division No. 18 (Greenview)). Post the Great Recession, 11 of the 18

districts in Alberta grew at least 2x higher than pre-recession rates.⁶

4 Alberta Government, Alberta’s Labour Market Highlights, 2014: Electronic

5 Statistics Canada. “Migration: Interprovincial, 2011/2012.” Statistics Canada. Electronic

6 Statistics Canada. “Migration: Interprovincial, 2011/2012.” Statistics Canada. Electronic

In 2011 / 2012 Alberta received as many interprovincial migrants as the two most populated provinces in all of Canada combined (Ontario and Quebec).

Workers flocked to Alberta for the commodity driven jobs and the jobs the commodity boom helped create

(i.e. residential construction, infrastructure, services etc..). Given the reduction in commodity prices, an increase

in unemployment is already occurring and we expect Alberta migration to drastically decrease in 2015. This has

already started occurring, in Q4’14 inter-provincial migration was down 13.3% y/y, netting out international

migrants, total migration was down 8.1%. ⁸

This creates less demand for apartments and will increases the vacancy rates of Boardwalk’s properties.

The post Great Recession migration was so large that in 2013 except for Saskatchewan, another commodity rich

area, every other province experienced an exodus of people. The 2013 surge in migration was the biggest in 23

years and increased Alberta’s population by 1.1%.⁹

Migration remained the main driver of population growth and as previously mentioned is highly correlated with

oil prices, as shown below.

Components of population growth¹¹

Migration is linked to oil prices¹²

7 Statistics Canada. “Migration: Interprovincial, 2011/2012.” Statistics Canada. Electronic

8 CREA. “Alberta Migration.” Electronic

9 Sturgeon, Jamie. “Migration to Alberta is exploding.” Global News. Mar 20, 2014: Electronic

10 Canaccord, “The Alberta Disadvantage: low oil prices to hit rental apartment fundamentals.” Feb 12, 2015: Electronic

11 Alberta Government, Alberta’s Labour Market Highlights, 2014: Electronic

12 CIBC Market Insights. Jan 30, 2015: Electronic

Correlation between the real GDP growth gap between Alberta and the rest of Canada vs net interprovincial

migration.¹³

Not surprising, the government of Alberta realizes in-migration is going to decline in 2015:

“But in-migration to Alberta is certain to slow—both from other parts of the country and internationally.

The energy sector slowdown will result in fewer new job openings. As well, better economic results in

Ontario and Quebec in 2015 will discourage as much migration from those provinces to the Prairies.”¹⁴

Simply put, when Alberta is growing faster than the other areas of Canada (driven by oil/gas prices, which in

turn helped drive a housing boom), Alberta experiences migration as people flock to the area for jobs. This will

reverse in 2015.

Alberta’s high growth over the past few years created new housing supply to meet demand. This excess supply

is expected to put downward pressure on Alberta apartment rental rates in 2015. Just how much has housing

supply risen in Alberta? In 2013, nearly a fifth of all new homes built in Canada were in Alberta, far above the

province’s 11.5% share of population and the highest proportion since 2007.¹⁵

Alberta’s new home building activity has already started to show weakness. The Canadian Home Builders’

Association – Alberta (CHBA – Alberta) members were sampled in January 2015 and expect Alberta housing

starts to decline by 20% in 2015 y/y for the multi-family segment, single-detached starts are expected to decline

11% from 2014. This follows a strong 2014 housing boom in the province where, according to the Canada

Mortgage and Housing Corp. (CMHC) multi-family starts were up 20%, driven by record performance in

Calgary, single-family starts were up 6%.¹⁶

13 Bonnell, Greg. “Real Estate Watch: Oil, western migration and home prices.” BNN. Dec 2, 2014: Electronic

14 ATB Financial, Economics and Research. “ Alberta Economic Outlook Q1 2015.” Jan 5, 2015: Electronic

15 Canadian Home Builder’s Association. “ Alberta Residential Construction.” June 19, 2014. Electronic

16 Panoptic News.” Alberta homebuilders expect moderate decline in 2015.” Feb 27, 2015: Electronic

Canada’s housing bubble

Alberta housing¹⁷

Here’s what the Canada Mortgage and Housing Corporation had to say in its Q1'15 report:

“Lower oil prices will impact oil-producing economies like Saskatchewan, Newfoundland and

particularly Alberta. Housing demand will be indirectly negatively impacted through adverse effects on

employment, household incomes and migration as a result of the potential delay, downsizing or

cancellation of major energy projects.”

Construction workers (both those tied to slowing E&P spending and residential construction) are likely to leave

Alberta to head to provinces, such as British Columbia that will lead Canada in non-residential construction

projects due to several infrastructure projects.¹⁸

On a regional basis:

Fort McMurray, the center of some of Canada’s biggest oil / oil sands plays, housing sales dropped 66% in

February, and down 30% in the first two months of 2015.¹⁹

Cold Lake, another oil town, two new single-family housing start permits were granted in January, compared to

20 a year ago.²⁰

Calgary, total housing starts in February fell 37.7% year-over-year with total starts for January / February down

40.8% from last year.²¹

March 2015 was just as bad with activity down 30% year over year and twice as many

houses on the market as a year ago.²²

Edmonton was a stable housing market earlier in this year was down 13% in March with a slight move higher in

the average sales price.²³

A lot of construction workers will soon be unemployed in Alberta, another key source of employment in

Alberta. The construction industry in Alberta, defined as residential building, commercial building,

industrial buildings (i.e. oil refineries, petrochemical plants, power plants), engineering works (i.e. highways,

bridges, pipelines); and subdivide and develop land in 2013 employed approximately 10.5% of Alberta’s workers.

17 Goatcher, Richard. “Alberta home builders expect moderate decline in 2015.” Panoptic News. Feb 27, 2015: Electronic

18 McMahon, Tamsin. “Alberta’s construction industry facing three years of job losses.” The Globe and Mail. Mar 16, 2015: Electronic

19 Business Vancouver. “Blood in the oil sands: Boom and bust in Alberta.” Mar 31, 2015: Electronic

20 Business Vancouver. “Blood in the oil sands: Boom and bust in Alberta.” Mar 31, 2015: Electronic

21 Toneguizzi, Mario. “Calgary housing starts plunge by 40% in February as construction activity slows.” Financial Post. Mar 9, 2015: Electronic

22 Johnson, Tracy. “Housing prices up in Edmonton, stable in Calgary in March.” CBC News. Apr 2, 2015: Electronic

23 Johnson, Tracy. “Housing prices up in Edmonton, stable in Calgary in March.” CBC News. Apr 2, 2015: Electronic

Moving away from slowing new home construction, increasing unemployment, and migration out of province

to apartment rental rates / vacancies. While real time data on vacancy rates isn’t as ample as other areas of the

Alberta economy, we do know that vacancy rates are rising and expected to rise in 2015.

Calgary – In October 2014 the vacancy rate was 1.4%, rising 40% from a year ago at 1.0%.²⁵

Fort McMurray - The rental vacancy rate is now at 12%, the highest in Alberta.²⁶

The below chart is from the Calgary Mortgage Housing Corporation’s (CMHC) October 2014 rental survey,

before the commodity correction post-Oct 2014. It can be assumed that rental vacancies will rise more than

expected by this study, and can rival the 2009 Great Recession and the 2003 / 2004 slump.

Edmonton isn’t immune from a potential rise in vacancy, the below chart from the Canada Mortgage and

Housing Corporation Fall 2014 demonstrates historic apartment vacancies similar to Calgary.

24 Government of Alberta. “Industry Profiles : Construction Industry.” 2014: Electronic

25 Burton, Brian. “Calgary’s rental vacancy rate rises.” Calgary Herald. Dec 30, 2014 :Electronic

26 Business Vancouver. “Blood in the oil sands: Boom and bust in Alberta.” Mar 31, 2015: Electronic

Another interesting point is in terms of debt to income, Alberta has the highest household credit risk profile in

Canada. One reason for Alberta households having the highest debt level is most migrants to the province are

young families with a higher ability to borrow, and a great chance of moving back home if they are not

successful in the province.²⁷

It’s really no surprise that Consolidated Credit Counseling Services of Canada has stated that credit counseling

services are highly sought after in Alberta with 38% y/y increase in Albertans hiring the firm (Feb’15) to avoid

bankruptcy.²⁸

There is a strong correlation (some reports even estimate it at a lagged 95%29) between Alberta’s in-migration

and oil prices, the driver of rental apartment demand in Alberta over the past several years. As with past oil

corrections, we expect in-migration to Alberta to greatly slow and possibly decline, pressuring Boardwalk’s

rental rates, increasing vacancies, reducing guidance and earnings in 2015. Furthermore, the Canadian housing

boom has skewed the supply / demand equation for Boardwalk, adding yet another headwind as new residential

construction, built to be sold, are turned into rentals.

Valuation

The investment thesis on Boardwalk is based on a weak Alberta economy driven by low oil/gas prices will force

migration to reverse / slow, apartment vacancies will rise, incentives use will result in lower rent and Boardwalk

will suffer from a lower NOI (as occurred in previous recessions).

27 CIBC Market Insights. Jan 30, 2015: Electronic

28 Krugel, Lauren. “Credit counselling in high demand in Alberta as oilpatch downturn hits home.” Financial Post. Mar 31, 2015: Electronic

29 Dundee Capital Markets. Feb 23, 2015: Electronic

Today, Boardwalk is the most expensive REIT in Canada trading at a premium to all peers.³⁰

On average, Canadian REITS have traded just over 15x P/fwd AFFO.31

Boardwalk has traded at a high multiple post Great Recession, during 2008 / 2009, the company traded down to

a P / AFFO in the mid teens as occupancy dropped to the mid 90s%.

Occupancy in Calgary and Edmonton has in the past dropped to the mid 90%s in other recessions, not just in the

Great Recession as demonstrated in previous charts. During these periods Boardwalk suffered from negative

NOI y/y growth, as illustrated below.

Boardwalk REIT year-over-year same-property NOI growth – Q1/04 to Q3/14³²

30 Dundee Capital Markets. Feb 23, 2015: Electronic

31 Dundee Capital Markets. Jan 26, 2015: Electronic

32 Canaccord, “The Alberta Disadvantage: low oil prices to hit rental apartment fundamentals.” Feb 12, 2015: Electronic

The visual representation above shows how bad NOIgrowth can get for Boardwalk. Boardwalk had 5 qtrs of

negative NOI growth, bottoming out in Q2’10 at -3.4%. History is expected to repeat in 2015.

Looking at Boardwalk’s rental rates for Edmonton and Calgary shows a strong correlation with oil, and

occupancy rates between the two cities are highly correlated:³³

33 CIBC. “Boardwalk REIT: Looming headwinds threaten valuation.” Feb 1, 2015: Electronic

With all this oil exposure, you would think Boardwalk’s stock would be off more, it isn’t and this is the

opportunity:³⁴

Boardwalk has gone through a few historic changes in its portfolio, it divested British Columbia, several years

ago only reported Calgary / Edmonton and ‘others’ for the rest of Alberta as well as giving property level but

not necessarily segment level vacancy rates to make life more complicated. The company also adopted IFRS on

1/1/11. Regardless, ample data exists to paint a picture of what Boardwalk will look like if oil sensitive regions

increase in vacancy and exhibit reductions in rental rates.

The below shows Boardwalk’s Alberta only portfolio, Calgary / Edmonton are projected to have a 94% vacancy

rate and a -3% decline in rental rates, NOI declines close to 10%.

34 CIBC. “Boardwalk REIT: Looming headwinds threaten valuation.” Feb 1, 2015: Electronic

The below shows the Alberta portfolio aggregated and sensitizes Saskatchewan to have rental rates down 5%

and vacancies in the mid 90s. The result is Boardwalk’s NOI declines to $272MM, down 7% y/y and implies

the stock trades at 23x P / AFFO (AFFO is $136MM) or at a 5.11% cap rate. On Boardwalk’s Q4’14 call

management reiterated AFFO guidance to be $165MM, up 6% y/y. If the below scenario does not occur, there

is a good chance management will at least reduce / cut guidance in 2015 which showed AFFO growing 6% .

Where should Boardwalk trade?

In terms of P / AFFO, Boardwalk today trades at 20x 2014, 19x mgt’s 2015 and 23x the model used above. In

2008 / 2009, Boardwalk traded down to the mid teens on an AFFO basis, a discount to the historic average

Canadian REIT AFFO multiple just over 15x. Expecting a case similar to our model to start occur in 2015, we

expect Boardwalk to trade on an AFFO basis in the mid to high teens using our $136MM AFFO, or a stock in

the mid $40s, a 30% return from the current $60 price. Furthermore, we struggle to see how Boardwalk can

maintain 2015 management guidance and how the stock can run against the short trade.

On an NOI basis Boardwalk currently trades at 5.5% cap rate, using the model NOI implies Boardwalk trades at

5.11%, only in 2012 did Boardwalk trade below 5%, typically the company trades between 5.5% and 6.2%,

again implying a stock price in the mid to high $40s.

On an EV / EBITDA basis Boardwalk trades at 21x 2014 EBITDA, however debt is entirely first rate

mortgages. EBITDA from the assumptions outlined earlier suggest a 22x multiple due to the large amount of

mortgage debt compared to the company’s overall enterprise value.

Risks

The constant sell side bull cash is Boardwalk trades at a discount to its NAV, however every sell side analyst

I’ve spoken to uses an NAV model based on 2014 NOI and doesn’t even look within Alberta to sensitize rental

rates or occupancy. Most are puzzled when I ask them about migration reversing.

Interest rates – both in the US and Canada matter for Canadian REITs. An increase in US rates later this year

will benefit this short thesis. The expectation in Canada is a rate rise will not occur in the near future.

Boardwalk may do a large real estate deal with a pension fund, there are no rumors on this but it’s always a

concern.

Home owners that are forced to sell their property may start renting apartments, this may create additional

demand for Boardwalk’s rentals.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.

Catalyst

Reduction of mgt's 2015 AFFO

Earnings misses

Weakening Alberta economy in 2015

show sort by

			2015	2016
Price:	59.72	EPS	3.277	3.613
Shares Out. (in M):	52	P/E	18.22	16.53
Market Cap (in $M):	3,105	P/FCF	16.93	16.61
Net Debt (in $M):	2,195	EBIT	304	308
TEV (in $M):	5,300	TEV/EBIT	17.45	17.22
Borrow Cost:	Available 0-15% cost