DBRS Comments on Cominar REIT’s Plans to Concentrate on its Core Markets and to Reduce Debt Level

On August 22, 2017, Cominar Real Estate Investment Trust (Cominar or the Trust) announced its intention to sell its properties located in regions outside of its core markets (defined as the Province of Québec and Ottawa) with an estimated fair value exceeding $1.2 billion. Management will use the majority of the sales proceeds to reduce its debt-to-gross book value ratio to below 48% (which becomes its new long-term debt target). DBRS Limited (DBRS) views the unexpected announcement favourably but notes that further steps will be required to result in a positive rating action.

The initial asset sales are expected to close in the first half of 2018, and the entire disposition process is expected to take approximately two years to complete. Management intends to deploy the front end of the asset sale proceeds into buying back up to nine million of Cominar’s units (or 5% of outstanding units) for a total investment of up to $125 million, followed by debt reduction ($875 million). Thereafter, any remaining proceeds exceeding $1 billion will be reinvested into acquisitions and developments in Cominar’s core markets.

Assuming the successful completion of the non-core asset sale program as described above, DBRS expects Cominar’s debt-to-EBITDA ratio to return to approximately 9.4 times (x), which is consistent with levels preceding the Ivanhoe Cambridge acquisition in 2014. Additional positive EBITDA events outlined by management (including lease-up of vacated Sears space, incremental net operating income (NOI) achievable on re-leasing of Sears-occupied space and additional occupancy gains) that are required to reach Cominar’s new targeted 90% adjusted funds from operations payout ratio would result in a further improvement in the expected debt-to-EBITDA ratio to possibly around 9.0x, all else equal.

Same property NOI growth at Q2 2017 was modestly lower than DBRS expected, and management subsequently reduced its NOI guidance for 2017 to -1% to 0% from 1% to 2% during the Q2 2017 earnings conference call following the release of the DBRS August 4, 2017, press release. The vast majority of DBRS EBITDA growth expectations through 2018 have been based on the narrowing of the gap between in-place and contractually committed lease agreements as disclosed by management. Management explained the variance as solely being due to timing differences related to unexpected non-renewals, unexpected bad debt expense and delays in tenants taking up occupancy. DBRS cautions that any further disappointments could result in a debt-to-EBITDA ratio above that currently expected by DBRS on successful completion of the non-core asset sale program.

DBRS is of the view that the loss in geographic diversification resulting from the proposed transaction will weaken the Trust’s credit profile. DBRS expects 93% of NOI to be generated in Québec pro forma the transaction, down from 77%, at the expense of an expected loss in geographic diversification in Ontario (excluding Ottawa), Calgary and Atlantic Canada. The increased geographic concentration is partially mitigated by the fact that 29% and 64% of the Québec exposure is expected to be attributed to Québec City and Montréal, respectively – two regions affected by materially different economic and industry drivers. DBRS further notes Cominar’s market leading and competitive position in Québec; the prominent position of the Greater Montréal Area, Québec City and Ottawa among some of Canada’s leading economic centres; portfolio diversification provided by the Trust’s property type and tenant mix; the improved quality of the Trust’s Québec-based portfolio over the last number of years; and the recently announced debt reduction strategy, further partially mitigating some of the risks inherent in geographic concentration.

DBRS recognizes the uncertainties and risks inherent in executing on the asset disposition strategy, including length of time to complete, ultimate quantum and use of net proceeds, downward revisions to EBITDA growth forecasts etc. Notwithstanding, DBRS is of the view that the proposed plan in conjunction with a more conservative financial leverage profile, including a further improvement in the debt-to-EBITDA metric to sustainable levels below 9.0x, could be sufficient to offset the higher risks presented by geographic concentration and could result in a positive rating action over the years to come, all else equal.

DBRS expects that the weighted-average lease term, lease rollover schedule, weighted-average term to maturity of mortgage debt, debt maturity profile, tenant mix, tenant quality and tenant profile for the core portfolio will not be materially different from the existing portfolio.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The principal methodologies are Rating Entities in the Real Estate Industry (April 2017) and DBRS Criteria: Recovery Ratings for Non-Investment Grade Corporate Issuers (February 2017), which can be found on dbrs.com under Methodologies.

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