Monday, December 18, 2017

A current AIM International Fund Holding: City Office REIT (CIO) by Mitchell Beine. "Stay Patient with this REIT"

City Office REIT, Inc. (CIO, $12.89): “Stay Patient with this REIT”

By: Mitchell Beine, AIM Student at Marquette University

Disclosure: The AIM Equity Fund currently holds this position.  This article was written by myself, and it expresses my own opinions.  I am not receiving compensation for it and I have no business relationship with any company whose stock is mentioned in this article.

  • ·        City Office REIT, Inc. (NYSE: CIO) is a real estate investment trust formed with the intent to acquire, own, and operate office properties primarily within the southern and western regions of the United States.  CIO has 18 employees and was founded in 2013 with its headquarters located in Vancouver, Canada.

  • ·       CIO operates in one industry segment through commercial real estate and 100% of the company’s revenues come from the properties located within the United States.

  • ·         City Office’s position in secondary markets will benefit the company moving forward, as this driver has not diminished in quality.

  • ·         One of the drivers behind this stock when it was pitched was it’s valuation, which has only grown more favorable with the slight drop in price.

  • ·         The stock has fallen just over 4% since it was pitched, and is down approximately 1.07% YTD.

Key Points: One of the main drivers behind CIO’s buy recommendation was it’s position in secondary markets and the growth opportunities this presents the company.  City Office REIT focuses on assets valued at $25-100 million with targeted cap rates, which are assets that large-scale REITs often pass over.  The company announced that it had completed a $33.3 million acquisition ("Papago Tech") in Phoenix, Arizona's highly desirable Tempe submarket as well as completed a $47.0 million property financing for a portion of the San Diego Portfolio that was acquired in Q2.  These acquisitions highlight the company’s ability to continue to find properties at a lower cost of capital than the CIO can earn back through rental income.  Despite a Q3 FFO miss by $0.02, the company reported revenue of $24.75M (+31.7% Y/Y).

The aforementioned acquisitions are evidence that City Office REIT will continue to expand its real estate portfolio to grow revenue.  This, along with positive business metrics such as same store cash NOI increasing 4.1% compared to the third quarter of 2016 and 7.3% compared to YTD 2016 show the company is growing its current properties in addition to its new ones.  If this continues to hold true, the valuation driver behind CIO when it was originally pitched will hold true as its rapid growth suggest it should trade at a higher multiple than the current P/FFO of 13.2.

Another positive for the stock is the risks that accompanied CIO when it was pitched have not come to fruition.  Rising interest rates negatively impact REITs, so it is a positive that rates have remained relatively stable since it was pitched and are not expected to dramatically rise in the near future.  Additionally, management did not announce any additional stock offerings following Q3.  The U.S. economy remains strong which will benefit City Office REIT as it continues to increase its occupancy rate with businesses.

What has the stock done lately?

CIO’s share price decreased by about 1.3% after reporting earnings on November 6th.  This reflects a slight disappointment as the companies FFO and revenue both missed slightly.  The stock has traded comfortably in the high $12s and low $13s since it was added to the AIM International Equity Fund.  It is clear that the market remains confident in management as the stock did not experience a more severe pullback following its earnings miss, and suggests that investors may be looking to reward the stock if it can manage an earnings beat in Q4.

Past Year Performance: After spending most of the year in the low $12s, City Office REIT briefly climbed into the high $13s in September, reaching a high for the year of $13.93.  Since this time, the stock has slowly sold off before finding a floor around $12.80.  The stock has not experienced any sharp swings of volatility in one direction or the other.  This combined with its large and consistent dividend make it a safe stock to own, while providing room for upside if the market places a higher valuation on the stock given its steady and substantial growth.

Source: FactSet

My Takeaway

City Office REIT was pitched to the AIM International Portfolio with a target price of $16.77 on October 6, 2017 with 22% upside.  Over the past few months, CIO has pulled back slightly from its purchase price of $13.44 and now resides at $12.89.  The market may be underestimating the growth in City Office REIT’s real estate portfolio, and the recent pullback may suggest that this stock may be facing an upward correction in the near future as its valuation cannot reasonably sink much lower.  As a result, I am recommending that the AIM International Portfolio hold City Office REIT as of 12/12/17.

Source: FactSet