Dundee Industrial: 2013 Brings Considerable Scale To The REIT

Executive summary:

• Dundee Industrial (OTC:DREUF) continues to grow its asset base, up from 77 properties at its IPO in October 2012, to 206 properties at the end of 2013


• Underlying cash flow continues to scale.


• Balance sheet is modestly levered, and able to handle additional debt should attractive portfolio of properties become available.

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Dundee Industrial provides investors a pure-play on an underappreciated asset class in Canada: light industrial property. Many recent reports indicate that light industrial properties continue to be the most undervalued and, therefore, attractive real estate assets in the US. I think the same is true in Canada, given capitalization rates are generally higher than other asset classes (office, residential, retail).

This real estate asset class is characterized by lower maintenance capex relative to other types of real estate, including office, retail and residential real asset classes.

The light industrial asset class is also quite fragmented, and Dundee Industrial is capitalizing on low interest rates and higher going-in capitalization rates that can be realized for other types of commercial real estate. However, there appears to be some growing competition in the race to consolidate the light industrial property sector, as a number of new firms have been established to capitalize on this asset class, including Pure Industrial REIT, Summit Industrial REIT and WPT Industrial REIT. However, relative to these competitors, Dundee Industrial carries the power of the Dundee brand name, which is well regarded as a quality partner in Canada.

2013 marked the first full year of operations for Dundee Industrial. That said, Dundee Industrial will likely come into the purview of investors after full year results are reported and screenable. After going public in October 2012, Dundee Industrial went on a buying spree and acquired 77 properties representing 6 million square feet of leasable area. By the end of 2013, Dundee Industrial claimed 206 properties under its umbrella, marking a particularly acquisitive year. Going into 2014, Dundee Industrial has meaningful scale and a large enough asset base to generate significant recurring rent roll.

DIR.UN data by YCharts

Like the other namesake Dundee REITs, Dundee is externally managed by DREAM Unlimited (OTC:DRUNF). While there is some fee leakage in terms of transaction and advisory fees payable to Dream, Dundee Industrial benefits from the growing scale Dream is achieving in terms of sourcing attractive deals.

And like Dundee International (OTC:DUNDF), another relatively newly formed REIT, Dundee Industrial trades at discounted multiples of cash flow and book value. Similarly, Dundee Industrial is conservatively levered, with only 52% of its asset base tied to debt. The leverage is generally comprised of low interest (3.84% effective interest rates), fixed rate debt, and the business has a healthy 2.9 interest coverage ratio. To that end, Dundee has the financial capacity to continue acquisitions when the right opportunities present itself. Moreover, Dream, the external asset manager, is incented to make smart acquisitions (i.e., not overpaying), since a portion of its advisory fee's are derived from variable incentive fees, once certain AFFO thresholds are met. Accretive capital allocation will help Dream achieve those incentive fees.

At the current $670 million valuation, Dundee Industrial trades at a low ~11x multiple and 1.2x book value. Given the growth prospects ahead of Dundee Industrial, there is plenty of room to grow the asset base.

To give perspective on the growth in the past year, it is instructive to look at the 2013 and 2012 comparative results. At the end of 2012, Dundee Industrial didn't really have a business. By the end of 2013, it owned enough properties to give it considerable scale, deriving significant revenue ($142 million) and FFO ($61.5 million). After a period of tremendous growth, integration will remain key as will continuing to look for new opportunities for growth.

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While I don't see any particular catalyst to push these shares higher other than the business screening better and investors becoming familiar with the light industrial players, Dundee Industrial remains cheap and risk-averse at these levels. I think investors can count on dependable income, and exposure to an asset class that is at the heart of economic output and logistics. Because the light industrial property is also characterized by less competition among bidders, investors are shielded from overpaying for assets that have been bid too high. That, in itself, should help investors sleep better at night.

Conclusion

Dundee Industrial represents a pure play on industrial property. Because of that, it also has leverage to a recovering economy as the need for logistics and storage increase. In my view, the Canadian "real estate bubble" chatter relates mostly to the residential sector. Given the going-in cap rates on industrial property are higher than in residential deals, it indicates these properties are cheaper on a relative basis (although they are not completely comparable asset classes). But, like I indicated above, industrial properties are also less capital intensive, which should leave more cash available for shareholders, all else being equal.

Investors looking for a nice dividend and some capital appreciation opportunity can continue to consider these shares. They are far from overvalued given the discounted cash flow multiples, large, sustainable dividend yields and only a slight premium to stated book value.

I expect these shares to retrace back to levels seen before the "Fed Taper" as Dundee Industrial continues to scale its operation, and increase its underlying value.

Source: Dundee Industrial: 2013 Brings Considerable Scale To The REIT

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)

Additional disclosure: I am long DREAM Unlimited whom serves as the external asset manager to Dundee Industrial.

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