Description

Killam is still a compelling long opportunity.  I wrote up Killam last year and was a bit early on the stock.  In the past year, the company has executed well on the operational side but the acquisition pace has taken a bit longer than I anticipated due to some poor execution on the capital markets side of the equation.  This is starting to get resolved and I believe Killam will imminently announce an official conversion to a REIT which should improve the company’s ability to raise capital. 

During its Q3 call, the company announced that it hired an advisor and is exploring a potential conversion to a REIT.  Killam doesn’t pay taxes so there is no bump up in increased FFO but given the recent proposal by the government to eliminate income trusts in Canada (announced on October 31^st), REITs have and will become more attractive to yield hungry investors.

Given the detail I provided in last year’s post, I will spare a re-hashing of the history etc…  To summarize, the Company acquires, re-develops and manages multifamily residential properties and manufactured home communities (MHC) in the urban areas of the Atlantic Canada region (New Brunswick, Nova Scotia, Prince Edward Island and Newfoundland).  As of September 30, 2006, Killam had a total of 13,626 total units - 7,664 apartment units and 5,962 MHC pads (land under an MHC).  The company had an 8.9% market share of the total rental apartment universe across its operating regions.  Killam now believes it can easily get to a 15% market share at still attractive cap rates.  In the latest quarter, overall occupancy levels are 98% (MHCs at 99.1% and apartments at 97.1%) which is very solid.

Killam has been aggressively acquiring apartment buildings and MHCs throughout Atlantic Canada and Ontario over the last several years with little competition.  As a result, the Company has been able to acquire units and pads at attractive cap rates (7-10% on the apartment side and 8-11% for MHCs) and finance the purchases at low costs of fixed rate debt (weighted average cost of 5.6%) typically using a loan to value of 75%.

Killam is cheap using a variety of metrics…

For Killam, I get 2007 FFO/Share of around $0.22 and $0.19 of AFFO.  At current prices that’s roughly 13.2x '07 AFFO – the closest Canadian comp (NP REIT) trades at 16.5x ’07 AFFO.  Using a 16.5x AFFO multiple gets you to around $3.14 for Killam’s stock. 

Assuming Killam converts to a REIT in 2007 and using a 6.25% yield would result in a $3.00 stock price. 

I also believe the company will be sold in the next year or two.  As the largest player in Atlantic Canada and with public REITs in Canada having little exposure to the region (less than 3% of total units), Killam has significant strategic value in a consolidating industry.  And considering the whole REIT universe trades at a significant premium to Killam on AFFO multiples and most have lower costs of capital, there is ample accretion to a buyer at much higher share prices.  Management has stated it believes it could sell the portfolio at 7-7.25% type cap rates.  Using a 7.25% cap rate on year end 2007 gives an NAV/share of just above $3.00 per share. 

As an additional measure of value, Killam’s apartment properties have been created at 50% of current replacement cost and its MHC’s have been created at 25% of replacement cost. 

Killam has a favorable risk reward.  The reward should come near term in a REIT conversion as yield hungry Canadians boost REIT valuations and long term in either the continued execution of its acquisition strategy or a sale of the company.

Catalyst