Global markets have generally grinded sideways over the past few weeks as they confronted a myriad of counter-balancing forces including a French presidential election, White House controversies including the firing of the Director of the FBI, oil prices oscillating in a 20% range, escalating tensions with North Korea, Chinese measures to deliver the domestic financial system, etc. Closer to home, Moody’s downgrading of Canada’s banks’ credit ratings capped off a period of general underperformance in Canadian stocks, heightening international focus on elevated household debt levels and over-heated real estate markets. In the U.S., a better-than-expected first quarter earnings season helped to remind investors of solid corporate fundamentals, powering the S&P500 and Nasdaq to new all-time highs.
Post in line Q1 results, our stable view of FCR is intact. Notwithstanding what appears to be a temporary occupancy slip, fundamentals are in good shape with internal growth expected to remain in the low-2% range. Capital allocation remains mostly aimed at developments with the pace of completions expected to build through 2H/17. As well, aside from our initial estimate, upcoming new disclosure should shed some light on management’s view of the long-term value creation opportunity through intensification. Our target price held firm with only minor revisions to our ~3.5% 2-year AFFOPS CAGR. The shares are trading at 18.8x 2017E AFFO/5.4% implied cap rate/1% below NAV (Exhibits 1-3 in the analyst’s full comment available on Scotiaview.com). Similar to its retail peers, FCR’s premium to the sector has compressed to below average levels which we partly attribute to investor expectations for stronger growth and a weak sentiment on retail. Still, with a best in class portfolio, we see a reasonable entry for patient capital.
Economic data globally remains supportive for markets helping factory orders, investment spending and earnings recover to multi- year highs. As economic data has remained firm, the IMF has upgraded its 2017 global economic growth forecast to 3.5%, a significant improvement from the 3.1% estimated for 2016. The improving economic backdrop is translating into rapidly improving corporate fundamentals as reflected in double-digit earnings growth across major markets (S&P500 EPS: +12.8%y/y). With global equities having registered six consecutive months of positive returns, the widely- followed VIX volatility index fell to a 10-year low on May 1st reflecting the broad improvement in market fundamentals over the past year. To be sure, there are a variety of issues that could cause bouts of market consternation in coming weeks including economic surprises moderating as forecasts catch up to stronger data flow, China tapping down on pockets of speculation (housing, commodities, FX outflows) and disappointment over the slow pace of progress on Trump’s tax cut legislation.
Our recommended Asset mix and Sector Strategy recommendations are unchanged. Our asset mix stance is Equity Overweight (OW)/Bond Underweight (UW), and we continue to believe the risk/reward outlook is tilted in favour of equities. In our view, equities are better positioned because the macro supports rising EPS and bonds look unattractive as stronger GDP/rising inflation pushes yields up.
Our asset mix model has been stuck near a maximum equity OW signal since Q3/16. U.S. 10-Yr yields Fair Value stands at 2.9% based on our model (vs. 2.3% currently). We expect the equity OW signal to fade in 2H17, but in the absence of an upward adjustment in yields, the likely result may be a rising Cash signal from the model.