Morguard owns and manages a diverse group of real estate properties across North America. Its assets include 10,000 apartment suites, close to 7 million square feet of office and industrial real estate and a 45% interest in the publicly traded Morguard REIT. Morguard is Canada’s largest integrated real estate company, yet its stock is illiquid, and it receives little to no analyst or media coverage. It’s easy for this company to fly under investors’ radar screens, but Morguard’s stock is too cheap to ignore. In fact, we believe that at its current price of $33, Morguard is trading at a 50% discount to its net asset value.
Let’s take a closer look. Morguard should generate about $140 million in operating income this year. When analyzing the value of real estate, one uses a formula called cap rate; the lower the cap rate, the higher the value of the property. To figure out a company’s value, take its operating income and divide it by its cap rate and then deduct any liabilities. The cap rates of top quality office and industrial real estate in Canada is as low as 6%. Let’s be conservative and say that Morguard’s properties are worth an 8% cap rate. If you divide $140 million by 8%, you get a value $1.75 billion for Morguard’s properties. If you add its 45% interest in Morguard REIT, you get a value of $2.1 billion. Now deduct Morguard’s liabilities which are about $1.3 billion. Add it all together and you get a value of about $57 per Morguard share. If you used a 7% cap rate, one would get a $75 value per Morguard share.
Another method used to evaluate real estate companies is to look at a company’s price to its funds from operations or FFO. Real estate firms generate so much depreciation and interest payments and this makes it hard to analyze them based on earnings. A better indication of performance is to strip out depreciation and interest to get FFO. In 2009, Morguard should generate $8 of FFO. At its current price, Morguard trades at just over four times FFO, a huge discount to some of its Canadian real estate peers which trade at ten times FFO. If Morguard traded at the same level, one could argue that it is worth $80 a share.
No matter how you slice it, Morguard should be worth up to $80 a share, and certainly not less than $57.
