Scotia’s autocalls on REIT basket offer equity-like premium with underlying growth play

By Emma Trincal

New York, May 17 – Bank of Nova Scotia’s 0% Strategic Accelerated Redemption Securities due June 2026 linked to an equally weighted basket of real estate stocks offer a double-digit call premium but no downside protection. The risk, however, is mitigated by the pick of three basket components, which are well-positioned for growth, according to Clemens Kownatzki, finance professor at Pepperdine University.

The basket consists of the common stocks of Equinix, Inc., Crown Castle Inc. and American Tower Corp., according to an FWP filing with the Securities and Exchange Commission.

The notes will be called at par plus an annualized call premium of 13.5% to 14.5% if the closing level of the basket is equal to or greater than its starting value on any yearly observation date.

The exact premium amount will be set at pricing.

If the notes are not called, the payout at maturity will be par of $10 plus 40.5% to 43.5% with full exposure to the decline.

Growth tailwind

“The entire real estate sector has been under pressure because of the higher interest rates. But these three specific REITs are not traditional REITs, especially Equinix, which is more like an IT company given its focus on data centers,” he said.

The Equinix share price has skyrocketed since the fall. It is now trading at $729, from an October low of $495. The stock hit an all-time high in September 2021 at $885.

“The obvious factor behind such jump is the growing demand for data centers due to the explosion of artificial intelligence. Artificial intelligence needs massive amounts of data centers to be able to compute sufficient capabilities,” he said.

The growth of Equinix can be put in parallel with that of semiconductor company Nvidia Corp., whose share price also “exploded” since last fall, he added.

“A lot of this bullish interest is related to AI. Nvidia produces graphic cards that are optimal for these AI calculations.

“I can see a massive uptrend for Equinix despite the interest rate headwind.”

Crown Castle and American Tower have a very different business model than Equinix, he added.

But their outlook is also positive.

“They own cell towers and develop wireless communications, a sector bound to grow as demand for 5G is flourishing,” he said.

Divergent market returns

Yet the two stocks have not performed as well as Equinix.

Equinix has gained 44% since October. Its current price is not that far from its all-time high of September 2021, he said.

But Crown Castle trades 46% off its high of December 2021. American Tower remains 36% lower than its high of September 2021.

“None of those two stocks has fully recovered the way Equinix did,” he said.

Crown Castle and American Tower are more vulnerable to higher interest rates than Equinix, which may have contributed to their less impressive market performance, he said.

“The constant conversation about AI on social media, the headlines on ChatGPT, the buzz on Wall Street... all this has created a huge momentum for Equinix.

“Everybody is talking about AI. Equinix has become a hot, trending stock,” he said.

Valuations, income

Equinix is trading at a richer valuation than the other two stocks with a price-per-earnings ratio of 81 versus 64 for American Tower and 29 for Crown Castle.

“Equinix is by far the most expensive of the lot. If you compare it to well-known traditional REITs like Simon Property and Public Storage with P/Es of 16 and 12, respectively, Equinix belongs to an entirely different category, closer to a tech stock than a REIT,” he said.

Even the other two stocks have higher P/Es than most traditional REITs, he noted.

“This basket is not a real estate play. These stocks are REITs by designation only,” he said.

A REIT is a company that owns and typically operates income-producing real estate or related assets, according to the SEC. To qualify as a REIT, a company must, among other requirements, distribute at least 90% of its taxable income as shareholder dividends each year.

Another big difference between the basket components and a typical REIT is the dividend yield. Most investors invest in REITs for the above-average income stream. For instance, Simon pays a 7% dividend yield and Public Storage, over 4%.

“While the 5.6% yield of Crown Castle is in line with REITs’ distributions, Equinix only pays a 1.9% dividend yield, which clearly confirms that you are dealing with a growth stock,” he said.

Playing the call

For Kownatzki, the sound choice of the stocks composing the underlying basket was enough to compensate for the downside risk at maturity.

“Having no downside protection is the real issue with this note. But both AI and wireless networks have a lot of growth potential, especially over a three-year period,” he said.

“Traditional REITs on the other hand don’t have those advantages. They will face serious headwinds over the next couple of years.

“Interest rates are not going to come down to levels we’re used to, and it will affect long-term rates, mortgage rates as well, making the cost of housing much higher.

“In contrast, growth REITs such as Equinix, Crown Castle and American Tower have a high probability of being above their initial levels in the next three years. The note is probably going to be called in the next year or two, that’s my guess.

“Getting 14% in a year as the overall real estate market is struggling, I think is a decent proposition.

“These stocks are not the grandiose tech stocks, the Apples and the Googles, but I’m optimistic that they will do OK in relation to big tech. I don’t expect them to jump 25% a year. So, 14% is a good return.

Risk mitigation

“The lack of any barrier or buffer is of course the main shortcoming of the note. Over three years it would be too costly to hedge the risk with a put strategy.”

But the diversified basket, even across three names, should help mitigate the risk.

“Even if Equinix has already gone up 50%, the others are down a lot since their highs. This is a weighted basket. You can reduce risk through diversification. It’s not as if you were exposed to just one name.

“I’m pretty optimistic about this basket. I would go for the note just because there’s quite a lot of upside potential,” he said.

BofA Securities, Inc. is the agent.

The notes are expected to price in May.

The fee is 2%.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.