With retail sales plunging and property values depressed it may not seem like the best time to invest in Canada's largest owner of shopping malls, but a high distribution and the hint of better days has investors taking another look at RioCan Real Estate Investment (REI.UN-T14.94-0.09-0.60%).
The company's units have gained 32 per cent since March, largely on the strength of a large financing and a first quarter that saw profit and vacancy rates remain robust despite the downturn - thanks to the stability of reliable tenants such as Wal-Mart and Sears Canada.
Meanwhile, chief executive officer Edward Sonshine promised investors in late May that he wouldn't cut the fund's distribution, currently set at $1.38 a unit per year. With the units trading at $15.05 yesterday, they yielded 9.2 per cent - a historic high that allows investors to gather income from a profitable company while waiting for an anticipated economic recovery in 2010.
"It's a large, well-diversified REIT with an approximately 10-per-cent yield," says Rick Stuchberry, a portfolio manager at Blackmont Capital. "It provides a strong monthly cash flow for investors who require an income stream, and looking out into next year - maybe the distribution gets higher. It's not a bad place to park your money."
What does it own?
RioCan owns 59-million square feet of Canadian retail space, predominantly in Ontario. Its properties tend to be anchored by large national chains such as Wal-Mart and Shoppers Drug Mart, with additional buildings providing space for smaller outlets such as fast-food restaurants and dollar stores. Movie theatres are its largest clients.
These companies pay rent - which is then handed back to investors through distributions.
With the majority of the tenants being large corporations that can sustain losses through a recession, RioCan's retail occupancy rate hasn't slipped below 94 per cent in the past 10 years. At the end of the fourth quarter, its properties were 97.5 per cent full.
"They are concentrated in the big six markets in Canada, and their retailers tend to be focused on necessities so you don't need to worry as much about economic cycles," said Dennis Mitchell, a portfolio manager at Sentry Select Capital who manages the firm's REIT fund. "They don't face a lot of competition, and their tenants are stable and best-in-class."
Making money
In the first quarter, the company earned $30.7-million - just $400,000 more than it did in the same quarter a year ago. Funds from operations - a commonly used measure of a REIT's performance - came in at $70.6-million, compared with $68.3-million last year.
"While we did see some deterioration, primarily from non-national tenants, the results of our strategic initiatives over the course of the last seven years - to focus our portfolio on the high-growth markets of Canada with a preponderance of national tenancies - are bearing fruit," Mr. Sonshine said.
The company's shares haven't shown the same stability as its earnings. Even after the 32-per-cent gain booked since March, they are still trading 47 per cent below their 52-week high. As they have fallen in value, yields have risen (yields move inversely to price), meaning they are paying investors a greater return. A higher yield can mean investors are worried about a distribution cut.
Desjardins Securities analyst Jeff Roberts is leery of the sector's prospects, warning that large retailers are being hammered by the recession. He uses Sears Canada as an example, with same-store sales down 10.4 per cent in the first quarter. "We believe that many REITs are nearly fully valued at current levels, and we would not be surprised to see a pullback in the next few months," he said.
At $1.38 a unit per year, analysts also estimate that RioCan is giving its shareholders more than it is actually generating. Still, Mr. Sonshine has said emphatically that RioCan will not chop the payout as some of its peers have chosen to do, because it intends to generate enough cash through new investments in the next several years to service the payments.
"While the payout ratio is forecast to remain above 100 per cent for an extended period of time, management does not believe there is any rationale for considering reducing the distribution," said Mark Rothschild, an analyst at Genuity Capital Markets. "Though we agree with management that reducing the distribution would not accomplish much in the near term, it is possible that it will be several years before recurring cash flow can cover distribution."
What's next
Earlier this month, the company took advantage of its recent stock market gains to raise $150-million. The cash will be used to make acquisitions, and to further develop properties it already owns. The cash will be added to the $180-million it amassed in March through a bond sale. Part of the proceeds - $55-million - is earmarked for paying down debts coming due in the next year. "They raised their equity at a bit of a discount and that implies they think the stock isn't overly cheap right now," Mr. Mitchell said. "It may be close to fair value - but I think it is still slightly undervalued right now. And, it's a good long-term value."