RIOCAN REAL ESTATE INVESTMENT TRUST $25 (Toronto symbol REI.UN; Aggressive Growth Portfolio, Manufacturing & Industry sector; Units outstanding: 303.2 million; Market cap: $7.6 billion; Price-to-sales ratio: 6.5; Dividend yield: 5.6%; TSINetwork Rating: Average; www.riocan.com) started up in 1993 and is now Canada’s largest REIT. It currently owns all or part of 295 retail properties, including 15 under development. These holdings account for 85% of its rental revenue. The remaining 15% comes from 51 malls in the U.S.

RioCan continues to expand beyond suburban big-box-style shopping centres. Mostly through joint ventures with other property developers, it has added mixed-use retail, office and residential buildings, mainly in densely populated urban areas.

RioCan’s revenue declined 0.8%, from $764 million in 2008 to $758 million in 2009. Some of the trust’s tenants went bankrupt during the recession, but it mostly offset that by adding new properties. RioCan’s revenue recovered to $882 million in 2010 and rose to $1.1 billion in 2012, as it took advantage of lower property values and interest rates to expand its portfolio.

Gains and losses on property sales make the trust’s earnings more erratic than its revenue. In 2008, its earnings fell from $0.67 a unit (or a total of $145 million) to $0.49 a unit (or $114 million) in 2009. Earnings then jumped to $6.04 a unit (or $1.5 billion) in 2010, but fell to $3.25 a unit (or $873 million) in 2011. Earnings rebounded to $4.57 a unit (or $1.3 billion) in 2012.

Most REIT investors focus on cash flow instead of its earnings, as this measure disregards non-cash items like depreciation. RioCan’s cash flow per unit fell from $1.48 in 2008 to $1.20 in 2009, then rebounded to $1.33 in 2010 and reached $1.52 in 2012.

Looking to the U.S. for more growth

RioCan is now reorganizing its U.S. holdings. As part of this plan, it recently ended several joint ventures with other developers and set up a new office in Dallas to manage its U.S. operations. These changes should make it easier for RioCan to manage its current malls and buy new ones.

The trust continues to make acquisitions. In the first nine months of 2013, it spent $576 million to buy eight properties in Canada and eight more in the U.S. At the same time, the trust is selling less-important properties, which helps offset the cost of its recent purchases. So far this year, RioCan has sold $401 million worth of its holdings. Other deals set to close in the next few months should raise an additional $279 million.

Expanding by acquisition adds risk. But its new properties have increased its exposure to six major cities—Toronto, Montreal Ottawa, Edmonton, Calgary and Vancouver—that are growing faster than other areas. These cities now account for 72.2% of its holdings, up from 67.5% at the end of 2012.

The trust also cuts its risk by focusing on properties that attract a wide variety of tenants. As of September 30, 2013, its occupancy rate was a high 97.0%. Moreover, well-established national chains like Wal-Mart, Canadian Tire and Cineplex theatres account for 86.2% of RioCan’s rental revenue. The trust spreads out the terms of its leases so that only a few expire each year.

The trust is also profiting from the expansion of U.S.-based Target Corp. (New York symbol TGT) into Canada. In January 2011, Target agreed to take over 220 Zellers department stores, including 34 in RioCan’s malls. Target is now moving into 23 of these stores.

New Target stores pay off in two ways

Target stores tend to appeal to wealthier shoppers than Zellers. As a result, RioCan can raise the rent it charges other tenants when their leases expire. RioCan is also successfully renting out the remaining stores that Zellers vacated. It has already found tenants for 56% of this space, and these stores’ average rental rates have increased by 96.8%.

RioCan’s long-term debt of $5.7 billion is a high 75% of its market cap. However, it only has to repay about 10% of its debt each year. As well, RioCan recently refinanced $600 million worth of debentures at lower interest rates.

The trust pays monthly distributions of $0.1175 a unit, for a 5.6% annual yield. These payouts accounted for 95.3% of RioCan’s cash flow in the third quarter of 2013.

Reinvestment plan conserves cash

However, 25.9% of RioCan’s investors take part in its distribution reinvestment plan, so it pays them in units rather than cash. To entice investors to sign up, RioCan increases the number of units that participants receive by 3.1%. Taking all this into account, cash payouts in the quarter were a more reasonable 70.3% of its cash flow.

The units trade at 11.3 times the $2.22 a unit that RioCan will likely earn in 2013, and 15.4 times its forecast cash flow of $1.62 a unit. These are reasonable multiples in light of RioCan’s strong growth prospects and U.S. expansion opportunities.

RioCan is a buy.