RIOCAN REAL ESTATE INVESTMENT TRUST $27

(Toronto symbol REI.UN; Aggressive Growth Portfolio, Manufacturing & Industry sector; Units outstanding: 303.2 million; Market cap: $8.2 billion; Price-to-sales ratio: 5.8; Dividend yield: 5.2%; TSINetwork Rating: Average; www.riocan.com) started up in 1993 and is now Canada’s largest REIT. In Canada, it owns all or part of 293 shopping centres, including 16 under development. These holdings account for 85% of its rental revenue. The remaining 15% comes from 47 malls in the U.S.

In the wake of the recession, RioCan took advantage of lower property values and interest rates to expand its portfolio. As a result, its revenue jumped 52.0%, from $758 million in 2009 to $1.15 billion in 2013.

Gains and losses on property sales make the trust’s earnings more erratic than its revenue. Its earnings soared from $0.49 a unit (or a total of $114 million) in 2009 to $4.57 (or $1.3 billion) in 2012. Earnings them fell to $2.29 a unit (or $709 million) in 2013.

Most REIT investors focus on cash flow instead of earnings, as this measure disregards non-cash items like depreciation. RioCan’s cash flow per unit rose from $1.20 in 2009 to $1.45 in 2010, but dipped to $1.43 in 2011. Cash flow rebounded to $1.52 a unit in 2012 and rose to $1.63 in 2013.

RioCan continues to diversify beyond its bigbox- style suburban shopping centres, which supply 44% of its Canadian rental revenue. Mostly through joint ventures with other property developers, it has added smaller outdoor malls (24% of rental revenue), enclosed malls (18%) and malls in urban areas (9%). The remaining 5% comes from office buildings.

Urban focus plan is a winner

The trust is concentrating on six main cities —Toronto, Ottawa, Montreal, Vancouver, Edmonton and Calgary—that are growing faster than other parts of the country. These cities now account for 71.7% of its holdings, up from 67.5% at the end of 2012.

In 2013, RioCan spent $849 million to buy 32 properties, plus four under development. It also sold 18, mainly in smaller cities, for $616 million, for a net cost of $233 million.

In addition to buying new properties, RioCan is also making better use of its existing space. For example, the trust is adding office and residential units to its malls, which is cheaper than buying new properties. This also helps RioCan’s retail tenants, because residents will probably prefer to shop at stores closer to where they live.

The trust expects to spend $100 million to $200 million each year to 2019 on the properties it is currently developing.

RioCan’s high-quality malls attract a wide variety of tenants. At the end of 2013, its occupancy rate was a high 96.9%. Moreover, well-established chains, like Wal-Mart, Canadian Tire and Cineplex theatres, account for 86.2% of its rental revenue. The trust also cuts its risk by spreading out the terms of its leases so that only a few expire each year.

Loblaw recently completed its takeover of Shoppers Drug Mart (see box on page 44). The combined company does not plan to close any stores, so it is now RioCan’s largest single tenant, accounting for 4.1% of its rental revenue.

Ready for new American tenants

The trust stands to gain as more U.S. retailers, like Nordstrom and Saks, expand into Canada. Meanwhile, it continues to rent out space from the now-closed Zellers chain to new tenants, such as U.S.-based Target, at nearly twice the old rate. So far, RioCan has rented out 56% of the old Zellers locations. It should lease or sell the remaining ones by the end of 2014.

RioCan’s balance sheet is stronger than it appears. Its long-term debt of $6.0 billion is a high 73% of its market cap. However, the trust spreads out these maturities so it only has to repay about 10% of its debt each year. As well, it mainly borrows at fixed rates, which limits its exposure when interest rates start to rise again.

The trust continues to pay monthly distributions of $0.1175 a unit, for a 5.2% annual yield. These payouts accounted for 86.5% of its 2013 cash flow.

However, 25.8% of RioCan’s investors opt to receive their distributions in units rather than cash. To entice investors to sign up, the trust increases the number of units that participants receive by 3.1%. Considering all this, its 2013 cash payout rate was a more reasonable 63.8% of its cash flow.

Freeing up cash for buybacks

As RioCan focuses more on developing its existing properties and selling its less-important holdings, it has additional cash available to repurchase its units. In 2013, it spent $22.1 million on buybacks.

The units trade at 15.9 times RioCan’s likely 2014 cash flow of $1.70 a unit. That’s a reasonable multiple in light of the trust’s high-quality properties and tenants.

RioCan is a buy.