RIOCAN REAL ESTATE INVESTMENT TRUST $27 (Toronto symbol REI.UN; Aggressive Growth Portfolio, Manufacturing & Industry sector; Units outstanding: 291.3 million; Market cap: $7.9 billion; Price-to-sales ratio: 5.0; Dividend yield: 5.1%; TSINetwork Rating: Average; www.riocan.com) is Canada’s largest real estate investment trust (REIT).

RioCan specializes in big-box-style outdoor malls. It owns 278 shopping centres in Canada, 10 of which are under development. Most are in suburban areas, where land is generally cheaper than in towns and cities. The trust often leaves room at its malls for expanding existing stores and building new ones. This makes itseasy to add more tenants.

In the past few years, RioCan has expanded in the U.S., where it now owns or invests in 48 malls, 22 of which the trust operates through a joint venture with Cedar Shopping Centers, Inc. (New York symbol CDR). RioCan owns 80% of this joint venture and 14.3% of Cedar.

However, the partners recently announced that they will end this joint venture. Under the terms of the breakup, RioCan will buy Cedar’s 20% stake in 21 malls, while Cedar will buy RioCan’s 80% stake in another mall.

The trust will pay Cedar $39.0 million for its interest and will hang on to its equity stake in Cedar. The partners did not say when they will complete this transaction.

RioCan’s revenue rose 6.1%, from $719.9 million in 2007 to $763.8 million in 2008. Revenue fell 0.8% to $758.0 million, in 2009, but rose to $882.0 million in 2010 and $988.0 million in 2011. The higher revenue was the result of the $3 billion of new properties the trust bought in the past three years.

RioCan’s earnings are more erratic than its revenue. In 2007, the trust earned just $0.16 a unit (or $32.4 million), mainly due to a $144-million non-cash charge to recognize future tax liabilities under Ottawa’s plan to start taxing income trusts.

Smart acquisitions paid off

Earnings rose to $0.67 a unit (or $145.1 million) in 2008, but fell to $0.49 a unit (or $113.9 million) in 2009. RioCan reversed its 2007 charge in 2010, because REITs are exempt from the trust tax. This pushed up its earnings to $6.04 a unit (or $1.5 billion). Earnings then fell to $3.25 a unit (or $873.0 million) in 2011.

Cash flow per unit fell from $1.51 in 2007 to $1.20 in 2009, but recovered to $1.43 in 2011.

Much of RioCan’s investment appeal stems from its high-quality tenants. National chains like Wal- Mart, Canadian Tire and Loblaw supply 85.8% of the trust’s rental revenue. These retailers tend to stay busy no matter what the economy is doing. As well, RioCan’s occupancy rate is a high 97.4%.

The trust should also benefit 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 will move into 23 of the RioCan stores, and Wal-Mart and Canadian Tire will take over one store each. Zellers will vacate the remaining nine stores over the next few months.

RioCan will pay Zellers a $9.3-million fee to break these remaining leases. However, Target stores tend to appeal to wealthier shoppers than Zellers, so RioCan should find new tenants for these stores and charge higher rental rates.

As well, Target has agreed to rent stores in other RioCan shopping centres, including becoming the anchor tenant at its new Stockyards mall in Toronto, which will open in early 2014.

Moving beyond malls

RioCan is also cutting its exposure to the retail industry by building more mixed-use retail-commercial properties. For example, it recently formed a 50/50 joint venture with Allied Properties Real Estate Investment Trust (Toronto symbol AP.UN) that will build and purchase mixed-use properties in major Canadian cities.

The partners will split the costs of any projects they build. Once they are completed, RioCan will manage the retail portion and Allied will handle the office portion. This arrangement will also let both partners share the cost of buying land for new projects and redeveloping their existing properties.

RioCan pays monthly distributions of $0.115 a unit, for a 5.1% annual yield. These payouts accounted for 93.9% of RioCan’s cash flow in the past year. However, 27.1% of the trust’s investors take part in its distribution reinvestment plan, so they get units rather than cash. On this basis, RioCan’s cash payouts were a more reasonable 71.4% of its cash flow. (If you opt for units instead of cash, you still have to pay income taxes on your distributions for the year when you receive them.)

Multiples still reasonable

The units have gained 11% in the past year. They now trade at 18.4 times the $1.47 a unit that RioCan will likely earn in 2012 and 18.0 times its forecast cash flow of $1.50 a unit. These multiples are high, but they’re still reasonable in light of RioCan’s high-quality properties and tenants.

RioCan is a buy.