Every Tuesday we bring you “Best Canadian Stocks.” You get our specific recommendations on the stocks we profile, with a full explanation of how we arrived at our opinion. You’ll read about stocks making moves you should know about, from coverage in one of our three newsletters featuring Canadian stocks—The Successful Investor, Stock Pickers Digest and Canadian Wealth Advisor.
This week we cover several Real Estate Investment Trusts (REITs). Yesterday we examined a REIT that we do not recommend to investors (see the article here). Today we report on a REIT that has expanded successfully and still has strong growth prospects.
RIOCAN REAL ESTATE INVESTMENT TRUST (Toronto symbol REI.UN; www.riocan.com) owns all or part of 292 shopping centres in Canada, including 15 under development. These holdings account for 84% of the REIT’s rental revenue. The remaining 16% comes from 48 malls in the U.S.
In the past few years, RioCan took advantage of lower property values and interest rates to expand its portfolio. As a result, its revenue jumped 39.8%, from $882 million in 2010 to $1.2 billion in 2014.
Due to gains and losses on property sales, earnings have been up and down in recent years. They were $2.10 a unit (or $663 million) in 2014.
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 26.3%, from $1.33 in 2010 to $1.68 in 2014.
The rising popularity of online shopping has forced several retailers to close some of their stores in recent years. That’s partly why Target is closing its 133 Canadian outlets, including 26 in RioCan’s malls. However, many of Target’s stores are in attractive locations, so RioCan should be able to rent them to new tenants, perhaps at higher rates.
RioCan now aims to reduce its reliance on retail by expanding into mixed-use properties with office and residential components. As part of this plan, the trust plans to spend $5 billion to $6 billion over the next 10 years to develop 19,000 apartment units.
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New venture with Hudson’s Bay will unlock more property value
Meantime, RioCan continues to find ways to unlock more of its existing properties’ value. For example, it recently agreed to merge two of its Ontario malls with 10 stores owned or leased by Hudson’s Bay Co. (Toronto symbol HBC).
RioCan will own 20.2% of the new firm that will run these properties, while Hudson’s Bay will hold the remaining 79.8%. The partners will likely sell shares in the new company to the public.
The trust’s long-term debt of $6.4 billion is equal to 73% of its market cap. That seems high, but RioCan spreads out its maturities so it only has to repay about 10% of its debt each year. It’s also replacing its maturing bonds with new debt at today’s lower interest rates.
The units trade at 16.2 times RioCan’s projected 2015 earnings of $1.73 a unit and 17.8 times its likely cash flow of $1.57 a unit. These multiples are high but still reasonable in light of RioCan’s 97.0% occupancy rate. Moreover, established chains like Wal-Mart and Canadian Tire supply 86.4% of the trust’s rental revenue. The $1.41 annual distribution rate yields 5.0%.
RioCan REIT is a buy recommendation of The Successful Investor.
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