In a world where other income-producing assets pay anemic dividends, investors are naturally drawn to any investment paying above 7%. After all, that’s more than seven times the yield offered by a Government of Canada five-year bond.
Alas, most of the time yields above 7% are simply too good to be true. Companies that pay more than 7% annually are either on the cusp of a business crisis, or else they’re paying out more than what they earn. Either way, that’s not a situation most investors want to get tangled up in.
But every now and again I’ll discover a company that pays a generous yield without any major warts. I believe Cominar Real Estate Investment Trust (TSX:CUF.UN) is one of those companies. Let’s take a closer look.
Cominar is one of Quebec’s largest owners of property, with the majority of its 563 unit fleet of commercial, retail, and industrial property being located in the province. It also has exposure to Atlantic Canada, the Toronto area, and western Canada. In total, the company owns more than 45 million square feet in gross leasable area.
The company recently made a large acquisition from Ivanhoé Cambridge Inc. (which is a division of Caisse de dépôt, Quebec’s pension giant), scooping up 10 shopping centres and office buildings across the province for more than $1.5 billion. Rather than just taking the cash outright, Ivanhoé elected to retain $250 million in ownership of Cominar, narrowly beating out the founding family as the largest shareholder.
Even before the acquisition was finalized, the company reported stellar results. For 2014 Cominar reported revenue that was up nearly 12% compared with the year prior, as well as adjusted funds from operations that were up more than 5%. The company’s dividend is $1.47 per share annually, while funds from operations were $1.86 per share. That puts the payout ratio at a pretty healthy 79%.
Then why exactly does this stock yield 7.9%?
There are a few minor things wrong with the stock that are enough to scare investors away when combined.
First of all, there’s the company’s debt situation. As of the end of 2014, its debt-t0-assets ratio stood at more than 53%, while the market likes to see no more than 50%. This has subsequently gone down thanks to an offering of more shares, but the debt is still a concern.
Secondly, there’s the Quebec economy. La Belle Province is notorious for being one of Canada’s most left-wing jurisdictions, and there’s always the risk of Quebec sovereignty rearing its ugly head again. Because of this, many investors view Quebec as a bad place to do business.
Finally, there’s the risk of swallowing a big acquisition. In a world where pension funds usually make headlines for buying assets, many investors wonder if there are serious warts with Ivanhoé getting rid of these properties.
Thanks to these concerns, shares are sitting at levels where they’re pretty cheap. The company trades at approximately 10 times its AFFO, which is about 35% cheaper than the average of its peers. It also trades at a little less than 85% of book value. These two metrics combined make Cominar one of the better values in the REIT world.
But perhaps the best reason to buy the REIT is the sustainable dividend. It isn’t very often investors can find a stock yielding nearly 8% that isn’t covered with giant red flags. Sure, Cominar has issues, but I think they’re just temporary growing pains. Once the company sees its way through them, the market will bid up the shares and give it a yield closer to 6%, in line with its peers. That represents an upside of 25% based on the current price.
If you combine the company’s generous dividend and the potential for upside once it trades at a similar valuation as its competitors, Cominar could be one of the big winners of a portfolio. And if not, the nearly 8% yield is a pretty fine consolation prize.
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This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.
Fool contributor Nelson Smith has no position in any stocks mentioned.