RioCan Real Estate Investment Trust (TSX: REI.UN) is down about 15% over the past 12 months, and investors are wondering if the sell-off is overdone.
Let’s take a look at the current situation to see if RioCan should be a part of your income portfolio.
Economic threats
RioCan’s core assets are shopping malls.
The company owns more than 300 sites in Canada and is in the process of selling its 49 properties in the United States. Most of the Canadian buildings are located on prime real estate and have top-quality companies as anchor tenants.
What’s the concern?
The entire REIT sector has been under pressure as investors fret about an economic slowdown and the threat of higher interest rates in the United States.
An economic downturn would certainly put pressure on some retailers but the big stores that RioCan primarily relies on are focused on recession-resistant areas of the consumer markets, such as groceries, pharmaceuticals, and everyday household items. These companies can easily ride out some tough times and are unlikely to shut down.
REITs tend to carry a lot of debt, so rising interest rates can be a threat. In Canada, there isn’t much risk of rates going higher in the near term. In fact, the next move could be another step down.
In the U.S., the Fed raised its target rate in December, and most market observers originally expected another three to four increases in 2016. With the global economy looking weak, the market might see the Fed slow down the process. RioCan should have little trouble adjusting to the rate increases as long as the moves are small and drawn out.
Replacing Target
RioCan took a hit when Target Canada went bust, but the company quickly found new tenants for seven of the Target locations and has new agreements in place or is wrapping up negotiations to replace at least 94% of the revenue lost by Target’s exit. Another 406,000 square feet was still available as of November 23.
In the November update the company said, “The new cash flow stream will be more diverse, have longer remaining terms, and will have a stronger growth profile than the previous Target Canada leases.” As such, the Target withdrawal should actually turn out to be a positive for RioCan and its investors.
New projects
RioCan will book net proceeds of about $1.2 billion from the sale of the U.S. properties. The funds are being used to pay down debt and set up the balance sheet for new opportunities.
One interesting project is the development of condos at some of the top retail locations. The initiative is in its early stages, but investors could see a nice boost to cash flow in the coming years if the idea is rolled out on a broader scale.
Distribution safety
RioCan pays a monthly distribution of 11.75 cents per unit, which yields about 5.7%.
The company reported a 5% rise in funds from operations in Q3 2015 compared with the previous year and renewed 1.3 million square feet of space in the quarter at an average rent increase of 8.6%. That suggests things are rolling along pretty well despite the economic headwinds.
Cash flow remains stable and the payout ratio is less than 90%, so the distribution should be safe.
Should you buy?
Investors looking for a reliable monthly distribution should consider RioCan. At some point, I think the market will realize the name has been oversold and the current discount will disappear.
