Why H&R Real Estate Investment Trust’s Price Refuses to Rise

Is H&R Real Estate Investment Trust’s (TSX:HR.UN) 7.2% yield sustainable? Is there more upside than downside from here?

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The Motley Fool

H&R Real Estate Investment Trust (TSX:HR.UN) is trading at $18.70 per unit, 4% higher than its 52-week low and 22% below its 52-week high. Does that mean there’s more upside to the diversified real estate investment trust (REIT) than downside?

Why H&R REIT’s price refuses to go up

Since the start of 2015 H&R REIT’s unit price has been in a downtrend. That’s thanks (or rather, no thanks) to its exposure to Alberta. About 28% of the REIT’s adjusted same-asset property operating income comes from Alberta.

H&R REIT earns 49.6% of its rental income from its top 15 tenants. Four are from the energy industry, and they generate 20.9% of the REIT’s rental income.

Encana Corporation (TSX:ECA)(NYSE:ECA) is H&R REIT’s top tenant, and it generates 12.6% of its adjusted same-asset property operating income and 11.3% of the its rental income.

Encana experienced its fourth consecutive quarterly loss and is cutting its workforce by 20%, slashing its dividend by 79%, and reducing its capital spending by about 55% year over year.

Including this workforce reduction, since 2013 Encana has cut its workforce by 50%, and its dividend has been slashed almost 93% from an annual payout of $0.80 per share to $0.06 per share. These actions are expected to add $50 million of cash flow to the company’s pot this year.

Additionally, as of February 19 Encana has hedged close to 75% of expected 2016 oil, condensate and natural gas production.

All of these actions should help Encana navigate the challenging environment. Encana rallied 23% on the news.

Since Encana has 22 years of remaining lease terms with H&R REIT, any good news for Encana’s business is good news for H&R REIT.

Is H&R REIT’s 7.2% yield safe?

On December 31, 2015 H&R REIT’s occupancy was 95.9%, 1.8% lower than a year before. Interestingly, the decrease was mainly due to Target Corporation disclaiming its leases.

Since the REIT maintains a high occupancy, has remaining lease terms of about 9.5 years, and has an adjusted funds-from-operations payout ratio of about 85%, its rental income should remain pretty stable, and its yield of 7.2% is sustainable.

However, investors should be aware that even when distributions are sustainable, the board can still choose to cut them for other reasons.

Conclusion: Is there more upside than downside?

Since H&R REIT has sizeable rental income from Alberta, there’s a higher risk of vacancy if commodity prices remain low. However, at least a part of that risk is priced into the stock, seeing that its unit price has declined since the start of 2015. When commodity prices improve, so will H&R’s price.

Based on its normal multiple, H&R could trade at least at the $22.50 level, implying there’s some margin of safety, and there’s potential upside of 20%. In the meantime, unitholders can collect a 7.2% yield.

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 Kay Ng has no position in any stocks mentioned.

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