In late July, I wrote, “Investors should be extra cautious with any REITs that have a payout ratio of over 90%.” At the time, Cominar REIT’s (TSX:CUF.UN) payout ratio was estimated to be about 116% for the year.
In early August, Cominar came out with a press release which had the mild-toned headline, “Cominar Restores Its Flexibility”.
Essentially, the company announced that it was halting the distribution-reinvestment plan (DRIP) and cutting its monthly distribution by 22.4%.
Is the DRIP suspension and distribution cut good or bad?
No company would cut its dividend if it didn’t have to. This is especially so for Cominar, which had a long-term distribution history; it had at least maintained its distribution for 15 years before it was slashed.
So, before we start criticizing the company, let’s take a look at why management made such a difficult decision.
Under normal or good market conditions, allowing shareholders to reinvest their dividends for free is a great way for companies to raise funds. However, each dollar that is reinvested will be dilutive to existing shareholders if the shares don’t come from the treasury.
When the unit price of the shares is low, like it is now, it is not only dilutive to existing shareholders, but it also doesn’t give a lot of benefit for the company as lower unit prices imply less funds raised. If Cominar had continued with the DRIP, it’d be a lose-lose situation for the shareholders and the business.
The suspension of the DRIP combined with the closure of Sears stores will reduce Cominar’s cash inflows. And so, the REIT chose to reduce its cash outflows by cutting its monthly distribution. By doing this, its payout ratio will be right below 90%, which makes its distribution more sustainable.
Debt and rising interest rates
As of the end of the second quarter, Cominar had reduced its debt ratio from 54.4% to 52.7% compared to 12 months ago. This aligns with Cominar’s goal to decrease its long-term debt levels to 50%.
Cominar has under $1.73 billion in outstanding unsecured debentures that bear interest at an average rate of 4.29%, which is roughly 1% higher than the current five-year mortgage rate. It has nearly 35% of this debt due by the end of 2019. So, the REIT’s interest expense can reduce if interest rates remain low.
In early August, DBRS downgraded the REIT’s senior unsecured debentures to non-investment-grade BB (high) from investment-grade BBB (low). So, the REIT would require a higher interest rate if it chooses to offer more unsecured debentures in the future.
That said, if Cominar finds interest rates to be unfavourable when its current debentures mature, it has $3.6 billion of debt-free properties that it can get collateral loans for.
Investor takeaway
Even after the distribution cut, Cominar’s payout ratio is still ~90%, which doesn’t give it a big margin of safety for its distribution.
Changing interest rates is just one thing Cominar needs to keep an eye on. More importantly, the REIT needs to focus on improving its funds from operations (FFO) per unit, which declined nearly 16.9% in the first half of the year compared to the previous year partly due to some non-core asset sales.
Cominar’s efforts in the first half of the year in renewals and new leases already dealt with almost 80% of the leases, which are maturing this year.
Going forward, unitholders would be more at ease to see some FFO-per-unit improvement, perhaps from its development projects.
