Over the last five years, the stock market has taught us one thing. Balance sheet debt should not be taken lightly, especially for dividend stocks. An inflationary environment, weak demand, regulatory changes, high interest rates, and market uncertainty make debt difficult to service. If companies have tight cash flow, with only enough cash to service debt and pay dividends and no financial flexibility, you can’t rely on those dividends, as they are the first to take the hit.
Dividend cuts by some strong dividend giants have made investors apprehensive of chasing high yields and opt for safer payments.
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Where to look for dependable cash payments?
When looking for dependable payments, seek dividend stocks with lower debt and significant cash flow that can manage inflation and provide assured cash flow in every market. You may think that only utility-like businesses can give dependable cash payments. But some non-critical businesses with impeccable business models and strong financial discipline are also a dependable source of cash payments.
Many REITs have slashed dividends post-pandemic. Sometimes lower occupancy was the cause, as was in the case of commercial REITs and RioCan. Sometimes rising maintenance costs drove up the dividend payout ratio above 100%, as was the case with Slate Grocery REIT. Such risks are beyond the REIT’s control, and all they can do is maintain a buffer to sustain inflation or a lean period. This is called the cost of holding. CT REIT (TSX: CRT.UN) overcomes external risk with its subsidiary model.
An impeccable business model
Although a REIT by structure, CT REIT is a subsidiary of retailer Canadian Tire (TSX: CTC.A). The inter-company transactions at fair market value protect it from lower occupancy issues. Let’s see how.
Business structure: Canadian Tire bought several stores over the years and built a sizeable property portfolio. It then opened a subsidiary, CT REIT, in which it has a 68% interest through Class B LP Units and Class C LP Units (debt), and 34 million units (equity). CT REIT used this money to purchase many of Canadian Tire’s stores and lease them back to the retailer. As the REIT buys property directly from the retailer, it need not pay brokerage and financing costs.
Debt levels: Canadian Tire has given debt worth $1.5 billion, a credit facility worth $113 million, and equity to CT REIT. It also pays rent on stores it leases from the REIT. CT REIT uses that rent to pay Canadian Tire a weighted average interest of 4.9% on Class C LP Units, service the credit facility, and pay distributions on equity units.
If we make a full circle, Canadian Tire is paying itself interest and distributions while claiming deductions on rent expense. The retailer gets a tax-deductible rent expense, and the REIT gets income. By keeping financing and leasing in-house, CT REIT protects itself from macroeconomic uncertainties.
Distribution ratio: For maintenance and intensification, CT REIT claims that amount through higher rent spread over the lease term. After deducting all operating, repairs, and maintenance costs, the REIT’s distribution amount is 72.7% of the adjusted funds from operations.
Strong financial discipline that makes cash payments dependable
To control development costs, CT REIT does not develop or intensify more than two properties at a time. This financial discipline keeps working capital under control, as properties under development don’t generate yield, and high inflation could increase development costs.
How to invest in CT REIT through a TFSA
CT REIT’s business model makes it a dependable dividend stock for your Tax-Free Savings Account (TFSA). You can lock in a 5.4% annual dividend yield, which the REIT pays in 12 monthly installments. It is perfect for a TFSA, as withdrawals are tax-free. If you opt for a dividend reinvestment plan (DRIP), you will be exempt from dividend tax and also enjoy 3% bonus units on the dividend amount. If your reinvested dividend is $100, CT REIT will issue DRIP units worth $103.
By investing in CT REIT through a TFSA, you could get inflation-adjusted, tax-free, dependable cash payments, with the option of compounding.
