So for us RioCan is a no-go at this stage of the cycle. Sure, it can go up, but the risks are not worth it to us. We are sticking with high quality bonds where we can get 7% plus returns with minimal to zero risk. We will get interested in RioCan possibly in the heart of the recession where the return profile will likely be better.
Source: “Look For More Valuation Compression.”
Since then, the stock is down about 3%. Investors might recall that we gave SmartCentres REIT (OTCPK:CWYUF) (SRU.UN:CA) the same “hold” rating but gave a “buy” to Automotive Properties REIT (APR.UN:CA).
All 3 ratings were around the same time and underscored our relative preference for a particular metric. What is that metric and has that changed today for RioCan? Let’s look at the Q2 2023 results and find out.
The starting point for the discussion for RioCan was the 5.2% increase in same property net operating income (NOI).
That increase resulted in a smaller increase in funds from operations (FFO) per share, which increased from 43 cents to 44 cents. The company continue to have a healthy liquidity profile, supported by a low payout ratio (sub 60%) and continued asset sales. As shown below in the next slide, the company remains on track for meeting its targets for the year.
This is not surprising, as the high demand continues to drive occupancy levels to maximum, and that results is better leasing spreads.
RioCan’s retention rate was high as usual and blended leasing spreads reached a double-digit milestone. Investors should also remember that only a small percentage of leases come up for renewal at any time and portfolio rents as shown in the third part of the slide below, move very slowly over time.
RioCan stuck to its 2023 guidance for FFO of $1.785 (midpoint). The company’s biggest hurdle here is completing development projects successfully while keeping interest costs low. The plan is to support the projects partially from retained cash flow after dividends and add capital recycling to lower debt ratios further.
If you look at the trailing 12-month information, though, there is no active debt reduction.
What RioCan is aiming for is a rising EBITDA, which automatically lowers debt to EBITDA ratios. Sure, there is the $860 million in asset sales total over 2023-2026.
But the company is planning $400-$450 million capex just in 2023. Debt to EBITDA is still at near 9.5X. That is at least 2 turns above where it needs to be in our opinion, and maybe just 1 turn higher if you use management’s target level.
The weighted average term to maturity of the debt is also just 3.37 years. Even there, management is aiming for 5 years. RioCan does have a well-spaced out debt maturity profile, but there is over $2.7 billion due in the next 2.5 years.
Thanks to some heavy hedges in place, the weighted rate on debt is still very low.
But over the next 2.5 years we will see at least a 2% increase on $2.5 billion of debt, and that works to $50 million extra that will weigh against FFO. Will leasing spreads be sufficient to offset that headwind and create growth? We are fairly certain on the former but we remain skeptical on the latter. One force that has worked for RioCan is that retail supply has been awfully low over the past years.
That, coupled with a large amount of immigration, has meant that nominal sales per unit of retail space has held up. Still, the continuous rate hikes by Bank of Canada, alongside a very short weighted debt profile for mortgages, will mean retail is likely to be pinched hard in a recession.
You have to love the RioCan Real Estate Investment Trust results. If we saw these with a 6 or 7X debt to EBITDA, we would be all over this name. At 9.5X, you have to pause and ask yourself how you see this evolving. The REIT has held up, as there is simply a shortage of both the condos it is selling and the retail space it owns. Maybe that works out at 9.5X debt to EBITDA. It certainly can. Valuation is not too demanding on the price to FFO levels, as RioCan is trading at 10.5X 2024 FFO levels.
Some people might be focused on the RioCan Real Estate Investment Trust NAV discount, but we are not too optimistic on that front. That NAV is derived using 5.33% cap rates and with a debt load that large, a 1% move in the cap rate should wipe out most of the “discount.” We have previously suggested longer-dated covered calls as an alternative when a stock is close to a price we like. But here, the implied volatilities are stupidly low.
So they don’t really give you an extra bang for your buck and there is very little downside protection to be had with at-the-money calls. Last time, we suggested that valuation compression was the theme for 2023, and we think we will see more of it over time. We will likely get a sub 10X FFO multiple at some point, but dividends and growth in FFO should offset that pain. RioCan gets a 5 on our potential pain scale rating.
Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.