RioCan: The Recovery Gains Steam

Summary

• RioCan is one of Canada’s largest real estate investment trusts.
• The REIT’s business model faced significant impacts during 2020 as the Covid-19 pandemic shuttered the economy.
• Since mid-2020, the REIT has rebounded, and operations have recovered lost ground.
• The latest quarterly results were strong and suggest the recovery continues to gain steam.
• The organization’s outlook is positive due to its development pipeline, favourable macro tailwinds, and valuations.

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Introduction

RioCan (OTCPK:RIOCF) is one of Canada’s largest real estate investment trusts. The REIT owns, develops, and manages a well-diversified portfolio of retail, mixed-use, and rental properties in Canada’s major cities. The company’s primary focus is in the Greater Toronto Area, followed by five other major urban markets – Ottawa, Calgary, Montreal, Edmonton, and Vancouver. The REIT is listed on the Toronto Stock Exchange under the symbol REI.UN, was founded in 1993 by its former Chief Executive Officer Edward Sonshine, and has been publicly listed since 1994.

For full disclosure, here at Contra the Heard, we have owned RioCan since 2010 when it was first purchased at CAD $19.52 in the aftermath of the Financial Crisis. In September 2020, the position was more than doubled at CAD $14.75 after the shares tanked in response to the global pandemic.

2020’s Pandemic Impacts

RioCan had a rough 2020. The organization’s strategy, which focused on owning real estate in major urban centres around transportation hubs, looked out of sync with the new pandemic normal as people fled to the suburbs and lockdowns kept others at home. Furthermore, the REIT’s portfolio of retail tenants, like grocery and liquor stores, movie theaters, gyms, restaurants, pharmacies, clothing brands, and many other small operators, suffered the brunt of pandemic restrictions. Government initiatives such as the Canada Emergency Commercial Rent Assistance program and later the Canada Emergency Rent Subsidy softened the blow, but the situation was tough.

In Q2 2020, for example, cash rents collected dropped to 73.3%, funds from operations declined 24% versus the prior year quarter, and RioCan (recognizing the issues) offered its smaller tenants a rent deferral program. As cash flows shrank, leverage metrics such as debt-to-adjusted-EBITDA and total-debt-to-total-assets also increased above the publicly stated goals of less than 8 times, and between 38% and 42%, respectively.

In December, RioCan reduced its monthly distribution from CAD $0.12 to CAD $0.08. The move saved CAD $152 million annually, but undoubtedly hurt income-oriented investors who rely upon REITs like RioCan for consistent income.

In all, RioCan’s full year numbers were rough. Revenues fell 13.7%, and the bottom line morphed from a CAD $775.8 million profit in 2019 to a CAD $64.8 million loss. For reference, in 2008 and 2009 during the recession, the REIT still generated net profits of CAD $145.1 million and CAD $113.9 million respectively. Therefore, one could persuasively argue 2020 was the worst year in RioCan’s history.

September 2020 Investment Thesis

Though RioCan’s situation in September 2020 was gloomy and we did anticipate a dividend reduction, we chose to more than double our position in the name at CAD $14.75. There were three reasons for this.

First, executives were reacting proactively to the challenging landscape. They put in programs to help their smaller tenants and implemented cost-saving measures including municipal tax deferrals, energy reductions, staffing adjustments, and salary freezes (see the Q2 2020 MD&A for more details). Management didn’t deviate from their urban strategy either. Even at the height of the pandemic, RioCan remained committed to major urban areas with virtually all of its development pipeline located in its six major urban markets, and 73% of its pipeline focused on the Greater Toronto Area. This, at least in our opinion, made sense as we felt the pandemic – however bad it could get in the short term – would eventually end.

Source: RioCan’s Investor Presentation Q2 2020.

Second, despite the growing leverage and falling cash flows, the financials appeared strong enough to weather the storm. In the second quarter of 2020, unencumbered assets totalled CAD $8.7 billion, liquidity stood at CAD $1.0 billion, and debt service coverage was healthy at 2.78 times.

Finally, the valuations were low, as the charts below suggest.

Source: Seeking Alpha’s historic Price/Sales valuation data for RioCan.

Source: Seeking Alpha’s historic Price/Book valuation data for RioCan.

Source: Seeking Alpha’s historic Price/Cash Flow valuation data for RioCan.

Regression to the mean is often a key ingredient in our analysis as deep value investors. Therefore, we liked the look of these charts in September 2020. Although the units have rallied 52.5% in the prior year, the valuations remain low and RioCan is not trading where it used to. This suggests there is room for the valuations to move higher and implies the recovery has yet to be fully priced in. In summary, RioCan looked like a solid contrary candidate on which to wager in September 2020, and better yet, it was an organization we knew well, given that we’d already been owners since 2010.

The 2021 Recovery and Latest Quarterly Results

RioCan’s latest results were strong. Year over year, revenues were up 10%, funds from operations increased 16%, and the net loss of CAD $350.8 million shifted into a CAD $145.3 million net profit. Cash rent collection has also jumped from 73.3% to 94.7%, and leverage metrics have started to improve. The organization sold an 80% stake in a Toronto-based condo project called “Verge” during the most recent quarter, for a price of CAD $30.4 million. RioCan retains a 20% stake, project oversight, and earns a management fee / income stream in the process.

In other news, Q2 2021 was the first quarter where the new Chief Executive Officer, Jonathan Gitlin, was at the helm. Though he is new to the job, he has been with the company since 2005 and was most recently RioCan’s Chief Operating Officer. The founder and long-time CEO Ed Sonshine is still in the picture as Chairman, and the firm recently appointed a new Chief Financial Officer as well.

Outlook

RioCan’s outlook is positive, with a robust development pipeline and various macro tailwinds at its back. The economy, for example, is recovering from Covid. 75.7% of the Canadian population has been partially vaccinated and 69.5% has been fully vaccinated as of September 14, 2021. These vaccination rates are among the highest in the world which is important as vaccines continue to be effective against variants of the virus. Moreover, Canada’s household savings rates remain in the double digits, which means that Canadians have funds to spend. Moreover, Toronto’s office vacancy rates, retail vacancy rates, and residential vacancy rates are all low versus comparable cities like New York, Boston, Chicago, Los Angeles, and San Francisco. This low vacancy rate is driving up rents, which will flow through to RioCan and its unit holders.

Source: RioCan’s Investor Presentation Q2 2021.

Furthermore, valuations remain low, as the charts above illustrate, and in time dividend expansion is likely. While the firm reduced its payout by a third late last year, the business is built for doling out cash and growing those distributions over time.

Conclusion

Though RioCan faced significant challenges during 2020 as Covid-19 shuttered the economy, the enterprise appeared strong enough to merit an increase of our stake in the name. Since mid-2020, the REIT’s ticker, traded on the Toronto Stock Exchange, has rebounded. The organization has experienced material recoveries in its revenues, funds from operations, and net income. The latest quarterly results were strong, and suggest the recovery is gaining traction. Going forward, the outlook remains positive as Canadian vaccination rates climb, the economy recovers, and rental vacancy rates in the core Toronto market remain low.

Disclaimer:

The opinions expressed – imperfect and often subject to change – are not intended nor should be taken as advice or guidance. The information enclosed in this article is deemed to be accurate and reliable, but is not guaranteed by the author.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of RIOCF either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.