SmartCentres: A 5.9% Yield From This Walmart-Anchored Grocery REIT

Summary

  • SmartCentres is a commercial REIT with Walmart as its largest tenant.
  • The REIT is diversifying into residential and self-storage development to diversify its asset base.
  • The 5.9% distribution is fully covered, but extending the leases expiring in 2022-2025 will be a key element to remain bullish.
  • Looking for a helping hand in the market? Members of European Small-Cap Ideas get exclusive ideas and guidance to navigate any climate. Learn More »

Walmart retail store entrance in Kanata, Ontario in Canada

Iryna Tolmachova/iStock Editorial via Getty Images

Introduction

I like grocery-anchored REITs and in Canada there are a few REITs with close ties to the main grocery chains. Choice Properties REIT (OTC:PPRQF) is related to the stores under the Loblaws banner and Crombie REIT (OTC:CROMF). In SmartCentres' (OTCPK:CWYUF) case, Walmart (WMT) accounts for about 25% of its annual rental revenue as the US-based grocery chain leases 101 stores in Canada from SmartCentres.

Chart
Data by YCharts

SmartCentres has its primary listing on the Toronto Stock Exchange where it's trading with SRU (or in some cases SRU-UN or SRU.UN) as the ticker symbol. The average daily volume exceeds 300,000 shares and the current market capitalization is just under C$5.4B. I will use the Canadian Dollar as base currency throughout this article.

Still anchor-focused, with a strong FFO and AFFO performance

The list of names of the 25 most important tenants does read like a who-is-who of the North American retail landscape. While Walmart is the largest tenant representing just over 25% of the gross rental revenue, there are several other grocery chains in the SmartCentres portfolio with for instance Loblaws making up an additional 2.8% of the rental income and Sobeys (also doing business as Safeway) represents an additional 2.1% of the annual rental income.

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SmartCentres REIT Investor Relations

This doesn't mean SmartCentres is a slam dunk as although most of the tenants appear to be sailing through the fallout of the COVID pandemic without too much damage, some retailers are struggling and number 14, Reitmans, is still in creditor protection while number 11, Recipe Unlimited, operates restaurants.

Breakdown

SmartCentres REIT Investor Relations

So although the portfolio of assets is clearly grocery-weighted, it will remain important to keep an eye on the rent collection levels at SmartCentres as this will ultimately determine the FFO, AFFO and the distribution. Additionally, SmartCentres will have to start dealing with lease expiries as in the 2022-2025 time period about 49.6% of the total square footage will be up for lease renewal. Some may think this could be an excellent moment for SmartCentres to hike the prices but maintaining a high occupancy ratio is the most important for me.

Lease expiration

SmartCentres REIT Investor Relations

Fortunately the collection rate remains strong as the average collection rate during Q3 2021 was approximately 97.1% while as of Oct. 22, it also already collected 94.6% of the monthly billings for that month. The table below shows SmartCentres only had to deal with a sub-90% collection rate for one month, after taking the Canadian government subsidy scheme into account.

Table

SmartCentres REIT Investor Relations

In the third quarter, SmartCentres reported a total FFO of approximately C$98M and an ACFO of C$92M including some adjustments.

Table

SmartCentres REIT Investor Relations

The ACFO also includes the gain on the sale of condominiums on the newbuild projects. The other "adjustments" include non-recurring events like the departure of a CEO and COVID-19 related expenditures as SmartCentres spent about C$0.8M on vaccination centres. Applying the ACFO with adjustments on the 172.3M shares represents an ACFO of C$0.53 per share.

Another important metric is the debt level. As of the end of September 2021, SmartCentres reported a debt to gross book value of 50.4% and a debt to aggregate assets (which includes the assets held for sale and equity accounted investments) of 44.5%.

The distribution remains stable for now

SmartCentres is currently paying a monthly distribution of C$0.15417 per share, which works out to be C$1.85 per share. Using the current share price of C$31.39, the current distribution rate represents a dividend yield of approximately 5.9%.

On a quarterly basis, the distributions come in at C$0.4625/share which means the coverage ratio of the current distribution rate is almost 115%. That's rather comfortable but it also indicates the condominium sales are important for the distribution coverage ratio. Excluding these condo sales, the ACFO would have been just C$0.487 for a coverage ratio of 105%. This doesn't mean we can just dismiss the condo sales as non-recurring as this simply is a return on an investment for SmartCentres. While it may not be a rental income, it is quite capital intensive to build condos and once this source of income dries up, SmartCentres can just easily redeploy the cash elsewhere.

As you can see on the image below, the Q3 condo sales income of C$6.4M was generated on an investment of C$17.5M. The cash investment is now being recycled and redeployed in other divisions of SmartCentres' pipeline.

Table

SmartCentres REIT Investor Relations

The distribution is still comfortably covered by both the FFO and ACFO, but I wouldn't mind seeing SmartCentres retaining a larger chunk of the earnings as the REIT is in the middle of a big push towards residential development. The SmartVMC project, where SmartCentres is pushing to redevelop a large plot in Vaughan, a suburb of Toronto where a total of almost 5,000 new units are being developed.

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SmartCentres REIT Investor Relations

The REIT's presentation offers excellent insight in how the management is working toward the full development of the plots and the end result (including the developments mentioned above) should look like this:

Image Vaughan city centre

SmartCentres REIT Investor Relations

While the focus will be on residential units, SmartCentres also has plans for other assets in its portfolio as it's pivoting away from being a pure commercial REIT to a more diversified REIT with exposure to residential, senior's residential and self-storage real estate assets.

Table

SmartCentres REIT Investor Relations

Investment thesis

I currently have a small long position in SmartCentres which I initiated in Q3 2020 when my previous article on the REIT was published. The share price is now almost 60% higher but I don't see a reason to sell my position yet. I like the move toward developing new assets and I'm happy to see a diversification towards residential assets.

The distribution is fully covered and the main focus in 2022 and 2023 will be on the lease extensions of its existing asset portfolio. The next three to four years will be very important for the REIT to renew leases.

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This article was written by

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Disclosure: I/we have a beneficial long position in the shares of CWYUF 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.

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