RioCan: Proving Us Wrong, One Residential Building At A Time
Summary
- We had a neutral outlook on RioCan and felt another REIT could deliver better results.
- RioCan executed superbly in 2021 and guided for some impressive growth.
- We examine the recent results and the guidance and see if it can change where we stand.
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All values are in CAD unless noted otherwise.
We last covered RioCan Real Estate Investment Trust (OTCPK:RIOCF) (TSX: REI.UN) back in May 2021. It was trading at a discount unlike its brethren SmartCentres Real Estate Investment Trust (OTCPK:CWYUF) (TSX: SRU.UN), and being bargain hunters, we could not help but give this primarily Ontario-based retail REIT another look.
RioCan has embarked on a multi-year endeavor to reduce its exposure to non-essential retail. It has its eye on developing mixed use properties, where essential retail such as grocery will co-exist with office and residential buildings. This is done on land the REIT already owns, hence the impact on the bottom line is expected to be accretive.
We were not impressed as RioCan would have to (and had started) sell top properties to finance this strategy. We concluded with:
That issue alongside the current distribution yield, makes it a mediocre choice for us at present. We remain neutral here but close to calling this a "sell". SmartCentres is still our preferred play although that is far out of our buy-zone as well. At present we are staying out of both.
Source: RioCan: A Marathon, Not A Sprint
Interestingly, since then, RioCan and SmartCentres tracked each other closely until the former broke away in late February.
We review the results to see if these returns were justified in our opinion or we are just looking at delayed pain for the bulls down the line.
RioCan Q4-2021
Q4-2021 hit the perfect trifecta for RioCan. Funds from operations (FFO) and adjusted FFO (AFFO) came in on target. Alongside that, RioCan showed a good increase in both net operating income (3.4%) and occupancy levels.
Occupancy (RioCan Presentation Q4-2021)
New and retention leasing spreads were quite strong as well.
Leasing Spreads (RioCan Presentation Q4-2021)
RioCan's rent per square foot inched up again and continued squarely to defeat the argument that retail is dead.
Rent Per Sq Foot (RioCan Presentation Q4-2021)
While the numbers were good, none of it was out of our expectation range. We did not think that the REIT would fall apart or have difficulty in meeting its dividend. Our thinking was based on the long-haul projects and the timeline to change this to a more mixed use REIT. Well, RioCan was apparently addressing our concerns square on in the Investor Day meeting.
Outlook
RioCan guided for a 5-7% targeted FFO growth per unit over the next few years. That seemed challenging to us considering the sheer amount of capital recycling we thought the company will have to do alongside building a lot of residential real estate. The company broke that growth being hit with about half coming from the development pipeline and the rest coming from growth of its retail rent mark-ups. For the first, it is aiming for $3.0 billion of residential properties coming online in the next 5 years. For the latter, it is counting on some big leasing spreads. Mind you, it needs total rents to move up by about 13% for this to be achieved but its renewals are rather modest during this time frame. So on those leases, it needs some decent-sized bumps.
We think the plan is a bit optimistic as RioCan will likely run into some strong inflationary headwinds on the build side. That said, if that turns out to be the case, it likely will get stronger rents when these properties are completed. The FFO growth is also likely to be optimistic as there are some retail headwinds that will become visible once we move past the government assistance phase. The plan though is clear and does ease some investor concerns. We think that, like us, the bulk of the retail investor base did doubt the ability to deliver anywhere close to this. The stock has reacted to this positive guidance, and we will have to see how it pans out.
Valuation & Verdict
A clear Mea Culpa is due. We missed the boat here on this name. Not only did it rise strongly on a nominal basis, but it also outperformed our suggested name. We got this wrong.
While we remain concerned about the debt, management also guided for getting the debt-to-EBITDA back under the 9X range.
Debt Load (RioCan Presentation Q4-2021)
The 9.0X number is also extremely high but balanced by a lot of property-specific mortgages and a well spaced out debt ladder.
Debt Ladder (RioCan Presentation Q4-2021)
The valuation, overall, is on the expensive side for us. Yes, we get the move to the residential side but 17X AFFO is still a bit high. Even after their 5-year plan, residential NOI will be under 10%. Last time we covered this, we were close to moving this to a sell. The execution and clear plans that we have seen though, still keep us neutral, despite the big share price gains. We remain sidelined here and this has been also influenced by the sheer abundance of opportunities we are seeing in REITs. Those looking for a redevelopment story should consider H&R REIT (OTCPK:HRUFF) in our opinion.
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.
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