RIOCAN REAL ESTATE INVESTMENT TRUST $17 – Toronto symbol REI.UN

RIOCAN REAL ESTATE INVESTMENT TRUST $17 (Toronto symbol REI.UN; Aggressive Growth Portfolio, Manufacturing & Industry sector; Units outstanding: 234.2 million; Market cap: $4 billion; Price-to-sales ratio: 5.4; SI Rating: Average) is Canada’s largest real-estate income trust, with properties in all 10 provinces. RioCan specializes in big-box outdoor malls, and owns 247 retail properties, 13 of which are under development. Most are in suburban areas, where land is generally cheaper than in towns and cities.

The trust also owns office buildings and residential complexes. These represent 4% of its net leasable area of 36.2 million square feet.

RioCan’s revenue rose 31.3%, from $581.7 million in 2004 to $763.8 million in 2008, mainly due to strong interest from retailers for big-box-style malls. These malls now account for 45% of RioCan’s holdings.

Despite the higher revenue, the trust’s annual earnings have stayed between $138.9 million (or $0.67 a unit) and $163.8 million (or $0.83 a unit) for most of the past five years, mainly because of the higher development costs. Cash flow per unit rose from $1.39 in 2004 to $1.51 in 2007, but fell to $1.48 in 2008.

High-quality tenants cut risk

RioCan’s occupancy rate remains high, at 97.1%, despite the recession. That’s because its main tenants are large, established firms, such as Wal-Mart, Cineplex, Canadian Tire and Metro supermarkets. Together, these types of companies account for 84.6% of RioCan’s revenue.

Moreover, grocery stores either anchor or co-anchor 76% of RioCan’s malls. Demand for food tends to remain steady regardless of the direction of the economy, so these stores generate stable rental revenue for RioCan.

As well, RioCan cuts its risk by structuring its leases so that only a small number expire each year. Only 3.0% of its leases expire this year, followed by 9.0% in 2010, 11.2% in 2011, 8.7% in 2012 and 8.8% in 2013.

Another way RioCan lowers its risk is by focusing its new developments on Canada’s biggest cities: Toronto, Ottawa, Montreal, Vancouver, Edmonton and Calgary. Together, these six cities represent 45% of Canada’s population.

Despite the recession, RioCan developed 173,000 square feet of properties in the second quarter of 2009. That’s up 34.1% from 129,000 square feet a year earlier. About 82% of this involved redeveloping existing properties.

Strategy allows for low-cost expansion

RioCan typically leaves lots of room at its malls for expanding existing stores or building new ones. This also lets it add office or residential units in suburban areas as the surrounding population grows.

The trust’s strong balance sheet will let it continue to invest in new and existing properties.

As of June 30, 2009, RioCan’s debt stood at $3.6 billion, or 90% of its market cap. However, a high debt load is common for REITs like RioCan. That’s because they need to borrow to fund new developments, but don’t get cash flow from these projects until they start operating. RioCan also staggers the maturity dates of its borrowings, which keeps its annual repayments manageable.

RioCan is a leading property developer, and its strong reputation helps it raise new capital to fund its development plans. For example, in June 2009, RioCan sold 10.3 million units to the public at $14.50 each, for net proceeds of $143.8 million.

RioCan has raised its distribution every year since it became a REIT in 1995. It currently pays a monthly distribution of $0.115 a unit, for a yield of 8.1% a year. In the first six months of 2009, RioCan paid out 111% of its cash flow as distributions.

True payout ratio is actually lower

The REIT can maintain a payout rate over 100% because about 18% of RioCan’s unitholders opt for new units instead of cash through the trust’s distribution reinvestment plan. RioCan also gives participants in the plan bonus units equal to 3.1% of the number of units received. If you exclude distributions of new units, the payout ratio falls to a more customary 92%.

RioCan’s units peaked at $27 in 2007, but fell to $11.23 last March. While they have risen over 50% since then, they still trade at a reasonable 13.3 times the $1.28 a unit that RioCan should earn this year. They also trade at 13.6 times its projected cash flow of $1.25 a unit.

RioCan is a buy.

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