2023-11-06 10:00:00 ET
Summary
- RioCan reported strong same property growth in Q3-2023, driven by occupancy rental growth.
- The REIT continues to maintain positive leasing velocity.
- We go over what we like and what we do not in the current setup.
All amounts referenced are in Canadian dollars unless noted otherwise
On our last coverage of RioCan ( REI.UN:CA ) we gave it a passing grade. The valuation was ok, the yield was decent, and we even identified all that it was doing right. We still could not hit the buy button and left you with this.
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.
Source: Moving Slowly To Our Target
The stock is down slightly since then. It was down significantly at one point, but last week's big bounce helped close the gap. On a longer timeline, we have only once given a buy rating on this and were fortunate to suggest an exit from that near the peak. Note that the amounts shown here reflect the OTC trading stock in US dollars.
We now look at the numbers from Q3-2023 and give you our take on how we read the tea leaves.
Q3-2023
RioCan reported 45 cents of funds from operations ((FFO)) and this was a bit ahead of consensus. The net loss comes from the IFRS requirement to mark properties to fair value and RioCan saw it fit to reduce valuations (increase cap rates) on some projects.
Same property net operating income ((NOI)) was quite strong and came in at 3.7% with year to date numbers at 4.3%. We will note here that this is still exceeding the company's original guidance, despite some turbulence in the economy since then.
RioCan highlighted the key number here that were driving same property NOI and that was the blended rental spreads of 14.9%. It also showed the embedded value in the portfolio. Current net rent is miles away from what deals they are signing on today, at $27.38 per square foot.
So the argument can be made that even in the case of economic weakness, rent growth will still trend up, even if it is at a lower rate.
Outlook
RioCan is still extremely capital intensive. You can see the "disciplined capital allocation framework" below.
In their system, the way to get their debt to EBITDA down over time is to pretty much not even bother reducing debt. It is via adding more EBITDA over time. That can work in many cases, but we are still not blown away by the idea. The company is still dancing with 9.45X debt to EBITDA. This is after quarter of completed developments and some asset sales as well. This quarter we saw completion of 151,000 square feet of net leasable area at The Well. 2023 will mark the completion of almost 600,000 square feet, and we will be on pace to do a similar amount in 2024. But the spend remains incredibly high in relation to what NOI is coming. These are relatively low cap rate projects. For example, even after all the enhancements, the residential side is still yielding a sub 5% cap rate.
So if you spend $400 million, you get an NOI of under $25 million. This is not going to do anything for debt to EBITDA and might even make debt to assets worse in a rapid rate rising environment unless we start disposing assets. The current numbers are showing debt to EBITDA at 9.45X.
11 months back we were right here.
Q4-2021, was just a shade higher.
That number is further worsened with a 3.25 year weighted average debt maturity.
Sure, if you exclude the development capex you can show a 7.2X net debt to EBITDA.
We would be happy to own it at that number with slow growth from the retail side. As far as we are seeing here, growth remains still on the low side with all of this debt as RioCan is facing rapidly rising interest costs. This is happening even with few refinancings. Consensus is for FFO to increase 3% in 2024 despite these headwinds, but that is hardly an earth shattering number to run with 9.5X leverage levels.
Verdict
As well roll out to looking at 2024 and 2025 estimates, RioCan begins to look cheap. Canada's awful immigration policy which has got in more immigrants than the system can deal with, has provided a floor on real estate values. RioCan is also benefitting from this as rents at renewals are really set at gross sales levels and those have continued to climb with the dual tailwinds of higher population and strong trailing inflation. So even in a mild recession, we don't really see RioCan suffering all that much. The stock is arguably cheap relative to its history. 2024 FFO multiple is near 10X and the stock traded during ZIRP at 13.5X. Of course, we gave you the answer right there as to why this is also "not cheap." Unless you are expecting ZIRP to make a comeback, there is only so far up the multiple ladder you want to climb with a 9.5X leverage level. The stock is trading at a modest discount to the consensus NAV estimate of $23.76 per share. The low estimate though is $18.08, and we think that is likely to be more accurate if we hit a recessionary bump. Pretty much no one is buying RioCan's NAV estimate of near $26 per share, and the stock continues to trade at a wide discount to that estimate. This is one of the widest discounts in the IFRS era (post 2014) and only exceeded in the COVID-19 crash.
The company did maintain its guidance for 2023 though it was forced to aim for the lower end of the range. Access to capital remains good and the recent debentures bore an interest rate of 6.488%. We rate the stock a hold and think the upside and downside risks are roughly balanced.
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.
For further details see:
RioCan: Wide Discount To NAV, What Keeps Us Out