Even good companies hit a rough patch from time to time.
Case in point: Canadian REIT.
Widely regarded as one the country's best-managed real estate investment trusts, CREIT (as it's also known) has suffered the double whammy of a downturn in the REIT space in general and exposure to Calgary's slumping office market in particular. After years of steady gains, the units have pulled back sharply. From a high of $50 in late 2014, they've fallen about 18 per cent. On Tuesday, CREIT closed at $41.19, down 10 cents.
I own CREIT's units personally and last summer I added to my position because, as a long-term investor, I believed the slump in the unit price presented a buying opportunity. I would love to report that the units have rebounded since then, but they've actually dropped a bit more.
So is it time to quit on CREIT? Not at all. Notwithstanding the current setback, I believe CREIT's long-term outlook remains solid. Here's why:
Cash flow is still growing
Even with the oil bust in Alberta, CREIT's total funds from operations or FFO (an industry measure of cash flow) still rose 2.4 per cent in 2015, which is within its target range of 2 per cent to 3 per cent annually. And FFO will likely continue to rise, albeit at a modest pace, in both 2016 and 2017, analysts say. CREIT's steadily growing cash flow has enabled the REIT to increase its distribution for 14 consecutive years, and more increases are expected as CREIT expands its property portfolio. The next hike could come within months: "We expect a 2016 increase, with an announcement by midyear," RBC Dominion Securities analyst Neil Downey said in a note.
The portfolio is diversified
CREIT owns a portfolio of nearly 200 retail, industrial and office properties across Canada, providing diversification by geography and property type. That helps to limit the damage when a specific sector is struggling: CREIT's highest vacancy rate is at its Calgary Place office complex, which is about 30 per cent empty after the departure of a major tenant. But office properties in total contribute just 22 per cent of CREIT's net operating income (with Calgary accounting for less than half of that), while retail and industrial properties generate 55 per cent and 23 per cent of income, respectively. Across the entire portfolio – which includes anchor tenants such as Canadian Tire, Loblaw, Sobeys and Wal-Mart – occupancy was a solid 94.6 per cent at the end of 2015. Looking ahead, CREIT is aiming to diversify its portfolio further by branching into rental apartment units. Because of CREIT's broad diversification and high-quality assets, "for individual investors seeking only one REIT in their portfolio over the long term, we often recommend CREIT," Mr. Downey said.
Management is conservative
CREIT has one of the industry's lowest payout ratios, which protects its distribution during difficult times and also frees up cash for it to put to productive use. In 2015, CREIT paid out just 59 per cent of FFO and 74 per cent of adjusted funds from operations or AFFO (a more stringent measure of cash flow that deducts maintenance capital expenditures). The balance sheet is also conservative, with EBITDA (earnings before interest, taxes, depreciation and amortization) covering interest payments by about 3.3 times – among the highest in the REIT space – and debt representing just 37.7 per cent of the gross book value of its properties, which is well under the 60-per-cent limit imposed by CREIT's own declaration of trust. As these ratios indicate, CREIT has the financial armour to do battle in the most challenging of economic conditions.
The valuation is attractive
Reflecting CREIT's solid track record, excellent diversification and strong financials, the units trade at higher multiples of cash flow than the industry average. However, the units are still priced at a discount of more than 10 per cent to the estimated net asset value of CREIT's properties, analysts say. That, plus the attractive 4.4-per-cent current yield and the prospect of future distribution growth, makes CREIT worth investigating further for income-seeking investors.
Closing thoughts
The downturn in Alberta will likely continue to pressure CREIT's results, and a prolonged recession could also hurt CREIT's retail and industrial properties in the province. But CREIT is in a strong position to weather the slump, analysts say.
"We continue to view CREIT as a core holding for investors, reflecting its conservative strategy, strong balance sheet and high cash flow retention, while maintaining a low payout ratio," CIBC World Markets analyst Alex Avery said in a note.
The silver lining for investors? Should the Alberta office market recover, CREIT would likely trade at "a significantly higher valuation," he said.
CREIT is certainly not without risks. A sluggish economy, a slowdown in consumer spending or a rise in interest rates would all pose a challenge. But CREIT has successfully navigated through difficult times before and it will likely do so again.
Yield Hog is part of Globe Unlimited's Strategy Lab series. Subscribers can read more at tgam.ca/strategy-lab