John Heinzl is the dividend investor for Globe Investor's Strategy Lab. Follow his contributions here. You can see his model portfolio here.
When I shop at the grocery store, I like to buy things on sale. The same goes for my investments: I prefer to buy good companies when they're selling at a discount.
Which brings us to Canadian Real Estate Investment Trust. Shares of Canada's oldest – and, some say, best-managed – REIT have plunged about 14 per cent since peaking at $50 in November. On Tuesday, they closed at $42.87, down 11 cents. I've owned Canadian REIT for years personally and I recently took the opportunity to add to my position.
I have no idea what Canadian REIT's unit price will do in the short run. But I'm confident that, over the long run, the units will rise, as will the distribution. Here's why:
It has a solid track record
Canadian REIT's distribution has grown for 14 consecutive years. It even rose during the financial crisis of 2008 and 2009, which is a testament to the company's financial stability and operating expertise. The most recent increase, of 2.9 per cent, was announced on April 30 and brought the monthly cash payout to 15 cents a unit, or $1.80 annually. Because of the rising distribution and falling unit price, the yield has climbed to an attractive 4.2 per cent from 3.5 per cent less than eight months ago.
It's run conservatively
Even though Canadian REIT raises its distribution regularly, it has one of the lowest payout ratios in the industry. In 2015, analysts expect it to pay out just 68 per cent of adjusted funds from operations (AFFO) – a measure of a REIT's operating cash flow. The conservative payout ratio allows it to reinvest excess cash in the business and also gives the the distribution ample protection should the economy head south. Canadian REIT also has a conservative balance sheet, with a 6.9 times ratio of net debt to estimated 2015 EBITDA (earnings before interest, taxes, depreciation and amortization), compared with a sector average of 8.3 times, according to Scotia Capital analyst Pammi Bir.
It's diversified
Canadian REIT generates about 55 per cent of its operating income from retail properties, whose anchor tenants include stable chains such as Canadian Tire Corp. Ltd., Wal-Mart Stores Inc. and Loblaw Cos. Ltd. The remaining 45 per cent of income is derived roughly equally from industrial and office properties. The REIT is also diversified geographically, with Alberta accounting for 37 per cent of income, Ontario 27 per cent and smaller contributions from other provinces. The downturn in Calgary's office market poses a challenge for Canadian REIT, but its less volatile retail properties and presence in provinces not directly hit by the oil slump should help it weather the storm.
It's growing
Canadian REIT's property portfolio is growing at a steady pace. Its $586-million development pipeline comprises 23 projects that will add about 3.1 million square feet of space over the next five years or so – an increase of about 14 per cent from current levels. These developments and others should keep Canadian REIT's cash flow and distributions growing well into the future.
The valuation is reasonable
In a recent report, Raymond James analyst Johann Rodrigues said Canadian REIT's units (priced at $42.27 at the time) were trading at an 8-per-cent discount to the net asset value of its properties – "the second-largest discount in its history." What's more, the units were trading at 15.6 times next year's estimated AFFO, well below the five-year average of 16.9 times AFFO. "We think the current price provides investors with an attractive entry point on one of the best REITs in Canada," Mr. Rodrigues said. The units have moved up slightly since the report, but they're still well back of Mr. Rodrigues's price target of $47.
Closing thoughts
One risk with buying REITs is a potential rise in interest rates. Because REITs borrow to finance properties, and because they generate stable, bond-like cash flows, they can be vulnerable if rates rise sharply. On the other hand, rising rates generally accompany an improving economy, which is good news for REIT occupancy levels. A prolonged downturn in the oil patch could also put pressure on Canadian REIT's units. Keep these risks in mind, and remember to do your own due diligence before investing in any security.