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Retrocom: A small REIT with big-growth potential Add to ...

Retrocom Mid-Market Real Estate Investment Trust may not be a household name, but as a flood of U.S. retailers rushes into Canada looking for space the small landlord is likely to get a big boost.

The Toronto-based company owns retail space in several key Canadian cities, and is in the midst of reinventing itself with some help from SmartCentres, one of the real estate industry's most successful developers.

It promises to be a busy year for the company, with management intending to announce its strategic direction in coming months, said CIBC World Markets Inc. analyst Brad Sturges.

"It is possible that the name of the REIT could be changed, representing the new strategic philosophy that the new management holds. The REIT is also working on a marketing program for its 35 properties to better position the assets in their respective communities," he noted.

What is it

Retrocom is a relatively small real estate investment trust that owns a 4 million square foot portfolio of community shopping centres in smaller Canadian cities. It is externally managed, with retail powerhouse SmartCentres - a major Wal-Mart Canada landlord and developer of outdoor power centres across the country - consulting on leasing and development.

How have the units performed?

The company's units have gained about 15 per cent this year, and are 60 per cent higher than they were a year ago. Two analysts follow the company, according to Bloomberg - one has a "buy" and one has a "hold." Their average price target is $6.38, modestly above the current trading price. The trust currently yields 7.7 per cent.

In its most recent quarter, it posted funds from operations - a key measure of profitability for real estate investment trusts - of 9 cents a unit. CIBC World Markets estimated annual funds from operations should improve from 40 cents a unit this year to 50 cents by 2012.

What's the back story?

After going public in 2004 and trading briefly over $10 a unit, the company cut its distribution by 20 per cent and faced the wrath of investors. Within two years the company had undertaken a "strategic review" that led to the replacement of several executives and a renewed focus on retail properties.

In 2006, the company put itself up for sale. But rather than a complete deal, Retrocom partnered with SmartCentres that saw the developer take a 38 per cent stake in the company.

"[The deal]represented the beginning of a long-term strategic relationship, which has only more recently served as the catalyst for Retrocom REIT's transformation," said Neil Downey, an analyst at RBC Dominion Securities Inc. "Interestingly, the ties between the two firms were strengthened further in August 2010, as Retrocom moved its head office to SmartCentres' building in Vaughan, Ontario."

What could give the units a boost?

Eight of its properties - accounting for about 40 per cent of its leasable space - are anchored by Zellers stores. Up to 200 Zellers locations are being converted to Target stores, which could be a boon for landlords who would be able to increase rents and attract better tenants to their malls.

"Should Target choose to assume a large percentage of these leases, the prospects for increased/higher-quality cash flow could be a potential catalyst behind a higher unit price," said Mr. Downey.

At the end of the fourth quarter, Retrocom had a vacancy rate of approximately 13 per cent - compared to its competitors who typically have rates ranging from 1 to 5 per cent. RBC has estimated that each percentage point of improvement in the occupancy rate adds $700,000 in revenues.

"Management sees the potential to improve occupancy as a 'low-hanging fruit' in its ability to drive earnings growth," Mr. Downey said. "Leveraging SmartCentres' leasing expertise and investing incremental capital into properties should be the drivers of occupancy gains... thus, improving occupancy by even a few percentage points could have a measurable effect on earnings growth.'

The company has also turned its sights to improving the properties. In the last year it has started renovations at the Southland Mall in Regina, Wheatland Mall in Swift Current, Sask., Lincoln Value Centre in St. Catharines, Ont. and the Chilliwack Mall in Chilliwack, B.C.

"Although Retrocom's redevelopment program may cause a temporary decline in net operating income as [space]is taken off-line for construction, we believe these initiatives will improve the long-term value of the REIT's existing property portfolio through increasing occupancy levels, which could lead to higher in-place rents over time," Mr. Sturges said.

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