HBC shares jump despite dividend cut

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Hudson's Bay Co. shares surged Monday after the retailer said it would launch a real estate investment trust off of its proposed $2.9-billion (U.S.) purchase of Saks Inc., while investors shrugged off the announcement HBC would halve its dividend and that the deal would be dilutive to its earnings per share.

"A REIT is highly logical," HBC chairman and chief executive Richard Baker told analysts on Monday.

The proposed move follows a recent REIT spinoff from grocery giant Loblaw Cos. Ltd. and one in the works from Canadian Tire Corp. While Loblaw's Choice Properties REIT has risen about 5 per cent since it started trading earlier this month, some analysts and money managers are skeptical about REIT growth in the future.

Despite the 5.8-per-cent rise in HBC shares on Monday, some investors remained concerned about future stock performance given the increasingly competitive retail landscape and weak economic growth across North America that could stunt consumer spending.

"Retail is a very tough business," said Paul Gardner, a partner and portfolio manager at Avenue Investment Management. "It's one of the worst sectors; low margins, high capital costs, renovations and a lot of real estate going up against technology."

However, he says HBC is making a shrewd move given that "the only way to survive is by getting bigger."

HBC, which also owns the Lord & Taylor department store brand, said the combined company would operate 320 stores, as well as three e-commerce sites.

Saks alone owns and operates about 60 per cent of its 42 Saks Fifth Avenue stores, including its New York flagship. The others are owned by a range of real estate companies, other public REITs, or large retail development and management companies, according to Morningstar analyst Paul Swinand.

An HBC-driven REIT has some potential, but the sector is getting a little stale, said Andy Nasr, managing director and senior portfolio manager at Middlefield Capital Corp. "I do think they could surface some value, but there's not as much as there was six months ago," he said.

That said, a REIT that includes properties in both Canada, where real estate has slowed, and the United States, where it's rebounding, could be promising for investors.

"It now becomes a cross-border read, which is more appealing to a lot of Canadian investors," Mr. Nasr said. "There's a lot more room for growth in the U.S. on the real estate side."

With HBC stock, Mr. Nasr is cautious given the highly leveraged Canadian consumer and given that results for both HBC and Saks, although improving, remain "choppy."

While Saks has benefited from increased spending by the U.S. consumer after the recession, Saks's turnaround is "still tepid," Morningstar's Mr. Swinand said in a recent note.

On Monday, Mr. Swinand said the HBC deal is good for Saks shareholders and he reserved his skepticism about REITs, saying the combined company will be stronger than most given that it has three strong brands – HBC, Lord & Taylor, and Saks. "We think this is a good price for Saks's shareholders and believe the deal will go through," he said.

HBC said it's paying $16 a share for Saks, which is a 4.5-per-cent premium to Friday's close, but 30 per cent higher than in late May, when speculation of a takeover drove Saks shares higher.

HBC shares began trading in late November following an initial public offering that valued the shares at $17 (Canadian) each. On Monday, shares closed at $17.45. If the proposed deal closes, HBC said its dividend would drop to 5 cents per share, down from 9.38 cents, "to accelerate de-leveraging in the short term."