Leasing Spreads And Limited Retail Supply Will Support Long Term Earnings Power

Catalysts

About RioCan Real Estate Investment Trust

RioCan Real Estate Investment Trust owns and operates necessity based retail properties concentrated in Canada’s largest, densest urban markets.

What are the underlying business or industry changes driving this perspective?

• Limited new retail supply in major Canadian markets, combined with persistent demand from strong necessity based retailers, is expected to sustain high occupancy and mid teens leasing spreads. This supports continued same property NOI and revenue growth.
• Over 10 million square feet of leases rolling in the next three years at in place rents well below current market levels provides visible mark to market potential as contracts reprice, which should support higher rental revenue and FFO per unit.
• Capital recycled from the sale of residential assets and the wind down of mixed use development can be redirected to retail infill projects on existing sites. This can add higher yielding square footage that may enhance NOI margins and long term earnings growth.
• Ongoing use of the normal course issuer bid while units trade at a sizable discount to NAV, alongside disciplined debt repayment, can support compounding NAV per unit and potentially lift FFO per unit as the equity base shrinks and interest expense moderates.
• Upgraded data and analytics capabilities across leasing, asset management and capital allocation should enable more precise rent setting, tenant mix optimization and project selection. This may improve operating efficiency, net margins and earnings stability over time.

Assumptions

How have these above catalysts been quantified?

• Analysts are assuming RioCan Real Estate Investment Trust's revenue will grow by 1.4% annually over the next 3 years.
• Analysts assume that profit margins will increase from 5.4% today to 63.3% in 3 years time.
• Analysts expect earnings to reach CA$823.0 million (and earnings per share of CA$5.88) by about December 2028, up from CA$66.8 million today.
• In order for the above numbers to justify the price target of the analysts, the company would need to trade at a PE ratio of 8.8x on those 2028 earnings, down from 80.7x today. This future PE is lower than the current PE for the CA Retail REITs industry at 15.2x.
• Analysts expect the number of shares outstanding to decline by 0.91% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.2%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Ongoing weakness in the broader land and development market and the decision to defer large mixed use projects such as Colossus, Scarborough Center and RioCan Hall for a number of years could lock in lower value for excess density and limit future embedded growth, putting downward pressure on long term NAV growth and earnings.
• If competition from new condo deliveries in key Toronto submarkets continues to weigh on rent growth and occupancy in the remaining residential rental buildings, the trust may face further fair value write downs and weaker than expected disposition proceeds, which would dampen capital recycling capacity and net income.
• A sustained environment of higher interest rates or tighter credit conditions would reduce the benefit of current deleveraging efforts, raise refinancing costs on unsecured debt and pressure interest coverage ratios, which could offset NOI gains and constrain FFO per unit growth.
• Reliance on a concentrated base of large anchor and necessity based tenants, some with long term fixed rent renewals such as Walmart, risks creating a ceiling on mark to market opportunities if retailer growth slows or bargaining power shifts, limiting future leasing spread upside and moderating same property NOI and margin expansion.
• The planned wind down of development, moderating fee and interest income from third party projects and HBC related assets, and a strategic pivot away from mixed use could structurally reduce diversified income streams and leave results more exposed to cyclical swings in core retail demand, increasing volatility in revenue and FFO per unit over the long term.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The analysts have a consensus price target of CA$20.57 for RioCan Real Estate Investment Trust based on their expectations of its future earnings growth, profit margins and other risk factors.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of CA$22.5, and the most bearish reporting a price target of just CA$18.0.
  
• In order for you to agree with the analysts, you'd need to believe that by 2028, revenues will be CA$1.3 billion, earnings will come to CA$823.0 million, and it would be trading on a PE ratio of 8.8x, assuming you use a discount rate of 7.2%.
  
• Given the current share price of CA$18.26, the analyst price target of CA$20.57 is 11.2% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.