You May Have Been Looking At SmartCentres Real Estate Investment Trust (TSE:SRU.UN) All Wrong

SmartCentres Real Estate Investment Trust is a CA$5.00b mid-cap, real estate investment trust (REIT) based in Vaughan, Canada. REIT shares give you ownership of the company than owns and manages various income-producing property, whether it be commercial, industrial or residential. The structure of SRU.UN is unique and it has to adhere to different requirements compared to other non-REIT stocks. In this commentary, I'll take you through some of the things I look at when assessing SRU.UN.

View our latest analysis for SmartCentres Real Estate Investment Trust

Funds from Operations (FFO) is a higher quality measure of SRU.UN's earnings compared to net income. This term is very common in the REIT investing world as it provides a cleaner look at its cash flow from daily operations by excluding impact of one-off activities or non-cash items such as depreciation. For SRU.UN, its FFO of CA$353.1m makes up 71.6% of its gross profit, which means the majority of its earnings are high-quality and recurring.

In order to understand whether SRU.UN has a healthy balance sheet, we have to look at a metric called FFO-to-total debt. This tells us how long it will take SRU.UN to pay off its debt using its income from its main business activities, and gives us an insight into SRU.UN’s ability to service its borrowings. With a ratio of 8.3%, the credit rating agency Standard & Poor would consider this as aggressive risk. This would take SRU.UN 11.98 years to pay off using just operating income, which is a long time, and risk increases with time. But realistically, companies have many levers to pull in order to pay back their debt, beyond operating income alone.

I also look at SRU.UN's interest coverage ratio, which demonstrates how many times its earnings can cover its yearly interest expense. This is similar to the concept above, but looks at the upcoming obligations. The ratio is typically calculated using EBIT, but for a REIT stock, it's better to use FFO divided by net interest. With an interest coverage ratio of 2.63x, SRU.UN is not generating an appropriate amount of cash from its borrowings. Typically, a ratio of greater than 3x is seen as safe.

I also use FFO to look at SRU.UN's valuation relative to other REITs in Canada by using the price-to-FFO metric. This is conceptually the same as the price-to-earnings (PE) ratio, but as previously mentioned, FFO is more suitable. In SRU.UN’s case its P/FFO is 14.15x, compared to the long-term industry average of 16.5x, meaning that it is slightly undervalued.

Next Steps:

SmartCentres Real Estate Investment Trust can bring diversification into your portfolio due to its unique REIT characteristics. Before you make a decision on the stock today, keep in mind I've only covered one metric in this article, the FFO, which is by no means comprehensive. I'd strongly recommend continuing your research on the following areas I believe are key fundamentals for SRU.UN:

1. Valuation: What is SRU.UN worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether SRU.UN is currently mispriced by the market.
2. Management: Who are the people running the company? Experienced management and board are important for setting the right strategy during a volatile market. Take a look at information on SRU.UN's executive and directors here.
3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.

Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.