Michele Robitaille, senior portfolio manager at Guardian Capital LP, says that after their stellar performance over the past two years, Canadian real estate investment trusts are likely to produce a more modest showing this year.
"Still, in the context of income-generating equities, REITs remain attractive relative to other income-producing securities," says Robitaille, who is a member of Guardian Capital's equity-income team.
"The current average yield on REITs is 5.7%, she notes. This compares "favourably" with the yield on the DEX High Yield Bond Index (a measure of the Canadian non-investment grade fixed-income market) of 6.7%, the yield on the new S&P/TSX Equity Income Index of 5.3%, and 4.6% on BBB Corporate bonds, (which are investment-grade bonds.)
"The REIT sector is currently fully yet reasonably valued, says Robitaille. "It is neither excessive, nor is it cheap, in the context of property fundamentals, interest rates and private valuations of the underlying properties."
"The sector currently trades at a 10% premium to its net asset value versus the 27% discount in 2009, the bottom of the market. "The average premium over net asset value over the past 14 years is 4%, says Robitaille, but it has been as high as 28% in 1998."
"The principal risk to REITs at this stage of the economic cycle is "a rising interest-rate environment." But, "geopolitical issues and concerns that an oil-price shock will derail global economic growth, is delaying this prospect."
"Within the Canadian income-trust universe, REITs are the only publicly listed equity securities to retain their original tax status, says Robitaille. Most other income trusts have converted to conventional corporations because of the changed tax regime, which came into force at the beginning of 2011.
""The conversions were largely seamless," Robitaille says. There were a few cuts in distributions, but most maintained their distributions/dividends and "we have already started to see dividend increases from some."
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| Michele Robitaille | |
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Guardian Capital (managed assets $14 billion) is a sub-adviser to the BMO Guardian family of funds. The equity-income team's responsibilities include BMO Guardian Growth & Income (which has assets of $549 million) and BMO Guardian Monthly High Income II, with assets of $850 million.
The equity-income team looks for businesses with a dominant market position, a strong balance sheet, a low payout ratio and management aligned with investors' interests. These businesses must trade at reasonable valuations.
At the end of February, BMO Guardian Monthly High Income's biggest weighting was in energy at 38%. "We have been taking profits across the board in energy due to the run-up in valuations," says Robitaille. "We entered the year with a 43% weighting in this sector." The portfolio had 24% in 10 individual REITs (which are classified as financial-services securities) at the end of February for a total weight of 31% in financials.
A diversified REIT that Robitaille considers is "reasonably valued given its top-tier assets," is Canadian Real Estate Investment Trust REF.UN. "It is one of Canada's oldest and largest REITs." It trades at a premium to net asset value of 8% versus 10% for the group, she notes.
CREIT has a portfolio of retail, office and industrial properties, a solid management team and a "strong long-term track record of generating growth in cash from operations." This REIT is geographically diversified with properties in nine provinces and one U.S. state. The trust pays $1.40 per unit, per annum and has a payout ratio of 71% on 2011, "which is conservative."
Canada's largest owner of multi-residential real estate, Boardwalk Real Estate Investment Trust BEI.UN also has "a high-quality portfolio and a conservative management team," says Robitaille. Chairman and CEO Sam Kolias and brother Van founded this business in 1984, she notes. "The Kolias family owns 25% of the REIT."
Residential real estate tends to be more defensive in an economic downturn than retail or industrial real estate, Robitaille says. The REIT has a strong balance sheet and the payout ratio is "reasonable" at 81%. "We expect some modest firming in its occupancy this year."
Although the Canadian energy sector has had a good run, energy companies generating strong cash flow continue to have an important role in a diversified income-generating equity portfolio, says Robitaille.
Companies like ARC Resources Ltd. ARX and Bonavista Energy Corp. BNP are good long-term holdings, she says. Both are in the top five holdings in BMO Guardian Monthly High Income.
ARC has "an exceptional management team led by CEO John Dielwart," says Robitaille. "The company has both a strong technical focus and a history of strong operational performance." ARC holds some of the most productive Montney shale gas acreage in northeastern B.C. "We expect these assets to be a key driver of growth over the next two years with two planned natural gas plant expansions."
Robitaille says the stock is fairly fully valued at the current share price, "but we believe that the company is a good long-term holding and investors should accumulate it on any price weakness."
Bonavista "has a premier management team led by CEO Keith MacPhail." It is a leader in adding production and reserves on a per-share basis, Robitaille says. (Bonavista was one of Robitaille's selections in the Encounter column published on April 28, 2010.)
The Guardian equity-income team sold its holding in Yellow Pages Income Fund, which converted to a corporation, Yellow Media Inc. YLO, late last year. "The unit price ran up through its conversion." The team, says Robitaille, had, for some time, been concerned about the fundamentals as advertisers have been moving from print to an electronic format. "But the trust offered an attractive yield and we considered that the downside in the unit price was limited." After the unit price ran up, "the risk-return became significantly less attractive and we sold it."
With the proceeds, the team bought Thomson Reuters Corp. TRI, a leading global information company aimed at businesses and professionals. It delivers its products electronically. "The stock's current and growing dividend, combined with the possibility of a multiple expansion, make it attractive," Robitaille says.
| Boardwalk REIT | Canadian REIT (CREIT) |
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| March.8 close | $45.83 | $32.51 | ||
| 52-week high/low | $47.49-$37.60 | $33.93-$25.00 | ||
| Market cap | $2.4 billion | $2.2 billion | ||
| Total % return 3Y* | 12.6 | 11.1 | ||
| Total % return 5Y* | 18.8 | 10.4 | ||
| Total % return 10Y* | 18.2 | 12.2 | ||
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*As of March.8, 2011 |
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