Canadian Tire REIT: Quality at a Reasonable Price

A couple weeks ago I wrote about Canadian Tire and further discussed the idea on Twitter, with certain folks suggesting the financial services division was a black box that would get decimated during the next recession. I argued with the stock at 8x earnings a big decline in financial services was already priced in, and the rest of the business would be able to survive a recession just fine, just like it has for the last 100 years. Tire’s brands are just too entrenched in the Canadian marketplace.

I even went out and bought some for family members’ accounts I manage.

However, I get that there are some red flags with Canadian Tire. The stock yields more than 4%, which is much higher than its historical yield. It has some exposure to Canadian housing. It’s much more sensitive to a prolonged recession compared to a Loblaws or Empire Company, thanks to brands like Mark’s and Sport Chek.

For investors who don’t want to take that risk, let me present another idea closely related to Canadian Tire. If the retailer is too risky for you, why not own the real estate?

Let’s take a closer look at Canadian Tire REIT (TSX:CRT.UN).

The Skinny

Like the other REITs that emerged from Canada’s largest retailers, Canadian Tire REIT was spun out of its namesake retailer back in 2013. Canadian Tire is by far the largest tenant and the parent maintains a large ownership position in the subsidiary. Some 90% of total rents come from the parent and Canadian Tire maintains a 32% ownership stake in its namesake REIT.

This relationship comes with a few distinct advantages. The leases are advantageous to the REIT, with each store responsible for building upkeep. There’s also a 1.5% annual rent escalator clause, which at least ensures rents continually go up over time. It’s a little light in an inflationary world, but it is a nice bit of protection.

The portfolio today looks something like this. It spans nearly 30 million square feet across 373 different properties. 144 of the properties are located in Ontario, 78 in Quebec, and 55 in Alberta. Just a hair under 50% of the gross leasable space is located in Canada’s six largest cities. 84% of total space is retail, but 16% is industrial in the form of distribution centres. Occupancy currently stands at an impressive 99.3%.

Growth has come from a number of different avenues. Firstly, the REIT has first right of refusal on every property the parent sells. It also is continually looking to acquire properties from third parties, ideally ones with Canadian Tire (or one of its other brands) as the primary tenants. Additionally, it has a number of properties that are good candidates for redevelopment, including 1.5 million square feet of space currently under various phases of completion.

Just a quick note on the potential for acquiring third party properties. A full 25% of Canadian Tire locations are owned by third parties, i.e. not Canadian Tire or the REIT. The REIT has acquired 19 Canadian Tire anchored properties since the IPO. And there’s potential to acquire other non-Tire properties too.

These growth avenues have helped the REIT post solid top and bottom line increases since its 2014 IPO. From a recent investor presentation:

Distribution growth has also been solid, as management has made a point to pass on AFFO increases to shareholders while bringing down the payout ratio. Steady dividend increases are somewhat rare in the REIT world, which makes this next graph all the more impressive.

Units currently yield 5.5%.

Valuation

This is the kind of stock that is unlikely to really get super cheap. The quality of asset owned is simply too good. I’d argue the best investors can do is buy when the company is reasonably valued, like it is today.

Firstly, let’s look at book value per share, which checks in at approximately $16.25. Shares currently trade hands at $15.85. Any discount to book value is a good thing.

It’s also reasonably valued on a price-to-AFFO perspective. Trailing 12 month AFFO was $1.14 per unit, giving us a price-to-AFFO ratio of approximately 14x. Compare that to RioCan, SmartCentres, or Choice Properties, and you won’t see much of a premium for CT REIT. Or, to put it another way, you’re not paying a huge premium for a REIT that has delivered solid distribution growth for the better part of a decade.

Yes, interest rates are a risk. It doesn’t look like rates will start to be cut anytime soon. Tire REIT is pretty well positioned against near-term interest rate increases, with a mere $250M worth of debt needing to be refinanced in 2023 and 2024. The REIT also has a fairly conservative balance sheet, with just a 40% debt-to-assets ratio.

The bottom line

There really isn’t much more to say. Yes, there are difficulties with Canadian Tire right now. That’s why the stock trades at such a low valuation. I understand there are some warts there.

The REIT, meanwhile, looks to me like the kind of stock you buy today and stash away for a very long time. It’s a quality company trading at a pretty reasonable valuation. Very few retail REITs offer consistent dividend growth with potential to keep up that streak, but I certainly like CT REIT’s chances to continue the streak for at least the next 5-10 years.

Finally, take a look at the REIT’s overall returns since the 2013 IPO. Not bad at all.

Disclosure: No position at time of writing, but will likely add to my portfolio this week