Description

At the current price, SmartCentres REIT (SRU) offers an opportunity to buy a Walmart-anchored shopping center REIT at 10x FFO and 8% dividend yield with significant development upside. 

SRU owns 148 open-air shopping centers with 34 mm square feet of GLA across Canada. Here are some notable portfolio characteristics: 

1. 70% of SRU’s revenues are derived from Canada’s largest metro areas - Toronto, Vancouver, Montreal, Calgary, Ottawa and Edmonton. 

2. 63% of SRU’s revenues come from Ontario. 

3. 115 properties are anchored or shadow anchored by Walmart, which represents 26% of SRU’s gross rents. 

4. SRU is Walmart’s largest landlord in Canada, representing about a quarter of Walmart’s footprint in the country. 

5. All of SRU’s retail properties have a grocery or pharmacy component. 

SRU is led by Mitchell Goldhar, the man credited with bringing Walmart to Canada in 1989. Over the ensuing two decades, Goldhar and his development platform SmartCentres developed 265 shopping centers in Canada, including 175 Walmart stores. In 2003, Goldhar sold a few Walmart-anchored shopping centers to Calloway REIT in exchange for Calloway shares and became a significant shareholder of Calloway. In the following decade, Calloway would acquire almost 100 Walmart-anchored shopping centers from SmartCentres after these properties were developed by SmartCentres. 

The relationship between Calloway and SmartCentres culminated in 2015 when Calloway acquired the SmartCentres platform and its 20 Walmart-anchored properties from Goldhar for $1.2 bn. $640 mm of the purchase price was assumption of debt, $160 mm was issuance of shares to Goldhar at $28.7, and balance was cash. Calloway renamed itself SmartCentres REIT, forming the publicly traded company today. 

Since March this year, Goldhar has bought approximately $20 mm of stock at an average price of ~$20, which is not too far below the current price. Currently, Goldhar owns about 21% of SRU. 

The health of SRU’s portfolio is evidenced by its industry-leading occupancy rate. SRU ended 2019 with 98.2% committed occupancy. As a public company (whether as Calloway or SmartCentres), SRU never cut distributions. Calloway, which derived 26% of its revenues from Walmart, reported flat same store NOI in 2009 and only 30 bps decline in occupancy (98.9% vs 99.2% in 2008).

SRU has held up well during the current pandemic. SRU ended Q3 with 97.4% committed occupancy. Q3 gross billed rent collection was 88.4% and 92.3% without/with the CECRA program. The Canada Emergency Commercial Rent Assistance program (CECRA) allowed impacted eligible businesses to pay only 50% of their rent, while the federal government pays the landlord 25% and the landlord forgives the remaining 25%. Rent collection progressed higher in each month of the third quarter. In September, SRU collected 89.5%/96.1% of rent without/with CECRA. As of October 23, SRU collected 90.8% of October rent without CECRA.  

CECRA expired in September (after multiple extensions) and was replaced by Canada Emergency Rent Subsidy (CERS) which expires in June 2021. CERS allows affected businesses to receive subsidies up to 65% of rents (including utilities, insurance, common area maintenance), subject to rent cap of $75,000 per location and $300,000 for all locations. Businesses whose revenues declined more than 70% would receive the maximum 65% subsidy, and the subsidy tapers off based on revenue decline. In addition, the government provides a lockdown support which provides another 25% of rent if a business is ordered to close by the government. Businesses that still offer deliveries, online sales and curbside pickups but whose indoor activity is shut down would still qualify for the lockdown support. The graph below best illustrates the CERS and lockdown support. There are also myriad other small business support programs offering wage subsidies, forgivable loans, loan guarantees etc. 

Leasing activities picked up in Q3 as well. In Q3, SRU started 160,000 SF of new leases, which at run-rate is already comparable to 2019. Renewal activity is comparable to 2019 as well - SRU renewed 2.8 mm SF in 9M 2020 at 4% spread, compared to 3 mm SF in 9M 2019 at 4% spread. 

SRU has a significant redevelopment pipeline. It has identified 256 mixed-use projects on 94 properties that will add 28 mm SF of density. These projects include multi-family, senior housing, self storage, hotels and condominiums. In almost every project, SRU works with an experienced JV partner in that particular vertical and contributes land (SRU owns 3,000 acres of parking lot). In the next 5 years, $5 bn of projects are expected to commence. When completed, these projects would expand SRU’s assets by 50%. 

SRU’s development capability is perhaps best exemplified by the SmartVMC at the Vaughan Metropolitan Centre (VMC). Goldhar bought 100 acres of farmland 20km north of downtown Toronto in the 1990s. This piece of land would become part of VMC, a massive 400 acre mixed-use development that would become the city of Vaughan’s new downtown. The government contributed $3.2 bn to build a 8.6km subway extension (completed in 2017) that terminates at the VMC. Thus far SRU has completed two office towers totalling 600,000 SF, both now fully leased to KPMG, PwC and other brand-name tenants. In addition, SRU has 100% pre-sold 2,800 condominium units in 5 towers (Transit City 1,2,3,4,5), 63% of which will close in 2020/2021 and contribute to FFO. SRU has also constructed a new 140,000 SF Walmart, freeing up the original Walmart on the site for densification. The new Walmart is a prototype store with 10,000 SF e-commerce fulfillment center, first of its kind in Canada. 

This month, RioCan announced it would cut its dividend by a third. I view a dividend cut at SRU as unlikely for the following reasons. 

1. RioCan insiders own negligible amounts of stock and just appointed a new CEO who might prefer setting low expectations. 

2. The closings of 1,110 units at Transit City 1 and 2 will add $49 mm of FFO this year, and the closings of 631 units at Transit City 3 will add another ~$20 mm of FFO. In Q3, rent forgiven and expected rent loss were about $40 mm annualized. In 2019, adjusted cash flow from operations (taking into account maintenance capex and leasing commissions) exceeded distributions by $45 mm. So it appears that these condo closings will soften the blow from lost rent in 2020 and 2021. 

3. SRU has strong liquidity. It has $400 mm cash on the balance sheet and an undrawn $500 mm credit facility. 

4. SRU has wide open access to the credit market. This month, SRU issued $350 mm of 5-year unsecured debentures at 1.74% and $300 mm of 8-year unsecured debentures at 2.307%. DBRS rates SRU at BBB (high) with a stable outlook. 

5. SRU has $6 bn of unencumbered assets (60% of all assets).

6. Until 2019, SRU raised dividends annually in October. This October, SRU maintained the monthly distribution.

As vaccines are distributed and the world normalizes, SRU should emerge from the crisis unscathed thanks to its value-oriented portfolio and government support for small businesses. I think SRU will benefit from a few tailwinds and re-rate to at least its historical 15x FFO multiple or >$30/share. 10-year government yield in Canada is currently 0.75% (100 bps lower since the pandemic began) and will likely stay low for a long time. While SRU is focused on Canada’s six largest metro areas, it has little exposure to downtowns. Instead, most properties are located in suburban towns surrounding these cities. If the population exodus from Canada’s downtowns into suburbs sticks, SRU will be a beneficiary. Finally, Canada plans to increase its immigration target by a third in the next 3 years. Historically, almost half of new immigrants settle in Ontario, where SRU’s portfolio is overweight. 

Catalyst

See above