RioCan beats estimates, but ‘retail apocalypse’ fears continue to weigh on stock

Solid first-quarter earnings from RioCan REIT did little to alleviate the fears of investors, who worry that trends toward online shopping will portend a “retail apocalypse” for bricks and mortar operations.

Units of RioCan REIT were flat on Wednesday afternoon, trading 0.2 per cent down at $23.44, after the company reported earnings that beat estimates, and lent some credence to the consensus price target of $27, according to analysts surveyed by Bloomberg.

Revenue was flat, at $290.1 million, and net income fell 16.6 per cent due to prior-year investment gains, but the all-important funds from operations (FFO) metric benefited from a tight market in major city centres, rising 6.1 per cent, to $0.46 per unit.

CEO Edward Sonshine expressed frustration as he told analysts on the conference call that business was “a lot better than most people think.”

“No doubt that the retail environment has been undergoing tremendous change,” he said, but “RioCan’s occupancy rates and same property growth rates are in the neighbourhood of historic highs.”

Units in the trust, currently trading at 2006 levels, have swung between $23 and $30 in recent years, reflecting widespread pessimism regarding the future of shopping centres in North America, as Amazon and other online retailers steal market share.

Last year, nine major U.S. retailers went bankrupt, including J.C. Penny, RadioShack and Sears. Amazon, meanwhile, has managed to sell Prime memberships to nearly half of American households, and it’s widely estimated that online shopping now makes up roughly 10 per cent of all retail.

Hence, the retail apocalypse theory. But analyst Matt Kornack at National Bank Financial says the bleak sentiment afflicting RioCan and other commercial REITS is overblown.

At its current price — with a yield over six per cent and a PE ratio under $11 — Kornack said RioCan is cheap: he has a target of $28.75 on the stock, implying a heady 30-per-cent upside.

Kornack said investors have ignored major differences in the Canadian market. While online shopping has hurt big box retailers in suburban areas, the domestic retail market is much more concentrated in major urban areas.

“I think the market is very much thematically trading right now,” he said. “Retail is obviously out of favour, given what people have seen in the U.S., but Canada is clearly a different animal, as these results are showing.”

Department stores and suburban big box retailers may still be vulnerable — and the closures of Target and Sears in recent years may have dealt a psychological blow to REIT investors — but Kornack says the retail market has shown resilience.

“Luckily in Canada, after the departure of Sears, we’re really only left with HBC, and there aren’t that many large anchors in the Canadian space other than HBC, whereas the U.S. still has a significant number of those where you may see further pressures.”

Nevertheless, RioCan has made moves recently to pivot away from softer markets. In October 2017, the company announced its plan to divest properties in secondary suburban and outlying markets.

RioCan has completed about 40 per cent of its divestitures, with $808 million in sales completed, committed or conditional. By end of 2019, the company expects 90 per cent of its commercial real estate to portfolio to be concentrated in major markets.

Earlier this month, RioCan also announced the launch of its RioCan Living division, which will pursue residential apartment assets. Within a decade, the company expects the division to bring in about 10 per cent of RioCan’s income.

While the market sentiment for residential development is healthier, Kornack said he sees challenges for the trust as it ventures into apartment leasing, where government policies have stifled development by keeping rents artificially low.

“That, more than anything, is what I see as a near-term issue for RioCan,” he said. “It’s not retail that I’m concerned about in terms of their story playing out in the near term — it’s more residential-related.”