Silver Linings - CT REIT

Sentiments towards commercial real estate has cooled since the pandemic shutdowns began earlier this year, slowing down business for many retailers. However, Amplus Fund manager Andrew James Labbad, CFA thinks some REITS deserve a deeper look.

Back in June, we took a bullish view on German auto debts. That cyclical strategy played out well for us. German auto credit spreads compressed by an average of ~180 basis points (bps) and outperformed the general market, which only tightened by 30 bps during that same timeframe. The credit market has come a long way, retracing 80% of the move we saw back in March. Lucrative opportunities have become more challenging to find not only in credit, but in all asset classes. Thankfully our deep-dive credit analysis has proven successful at finding diamonds in the rough.

We start this latest Silver Linings with a quote from legendary investor Peter Lynch, whose fund famously returned an average of +29% annually from 1977 to 1990. Lynch said, invest in what you knowand although this is perhaps the most famous of all his quotes, it is often misunderstood. Lynch is not advising you to buy equity or debt in a company simply because it makes your favorite product or service. It is a starting point to dive deeper into a business’s financial position, growth prospects and competitive edge. This got me thinking: what have I been spending most of my free time and money on lately? It was a no-brainer. I quickly concluded the answer is home improvements and yard work. Since the COVID-19 lockdowns started back in March, I have been spending countless hours in line at home improvement stores throughout the summer, and I was not alone. With more people re-deploying money from vacation budgets to home-improvement budgets, home hardware stores have been wildly successful. At Wealhouse, we have capitalized on this trend in our equity funds with investment theses in Home Depot and Lowe’s. The next question we asked was: how would Amplus profit and outperform from this trend on the credit side? CT REIT bonds would prove the profitability of this strategy. It is a direct play on Canadian Tire Corporation, with additional yield and great leverage metrics.

We owned the name since May, and it has performed exceptionally well for our investors. The value proposition is more evident now than it has been throughout the year. In a world where the average 1-5-year corporate bond spread is 89 bps, we see further upside in this name. CT REIT adds 35-95% additional spread for 1.5-Year and 4.5-Year bonds when compared to the average market spread of Canadian corporate bonds. In addition, it adds 40-50% more spread than Canadian Tire bonds.

CT REIT’s biggest tenant is Canadian Tire Corporation (CTC) representing 92% of the total portfolio. Of the remaining 8% tenant base; banks and grocers make up 3%, big box retailers (Winners, Dollarama, and Best Buy) make up 1%. The CTC store leases also contain contractual rent escalations of approximately 1.5% per year, on average, over their initial term and have a weighted average remaining lease term of 9.2 years. The weighted average lease term of all leases in the REIT’s portfolio is about 9.0 years.

Close to 96% of the overall portfolio represents high-quality tenants. During the height of the pandemic, rent collection from this strong tenant base remained over 97%. As of October, rent collection improved to over 99%. In addition to this, 98.8% of their properties are currently occupied. These numbers are well ahead of most REITs.  Their leverage metrics are best-in-class, representing some of the lowest leverage in the Canadian real estate universe. In their latest quarter, most metrics showed improvements despite the pandemic:

  • Debt/Gross Book Value improved to 42.2% from 42.7% for fiscal year 2019 (FY19)
  • Interest coverage improved 0.15x to 3.6x
  • Total debt/EBITFV improved to 6.85x from 6.94x FY19

At quarter-end, secured debt comprised 2.55% of CT REIT total indebtedness, leaving a high-margin of safety for the senior unsecured bonds that we have been buying.

Since CT REIT is a play on the Canadian Tire brand, we need to dig deeper on CTC. Recently, they reported Q3 results that showed retail sales increasing ~20% (ex-petroleum) year-over-year (YoY), with Canadian Tire branded stores producing sales growth of over 28% YoY. Profits (EBITDA) rose close to +14% YoY as well. The company’s net debt levels decreased by 15% from a year ago, leading to improved leverage metrics. CTC also retains a ~69% equity interest  in CT REIT, and several long-term agreements are in place to govern operating relationships between both entities. In many ways, after seeing last month earnings for Home Depot and Lowe’s, we felt that Canadian Tire would see the same impressive earnings momentum in Q3. We have been adding CT REIT paper to our portfolios over the last month.

As good as this investment looked, we had doubts about CTC’s other banners that are primarily in enclosed malls such as SportCheck and Mark’s Warehouse. Despite those banners showing flat growth YoY, we were delighted to see that they made up only 2% of CT REIT overall portfolio, the remaining 90% is Canadian Tire stores and distribution centres, their growth engine.  

In a world where interest rates keep going lower, we feel excited and confident in owning CT REIT paper that provides all-in yields significantly higher than other best in class REITs. As a result, our investors receive a higher yield for less risk as compared to competitors with lower rent collections, higher vacancies, and higher leverage metrics. We are confident that CT REIT will outperform and drive great returns for our valued investors.