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The Happy Accident

By Ari Charney on December 24, 2015

The falling Canadian dollar has been a major bummer for U.S. investors who once enjoyed a tailwind from a rising loonie. At the same time, it also means that those who are new to Canada’s investment story finally have an opportunity to buy Canadian stocks at a significant discount in U.S. dollar terms.

Thankfully, there’s also a way for both sets of investors to benefit from a lower exchange rate. Canadian firms whose operations have significant exposure to the U.S. can get an earnings boost when profits are translated back into Canadian dollars.

But one Canadian firm recently pulled off an even bigger feat–one that required the shrewdness to enter the U.S. market when values were abundant and the Canadian dollar was ascendant and the fortuitous timing to exit the U.S. market when the situation reversed.

When it comes to making macro calls like that, it’s exceedingly difficult to get the timing right. And yet the CEO of Canada’s biggest real estate investment trust, RioCan REIT (TSX: REI-U, OTC: RIOCF), managed to do just that.

Back in late 2009, RioCan CEO Edward Sonshine seized the opportunity to extend his shopping mall empire to the U.S., at a time when Canada’s neighbor to the south was still reeling from the aftermath of the real estate crash and the ensuing Global Financial Crisis.

Sonshine couldn’t resist what he saw as a classic market dislocation. Following the downturn, U.S. real estate prices were still low, especially compared to Canada, but most of the domestic players were still too busy shoring up their finances to take advantage of it. Meanwhile, Canada’s relative economic strength, thanks in part to its resource riches, had pushed the Canadian dollar to near parity with the greenback.

So Sonshine pounced. And he soon assembled a U.S. portfolio of 49 shopping centers in Texas and the Northeast that accounted for about 18.5% of the REIT’s gross leasable area and 17.8% of overall revenue over the trailing four quarters.

Then, as Sonshine put it, a happy accident occurred. The Canadian dollar’s slide accelerated just as the firm was preparing to undertake a strategic review of its U.S. assets.

While the rising U.S. dollar helped inflate the value of the U.S. portfolio in Canadian dollar terms, it was also making it too costly for RioCan to continue its expansion there.

Consequently, RioCan has agreed to sell its U.S. portfolio to the private-equity firm Blackstone for US$1.9 billion, or C$2.7 billion, a 57% return on its initial investment. The deal comes close to netting RioCan a cool billion in Canadian dollar terms.

“I won’t say we have been cheering [the Canadian dollar] down because that would be unpatriotic, but the trajectory of the dollar has certainly helped our decision-making,” Sonshine told the Financial Post.

Now Sonshine sees greater values emerging in Canada again. And he plans to put the proceeds to work there. First up is C$510 million to cover RioCan’s recent acquisition of 23 Canadian properties from its join-venture partner Kimco Realty Corp. The remaining balance will be used to pay down debt, which should help improve RioCan’s cost of capital in future financings.

Next, RioCan will focus on using the greater balance-sheet strength resulting from the deal to fund organic growth opportunities from its Canadian portfolio, with a development pipeline focused on intensification of its urban properties. That’s REIT speak for generating higher rental income by modifying a property to increase the number of tenants, typically by building up instead of out.

And naturally, Sonshine will also be on the lookout for good deals on other properties.

Despite the fact that RioCan’s U.S. venture was a “home run” in the words of one analyst, Bay Street still had to dock the REIT a few points for the fact that, at least temporarily, it will lead to slightly lower funds from operations (FFO).

Although the income from the Kimco properties and the interest saved from the debt reduction will replace two-thirds of the FFO generated by the U.S. properties, RioCan will still be missing out on around C$29 million in annualized FFO.

So analysts pared their forecasts for FFO per share for 2016 and 2017 by 5.1% and 6.6%, respectively. Perhaps as a consequence of those adjustments, RioCan’s units have dropped 3.6% in Canadian dollar terms since the deal’s announcement, in contrast to a 0.3% decline for the Bloomberg Canadian REIT Index and a 2.1% gain for the S&P/TSX Composite Index.

Nevertheless, we expect Sonshine to hustle fill that gap and then some.

Though RioCan’s projected growth is muted, its monthly distribution currently yields 5.8%. So investors are being well paid to wait for Sonshine to make his next home run.

Equally important, Sonshine understands the sanctity of the dividend. In an interview with the Financial Post in 2013, he acknowledged that during the global financial crisis the firm was under-earning its distribution, and he was facing tremendous pressure to cut it.

But Sonshine made a deal with the board to maintain the payout and then review it again in two years if the company didn’t experience a turnaround.

Defending that action, Sonshine said, “I just felt a lot of people were relying on [the distribution]. I felt we have this covenant with those people.”


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