In addition, many of its new developments are focused on office and residential space, respectively, as it looks to diversify a bit in the coming years.
Choice Properties is present in multiple markets across Canada. The trust’s strategy is to focus on mid- to large urban areas in Canada, and it has focused intensely on the Toronto market. More than half of the portfolio is concentrated in large urban areas, while the balance is a mix of small and mid-sized cities.
From an investment perspective, Choice Properties has some interesting characteristics, not the least of which is its yield. However, it also has an unusual dependency on one tenant, a lack of diversification that we find somewhat troubling.
Loblaws and Shoppers combined make up a staggering 57% of Choice Properties’ gross rental revenue. The trust has taken care to diversify itself within Canada’s various markets, but has bet in an enormous way on the future of Loblaws and Shoppers.
While grocery stores and drug stores are generally quite stable, this level of concentration on what amounts to one tenant is very rare. This lack of diversification is a significant consideration for investors that are looking at Choice Properties.
While it would be preferable for the company to diversify to fix its concentration, that is a slow process. In addition, since the tenant it is so dependent upon is generally stable, we don’t necessarily see a huge risk due to the industry struggling. However, this sort of concentration on one tenant is extremely unusual for a REIT, and it is worth noting.
Growth Prospects
Choice Properties has struggled with growth since it came public in 2013. Since the end of 2014, the trust’s first full year of operations as a public company, it has compounded adjusted funds-from-operations per share at a rate of just 0.3% per year.
The trust has grown steadily in terms of portfolio size and revenue, but relatively high operating costs and dilution from share issuances have kept a lid on returns for shareholders. History has shown Choice Properties can exhibit strong growth characteristics on a dollar basis, but once translated to a per-share basis, investors have been left wanting.
Choice saw revenue rise 10% in 2019, while FFO rose nearly 13% on a dollar basis. However, the share count also increased 18%, so FFO-per-share was up only 3% on an adjusted basis. Choice Properties’ organic growth rate has been in the low single-digits, although it does have a history of acquiring large amounts of growth.
The problem is that it acquires this growth largely via new shares, which dilutes away much of the potential gains for existing shareholders in terms of acquisitions. Choice Properties hasn’t had a difficult time expanding, but when growth is largely financed by dilution, the impact on shareholders is sizable.
However, its reliance upon consumer staples businesses – namely Loblaw’s and Shoppers – saw it weather the storm in the first quarter of this year. When REITs with portfolios leveraged to discretionary spending were struggling to collect rent, revenue was flat year-over-year in Q1, as was NOI. AFFO came in only fractionally lower than the same period in 2019 and occupancy remained in excess of 97%. The trust said it continues to collect the vast majority of contracted revenue through the crisis.
We see Choice Properties as continuing to grow very slightly, if at all, in the coming years. The concentration of the trust’s portfolio and constant dilution make Choice Properties unattractive from a growth perspective. When constant share issuances are factored in, the outlook becomes even less attractive.
Dividend Analysis
For all of its growth woes, Choice Properties’ dividend appears to be secure for the time being. The 2019 payout ratio on adjusted FFO-per-share was 87%. While that is high, it is also true that REITs generally distribute close to all of their income, so it is hardly unusual that Choice’s payout ratio is nearing 100%.
Choice Properties’ current distribution gives the stock a 5.8% yield, which is an attractive dividend yield.
Note: As a Canadian stock, a 15% dividend tax will be imposed on US investors investing in the company outside of a retirement account. See our guide on Canadian taxes for US investors here.
Investors should not expect Choice Properties to be a dividend growth stock, as the distribution has remained flat since May 2017. With the payout ratio has high as it is, and FFO-per-share growth muted, investors should not expect the payout to be raised anytime soon.
Choice Properties hasn’t cut the distribution, and we don’t see imminent threat of that right now. But it is worth mentioning that if FFO-per-share deteriorates significantly going forward, the trust will likely have to cut the distribution due to its high payout ratio.
This is particularly true because we see Choice Properties’ borrowing capacity as limited, given its already-high leverage. Choice Properties has debt to EBITDA of 7.5X, which according to the company is below the industry peers, but is still alarmingly high. To be fair, it is down from slightly higher levels in past quarters, but Choice still has a lot of debt in absolute terms.
In addition, it has large amounts of debt coming due in stages in the coming years, so we see the trust’s debt financing as near capacity today. Choice has steady debt maturities in the coming years, and while they are spread out, the amounts are significant. Choice has no ability to pay these off as they mature, so refinancing appears to be the only viable option.
Should it experience a downturn in earnings, Choice Properties would have to turn to more dilution for additional capital. While we don’t see a dividend cut in the near future, the combination of a lack of adjusted FFO-per-share growth, the ~90% payout ratio, and a high level of debt appears risky.
Final Thoughts
Choice Properties’ high dividend yield and monthly dividend payments make it stand out to high yield dividend investors. However, a number of factors make us cautious on Choice Properties today, such as its lack of diversification within its property portfolio, and its alarmingly high level of debt.
With a somewhat risky dividend, we view the stock as unattractive for risk-averse income investors. Investors looking for a REIT that pays monthly dividends have much better choices with more favorable growth prospects, higher yields, and safer dividends.
