DBRS Confirms RioCan REIT at BBB (high), Trend Stable

DBRS has today confirmed the Senior Unsecured Debentures and Preferred Trust Units of RioCan Real Estate Investment Trust (RioCan or the Trust) at BBB (high), and Pfd-3 (high), respectively. The trends are Stable. The confirmation reflects the Trust’s significant portfolio growth, recovering interest coverage ratio and negative free cash flow position. In 2010, RioCan achieved significant growth in operating income driven primarily by $1 billion of property acquisitions. These investments were evenly split between Canada and the United States (focused in the Northeast and Texas). To date, RioCan has acquired almost four million square feet (sq. ft.) (represents 9.8% of total net leasable sq. ft.) in the United States through joint ventures formed with Cedar Shopping Centers Inc., Inland Western Retail REIT and Kimco Realty Corporation. RioCan’s U.S. properties are predominantly grocery store-anchored and new format shopping centres, which complement the Trust’s existing portfolio with good occupancy levels (98.2% as at Q4 2010) and quality tenants, such as Giant Food Supermarkets and Lowes. RioCan also achieved same portfolio net operating income (NOI) growth of 2.4% driven by higher average rental rates on lease renewals and fixed rent step-ups on existing leases. The Trust’s portfolio also continues to achieve high occupancy levels (97.4% as at Q4 2010) and high tenant retention rates (90.9%).

From a financial standpoint, higher cash flow levels have meaningfully improved the Trust’s payout ratio and negative free cash flow position. However, DBRS still believes that RioCan’s payout ratio is aggressive for the current rating. In 2010, RioCan used a higher proportion of debt than equity to fund investments and its negative free cash flow position, which resulted in the Trust’s debt-to-gross book value assets ratio to increase modestly to 57.1% from 55.6% a year earlier. EBITDA interest coverage, however, improved to 2.33 times (includes capitalized interest) benefiting from cash flow growth and lower interest costs on refinancing activity.

RioCan’s BBB (high) rating incorporates the following strengths: (1) dominant retail portfolio with well located properties; (2) diverse tenant base; and (3) reasonable balance sheet and coverage ratios. The rating also takes into consideration the following challenges: (1) geographic concentration in Ontario; (2) high payout ratio and negative free cash flow position; and (3) countervailing power of large tenants.

The stable outlook takes into consideration DBRS’s expectation for continued cash flow growth driven mainly by recent property acquisitions. In the near term, DBRS expects that higher capitalization rates in the United States (7.5% to 8%) than in Canada (6.5% to 7%) and the availability of suitable retail properties will continue to be a source of motivation for the Trust to build out its U.S. operating platform. DBRS views RioCan’s expansion into the United States as slightly positive for the credit rating, given that the Trust has mitigated some of the risks of entering into a new market by forming joint ventures with experienced partners that have local expertise and an operating track record. The Trust is also expected to achieve reasonable same portfolio NOI growth and maintain strong portfolio occupancy levels underpinned by recovering economic conditions and increasing demand for retail, particularly from U.S.-based retailers.

In terms of financial profile, continued cash flow growth expected in 2011 should help to narrow RioCan’s negative free cash flow position. In addition, RioCan continues to have good access to the capital markets and has more than sufficient liquidity totalling $477 million (as at Q4 2010) to fund its capital requirements in 2011.

RioCan has a laddered debt maturity profile, which limits its exposure to refinancing and interest rate risk. DBRS expects that RioCan will continue to achieve interest expense savings on upcoming debt maturities (debt maturities in 2011 have a weighted average interest rate of 5.76% compared with recent financing rates done at below 5%). In the near term, DBRS expects EBITDA interest coverage to improve and to also benefit from interest expense savings on debt refinancing and the retirement of higher-cost debt, including the 8.33% Series L senior unsecured debentures. Going forward, DBRS expects RioCan to maintain sound credit metrics with reasonable debt levels in the 55% to 60% range based on the gross book value of assets and an EBITDA interest coverage (includes capitalized interest) in the 2.3 times to 2.4 times range, which is reasonable for the business risk profile of the Trust.

Note:
All figures are in Canadian dollars unless otherwise noted.

The applicable methodology is Rating Real Estate Entities, which can be found on our website under Methodologies.