Interest-sensitive securities still hold appeal

Despite rising interest rates, income securities still have a place in conservative stock portfolios. Yielding 4.1 per cent, Canadian Real Estate Investment Trust is a buy for growth and income.

Income_SecuritiesThe potential for rising interest rates has caused investors to shy away from income stocks lately. The S&P/TSX Income Trust Index declined 1.7 per cent in July, while the broader market gained 0.3 per cent. Utility stocks, meanwhile, lost 2.1 per cent of their value.

But while such interest-sensitive stocks may underperform the broad market as interest rates rise, these securities will still hold appeal for income investors. For one thing, if their prices decline, such as they did in July, you have the opportunity to buy in at a lower price and receive a higher dividend yield.

For another thing, though they may underperform for awhile as rates rise, they still have the potential for capital appreciation if their profits and dividends continue to rise.

One security we expect to hold up relatively well as interest rates rise and do well over the long term is Canadian Real Estate Investment Trust (TSX—REF.UN), or CREIT. This REIT’s portfolio is diversified across product types—retail, industrial and office—and is geographically dispersed in Canada, with one retail property in Chicago.

CREIT’s real estate assets produce consistent and stable financial results. For the six months ended June 30, 2017, CREIT’s funds from operations, or FFO, were $122.9 million, or $1.68 a unit, compared with $120.1 million, or $1.64 a unit, in the same period of 2016.

The results include lease termination income of $0.8 million in the latest period, and $6.8 million in the prior period. Excluding these items, FFO increased 7.7 per cent to $1.67 a unit from $1.55 a unit.

FFO growth was driven mostly by higher rental income caused by occupancy strength in CREIT’s real estate portfolio, the income contribution from completed development projects and its mezzanine lending program.

CREIT’s stable FFO lets it consistently raise its cash distribution year after year. This year, it raised its quarterly distribution 2.2 per cent to $0.1558 a unit.

CREIT runs its business conservatively. It’s well diversified by product type and geographic location. It maintains conservative debt levels, with low indebtedness (38.6%) and leverage (6.67 times) ratios. It also has a low distribution payout ratio, which was 61.8 per cent of adjusted cash flow from operations in the latest period. This conservative approach positions the REIT well to withstand rising interest rates and to continue to grow over the long term.

The units trade at a high but still reasonable 13.8 times CREIT’s projected 2017 FFO of $3.26 a unit. The current annual distribution of $1.87 a unit yields 4.1 per cent. CREIT is a buy for growth and income. 

This is an edited version of an article that was originally published for subscribers in the August 18, 2017, issue of Money Reporter. You can profit from the award-winning advice subscribers receive regularly in Money Reporter.

Money Reporter, MPL Communications Inc.
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