Stock and Dividend Analysis: Choice Properties

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Choice Properties (TSX:CHP.un) emerged in 2013 when Loblaw, Canada’s largest grocer, spun off its real estate portfolio. Choice then merged with Canadian Real Estate Investment Trust (a favourite of our old friend, Tony Fell, who is well worth a few minutes of your time), back in 2018. This created Canada’s largest REIT, a title Choice still holds today.

The company is controlled by the Weston family via their holding company, George Weston (TSX:WN). As of October 5th, 2024, George Weston owned 61.7% of all Choice Properties shares, and the two companies share office space in Toronto. George Weston also has representation on Choice’s board of directors.

Let’s start off by taking a much closer look at the assets the company owns.

Choice in a nutshell

As you’d expect from a REIT created from a grocery store, Choice Properties owns an awful lot of grocery-anchored retail real estate. But it has been diversifying throughout the years, and has expanded into industrial and residential space.

Altogether, the company owns 705 properties across Canada, spanning slightly more than 67M square feet of gross leasable area. Together, these properties are worth about $16.3B, and current occupancy is 97.6%. Occupancy hasn’t dipped below 97% in the REIT’s entire history.

From a fair value perspective, approximately 70% of the portfolio is invested in retail real estate, 25% is in industrial property, and 5% is invested in mixed-use and residential properties. The latter are buildings with retail space in the bottom and apartments built above, located in large cities and close to mass transit. There’s also a development portfolio with 44 properties in various stages of completion.

The portfolio is spread across Canada. Close to half of net operating income (NOI) comes from Ontario, with Alberta, B.C., and Quebec also pretty well represented.

We’ll also note that while a big chunk of the portfolio’s rents (and virtually the entire development portfolio) comes from Canada’s largest cities, Choice has property in smaller centers as well. This gives it an added layer of diversification. Besides, a small town grocery store with very limited competition isn’t such a bad tenant.

Approximately 57% of total rents come from various Loblaw entities, including Shoppers Drug Mart. Loblaw warehouses are also the largest tenants on the industrial side, but that part of the portfolio is a little more diversified.

Some of you might not like that focus on one particular customer, but I’m a fan. Firstly, Loblaw is Canada’s largest — and arguably best — grocer. It continues to grow earnings, repurchase a surprising amount of stock, and invest in its loyalty program. PC Optimum is a wonderful asset, and Loblaw gives it the investment needed to thrive.

Secondly, Loblaw had nearly 100 years to build up its real estate empire before spinning it off to Choice. Choice inherited a well-located portfolio stuffed full of properties carefully amassed over decades. The quality is quite good.

Grocery stores also sign long-term leases. Choice’s average lease runs through 2031, but there are still enough leases that expire on a yearly basis for the company to capture some upside in leasing spreads.

Recent results

Choice recently released its 2024 results, and numbers were solid.

For the full year, the company increased rental revenue by approximately 4%, and grew same-asset NOI by 3.2%. It completed $426.5M in real estate transactions, including buying a 50% stake in the old Maple Leaf Gardens in Downtown Toronto.

Funds from operations (FFO) increased to $1.032 per unit, an increase of 3% versus 2023. We’ll note that FFO would’ve been higher, but Choice was impacted by higher interest rates. As were so many of its peers. By the looks of it, rates should continue to slide in 2025, providing some relief there.

Choice also reported a 2.9% increase in its net asset value, with that increasing to $14.07 per unit. As I type this, Choice trades at about a 5% discount to its NAV.

Choice has always maintained a nice balance sheet, and prudent debt management is one area where the controlling family shines. Choice has a 40% debt-to-assets ratio, well under its 50% target. It owns more than $13B worth of unencumbered properties, and much of its debt is secured against the company itself, rather than mortgages on the underlying buildings. It also has an unused $1.5B credit facility it can easily tap if needed.

Choice’s recent results have been decent, but it has been impacted by the entire REIT sector. Investors just aren’t keen on REITs today, and the entire sector has been weak.

Long-term results

Choice has a demonstrated ability of outperforming the broad REIT index. It has returned 8.4% annually from its IPO through the end of 2024. The average retail REIT, meanwhile, increased 5% annually.

Outperformance has been even better since it acquired Canadian REIT in 2018.

How will it grow?

Choice is already the largest REIT in Canada, and its largest shareholder isn’t exactly known for being a risk taker. One of the biggest criticisms stems from this, so let’s dive in.

Just how will Choice grow, anyway?

The company has a four-pronged growth plan, but it executes it slowly. Balance sheet strength is quite important, and this patient approach should result in a higher quality portfolio over time.

The first prong of the growth approach is via acquisition. Properties can be acquired from Loblaw — like Maple Leaf Gardens was — or from other third-party sellers. Choice has diversified itself away from Loblaw enough at this point that it’s happy to look at non-Loblaw properties.

For instance, in Q4, Choice acquired a property that’s primarily rented to a Farm Boy supermarket in Ottawa. Farm Boy plans to abandon the lease when it expires in 2027, so Choice secured Loblaw as a tenant before it even made an offer. It was a win-win, and a great example of the Loblaw benefit.

The second prong is retail intensification. Basically, Choice owns a lot of Loblaw properties that have a grocery store, maybe a few other businesses, and a big ol’ parking lot. That’s basically wasted space, and it’s a great spot to put ancillary property. They’re attractive to tenants like fast food places, because the store draws in traffic. And they’re cheap to develop, because the land is already paid for.

There’s the potential to do hundreds of these in the medium-term, the only problem is Choice’s size. It’s so large that it takes a lot of fast food restaurants to move the bottom line. So this needs to be combined with other growth avenues.

The third prong is the industrial portfolio. Choice has experience building warehouses and distribution centers for tenants like Canadian Tire, Pet Valu, Amazon, and, of course, Loblaw. There’s also potential to acquire other warehouses from third parties.

I’ll highlight the massive Caledon Industrial Park, which will have 4.2M square feet of gross leasable industrial space. This is already under construction and will add to the bottom line in 2025 — but mostly in 2026.

I’ve saved the most interesting growth path until last. Choice has multiple properties in Toronto — and other cities — that is underutilized. One example is 905 Woodbine in Toronto, which is the current home of a Valu-Mart, and is right on top of the Woodbine metro stop. The plan is to build a mixed-use development there, which will include a grocery store (and other retail) in the bottom level, and about 600 apartments on top.

There are dozens of these potential developments, utilizing land that Choice already owns. And not just in Toronto, either. Similar opportunities exist in Montreal, Vancouver, Calgary, and Ottawa.

There’s really just one problem with this growth plan — it won’t happen fast enough for many of you. Remember, Choice takes its balance sheet strength seriously. It isn’t about to borrow too aggressively to supercharge development plans. It’ll continue to take a prudent approach here, which is the best long-term strategy.

Valuation

Choice is too conservative to ever become truly cheap. The best REITs are almost always set up that way, and it’s a feature, not a bug. You’ll miss out on big upside when the sector recovers, but that’s coupled with less downside during bad times. I’m a big fan of that tradeoff.

However, there are still indications that Choice is decently valued, which goes really nice with its conservative balance sheet and expansion plans. Firstly, as mentioned above, Choice trades at about a 5% discount to its NAV. It traded at a premium to its NAV for pretty much its entire existence, so today’s valuation is a bit of an anomaly.

It’s also relatively cheap on a price-to-FFO basis as well. As it stands today, Choice trades at $13.47 per unit. 2024’s FFO was $1.02 per share, and I believe we can expect about 3% growth in 2025. So forward FFO will be in the neighbourhood of $1.05 per share.

That puts us at about 13x FFO. Although that’s not as cheap as others in the sector — Primaris, for example, trades at about 9x FFO — it’s a very fair price to pay for a REIT with Choice’s balance sheet, its tenant roll, and its development potential.

Dividend analysis

Let’s take a closer look at Choice’s distribution next.

(Note: I’ll use the terms distribution and dividend interchangeably here, but let’s be clear. Choice — just like any other REIT — pays a distribution, not a dividend. The big difference is tax wise, a distribution will be taxed differently than a dividend.)

As it stands today, Choice pays a $0.77 per share annual dividend. As I type this, that works out to a 5.7% yield, which is a fairly attractive payout. The typical GIC rate in Canada is in the 3.5% range, but you can get slightly more on a shorter-term GIC.

This gives us a payout ratio in the 75% range of FFO, which is a little bit high compared to some of its peers. RioCan, for instance, has an FFO payout ratio in the 60% range, and the previously mentioned Primaris is offering a payout ratio of approximately 50%. So it’s a little high, but at the same time, the payout is definitely safe.

In terms of dividend growth, I’m the first to admit you won’t see huge upside here. But I think there’s potential for the distribution to slowly head higher here. Earnings should increase by 3-5% annually, and income growth should match that.

The bottom line

Choice Properties is much different than Ingles Market, which I covered last week. One is a high quality asset, ran by solid, professional managers who have a demonstrated ability of delivering shareholder value. The other is ran by a family who is mostly interested in controlling the real estate they need to sell groceries.

Advantage: Choice Properties

This one checks off a lot of boxes for me. The balance sheet is good. The portfolio is high quality. The primary tenant is about as solid as they get. There’s all sorts of growth potential that’ll happen while keeping the balance sheet in good shape. And I think the Weston family ownership is a great thing. This is a family that knows a thing or two about how to thrive over the long-term.

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