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You May Have Been Looking At H&R Real Estate Investment Trust (TSE:HR.UN) All Wrong

Simply Wall St

H&R Real Estate Investment Trust is a CA$6.7b mid-cap, real estate investment trust (REIT) based in Toronto, Canada. REITs own and operate income-generating property and adhere to a different set of regulations. This impacts how HR.UN’s business operates and also how we should analyse its stock. In this commentary, I'll take you through some of the things I look at when assessing HR.UN.

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Funds from Operations (FFO) is a higher quality measure of HR.UN's earnings compared to net income. This term is very common in the REIT investing world as it provides a cleaner look at its cash flow from daily operations by excluding impact of one-off activities or non-cash items such as depreciation. For HR.UN, its FFO of CA$462m makes up 72% of its gross profit, which means the majority of its earnings are high-quality and recurring.

TSX:HR.UN Historical Debt, May 17th 2019

In order to understand whether HR.UN has a healthy balance sheet, we have to look at a metric called FFO-to-total debt. This tells us how long it will take HR.UN to pay off its debt using its income from its main business activities, and gives us an insight into HR.UN’s ability to service its borrowings. With a ratio of 6.7%, the credit rating agency Standard & Poor would consider this as aggressive risk. This would take HR.UN 14.88 years to pay off using just operating income, which is a long time, and risk increases with time. But realistically, companies have many levers to pull in order to pay back their debt, beyond operating income alone.

Next, interest coverage ratio shows how many times HR.UN’s earnings can cover its annual interest payments. Usually the ratio is calculated using EBIT, but for REITs, it’s better to use FFO divided by net interest. This is similar to the above concept, but looks at the nearer-term obligations. With an interest coverage ratio of 1.75x, HR.UN is not generating an appropriate amount of cash from its borrowings. Typically, a ratio of greater than 3x is seen as safe.

In terms of valuing HR.UN, FFO can also be used as a form of relative valuation. Instead of the P/E ratio, P/FFO is used instead, which is very common for REIT stocks. In HR.UN’s case its P/FFO is 14.46x, compared to the long-term industry average of 16.5x, meaning that it is slightly undervalued.

Next Steps:

In this article, I've taken a look at Funds from Operations using various metrics, but it is certainly not sufficient to derive an investment decision based on this value alone. H&R Real Estate Investment Trust can bring about diversification for your portfolio, but before you decide to invest, take a look at the other aspects you must consider before investing:

  1. Future Outlook: What are well-informed industry analysts predicting for HR.UN’s future growth? Take a look at our free research report of analyst consensus for HR.UN’s outlook.
  2. Valuation: What is HR.UN worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether HR.UN is currently mispriced by the market.
  3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.