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Why You Shouldn't Look At European Residential Real Estate Investment Trust's (CVE:ERE.UN) Bottom Line

Simply Wall St

European Residential Real Estate Investment Trust is a CA$425m small-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 ERE.UN’s business operates and also how we should analyse its stock. Below, I'll look at a few important metrics to keep in mind as part of your research on ERE.UN.

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View our latest analysis for European Residential Real Estate Investment Trust

Funds from Operations (FFO) is a higher quality measure of ERE.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 ERE.UN, its FFO of €3.8m makes up 17% of its gross profit, which is relatively low, given most REITs' earnings are predominantly high-quality and recurring funds from operations.

TSXV:ERE.UN Historical Debt, May 27th 2019
TSXV:ERE.UN Historical Debt, May 27th 2019

Robust financial health can be measured using a common metric in the REIT investing world, FFO-to-debt. The calculation roughly estimates how long it will take for ERE.UN to repay debt on its balance sheet, which gives us insight into how much risk is associated with having that level of debt on its books. With a ratio of less than 1%, the credit rating agency Standard & Poor would consider this significantly high risk, and ERE.UN may need to sell off assets or take out more loans to keep afloat. At the level of debt, it would take over 50 years to pay off using just operating income, which is extremely long. 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 ERE.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 0.23x, ERE.UN is not generating an appropriate amount of cash from its borrowings. Typically, a ratio of greater than 3x is seen as safe.

I also use FFO to look at ERE.UN's valuation relative to other REITs in Canada by using the price-to-FFO metric. This is conceptually the same as the price-to-earnings (PE) ratio, but as previously mentioned, FFO is more suitable. ERE.UN's price-to-FFO is 78.96x, compared to the long-term industry average of 16.5x, meaning that it is highly overvalued.

Next Steps:

European Residential Real Estate Investment Trust can bring diversification into your portfolio due to its unique REIT characteristics. Before you make a decision on the stock today, keep in mind I've only covered one metric in this article, the FFO, which is by no means comprehensive. I'd strongly recommend continuing your research on the following areas I believe are key fundamentals for ERE.UN:

  1. Future Outlook: What are well-informed industry analysts predicting for ERE.UN’s future growth? Take a look at our free research report of analyst consensus for ERE.UN’s outlook.

  2. Valuation: What is ERE.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 ERE.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.