Hudson’s Bay Co. Chief Executive Officer Richard Baker says rising interest rates pose no hurdle to a potential spinoff of the retailer’s real estate, including its future Saks Inc. stores, because they hold so much value.
HBC, Canada’s oldest department store chain, agreed last month to buy New York-based luxury chain Saks for $2.9 billion including debt, and said it would evaluate creating a real estate investment trust. The plan follows a 12 percent decline in the Standard & Poor’s/TSX REIT index this year amid concern that interest rates are poised to increase.
“We believe the quality of our real estate is very strong and would be successful in any interest-rate environment,” the 47-year-old Baker said in a telephone interview yesterday.
HBC is following efforts by Loblaw Co. and Canadian Tire Corp. to unlock the value of retail real estate through a REIT. Loblaw’s Choice Properties REIT raised C$400 million ($387 million) in its initial sale in June, and rose 4.6 percent through yesterday. Canadian Tire plans to spin off a $3.5 billion REIT this year.
Fifteen REITs have had initial public offerings since the beginning of 2012, raising about $1.72 billion. REITs invest in properties from seniors homes to factories, and have a tax structure that allows them to pay out the bulk of their earnings in unit distributions to investors.
HBC expects to complete the acquisition of Saks before the end of the year, according to the company’s statement on July 29. A REIT would likely follow shortly after, Baker said.
The HBC real estate portfolio would include 32 million square feet (3 million square meters) of retail space, including the Saks Fifth Avenue flagship store in New York City, stores under its Lord & Taylor’s banner, and Hudson’s Bay stores in downtown Vancouver, Toronto and Montreal.
HBC is forecast to report second-quarter adjusted earnings of 13 cents per share on Sept. 12, according to analysts’ estimates compiled by Bloomberg News. The shares rose 0.2 percent to C$17.49 at the close in Toronto today and have risen 4.6 percent this year.
The spread between North American retail REIT dividends and bond yields has narrowed to the tightest since mid-2011 as bond yields have risen, according an Aug. 1 Bloomberg Industries report.
The spread stood at about 120 basis points as the yield on the U.S. 10-year rose to 2.6 percent yesterday compared with about 1.6 percent amid speculation the U.S. Federal Reserve would begin to taper its $85 billion a month bond-buying program as the U.S. economy recovers. Yields on Canadian government bonds have risen a similar amount and were at 2.6 percent yesterday. A basis point is the equivalent of 0.01 percentage point.
U.S. 10-year yields are projected to rise to 2.7 percent by end of 2013, according to the median average of analysts surveyed by Bloomberg while Canadian yields are forecast at 2.6 percent.
“Investors are still concerned about where interest rates might be going in the future and whether we might see sharp rises in them,” said Michael Missaghie, a portfolio manager at the Sentry Investments Inc. REIT fund, which manages C$1.3 billion. “HBC would probably be facing a market that would be a little less enthusiastic about new REIT IPOs.”
Derek Dley, an analyst with Canaccord Genuity, who estimated in a note to clients on July 29 that the HBC REIT could be sold at C$13 per unit, said rents from a REIT offers higher value than retail earnings.
“The valuations in the real estate market and the REIT square are higher than what you get in the retail square, and that’s why we’re seeing Canadian Tire, Loblaw and eventually, and I think sooner rather than later, the Bay, looking to spin off and monetize their real estate assets,” Dley said in a phone interview yesterday from Vancouver.
“Do people still have cash and liquidity on their balance sheets they have to invest? The answer is yes,” said Zeke Turner, chief executive officer of HealthLease Properties Real Estate Investment Trust, in a phone interview. “Do they still want and need yield as part of their investment strategy? And the answer is also yes.”
The acquired Saks properties have an estimated value of $3.5 billion to $4 billion, according to retail analyst Patricia Baker at Scotiabank. Patricia Baker also said in a note to clients on July 30 that the properties would hasten the deleveraging of the Saks deal and allow “the transaction to become accretive sooner.”