Australia | Mar 26 2013
-Westfield enters new JV
-Transaction earnings dilutive
-Buyback continues but what else?
-Most view stock fully priced
By Eva Brocklehurst
Westfield Group ((WDC)) will form a joint venture with O'Connor Capital Partners, which will buy a 49.9% stake in six Westfield shopping centre assets in Florida. In response to the announcement, brokers have taken a closer look at the company's development plans. The sale of the Florida stake is at book value and Westfield is expected to realise a net US$700 million from the transaction. Westfield is a blue chip shopping centre manager and developer with a strong global footprint. What will the company do with the money?
Initially, the transaction will be earnings dilutive. Macquarie notes Westfield has limited floating rate debt to pay down and thus the proceeds will be parked in cash, which results in earnings dilution of around 2.5% on a full year basis. The company will continue the on-market share buyback, partially offsetting this dilution. This is business as usual, says Macquarie. The assets are not part of the non-core portfolio that Westfield is intent on selling over time. It is in line with the strategy of selling interests in assets where 100% ownership is not necessary, according to Macquarie. While none of the Florida assets are on the list for major development, the broker suspects redevelopment at some point is likely. Macquarie assumes $1.1bn in development starts per annum for Westfield.
Deutsche Bank finds the deal in line with Westfield's strategy of reducing balance sheet exposure to smaller, less productive shopping malls. Westfield will retain property, leasing and development management roles for the portfolio. For the broker, the dilution to earnings is outweighed by the associated enhancement to portfolio quality, incremental property management fee streams and reduced leverage. Deutsche Bank's forecasts allow for US$500m of non-core disposals over the second half, along with completion of the 10% buyback over the course of 2013 but notes Westfield has not guided for any further buyback activity or asset sales.
UBS notes Westfield is closing in on execution of a significant development pipeline. The broker has looked at the asset sales in the US in detail as well as longer-term sources and uses of capital as legacy hedging rolls off. UBS anticipates up to US$4 billion of capital will be realised over the next three years from further non-core asset sales and joint ventures. Westfield has a stated development pipeline of $12bn, with a share of spending 30-40% on average over the medium term. Deployment of asset sale proceeds into the development pipeline over the medium term warrants further consideration, UBS maintains. Currently, the development spending is at historically low levels, despite the company realising $5.2bn from a number of capital initiatives. Moreover, no debt facilities are to be retired in the US, so the buyback becomes the immediate option for deployment of excess capital.
Credit Suisse also asks the question and wants to see more evidence of what will be done with the proceeds of sales before re-rating the stock. The broker believes it could be a case of improving operational leverage to the detriment of financial leverage. After spinning off Westfield Retail Trust ((WRT)), Westfield has engaged in a number of third party capital partnerships/management roles. This increases operational leverage but, in Credit Suisse's view, the associated proceeds have seen financial leverage reduce toward 32%, depressing return on equity to 11.4% and reducing earnings growth.
Fundamentally this deal makes sense. Credit Suisse notes the structure has been levered up to 50%, on a secured basis, increasing proceeds to US$700m and associated cost of debt below 4%. While Westfield's development capability is unquestioned, more transparency on use of capital – either through an increased buyback, development plans or even a special dividend – is required by the broker. Credit Suisse suspects distribution growth will lag earnings growth.
For BA-Merrill Lynch the announcement highlights two themes. First, Westfield continues to reduce outright ownership of lower growth assets and has now lifted its third party assets under management to over 50% of the $64.4bn in global malls. Secondly, the company can grow its earnings by accessing cheaper debt. BA-Merrill Lynch expects short term dilution of earnings before any reinvestment. The broker expects Westfield to offset the dilution with the buyback program and redeployment of capital. Merrills is underwhelmed by the fact that six assets were vended into the joint venture at book value or a 6.49% cap rate, believing US malls should be trading on firmer yields. Moreover, the sale price is 15% lower than the peak 2007 value. The broker muses that, perhaps this is the discount required to sell minority stakes in below-average malls with a full service management agreement with Westfield.
UBS also makes the interesting observation that Westfield is using the low comparative cost of debt in Australia to increase gearing in Australia and reduce gearing in the US. Equity in the US increased over the past year at the expense of the Australian exposure. UBS notes Westfield is increasing the proportion of earnings in the US dollar that is unhedged. The broker estimates 34% of Westfield earnings are derived from the US after debt costs, up from 16% before the WRT restructure. Therefore, a 10% move in the current alters earnings by 3-4%.
Macquarie is the sole broker on the FNArena database with a Sell rating for Westfield. In the broker's view the stock is overpriced. There are four Hold and two Buy. Deutsche Bank is one of the Buy ratings and is focused on the earnings yield. The broker accepts the yield is tighter compared with others in the sector but maintains the stock has strong earnings growth potential. The consensus dividend yield is 4.7% based on FY13 earnings estimates and 4.8% for FY14. The consensus target price of $10.91 is showing a bare 0.3% upside to the last traded share price.
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