Woolworths Spin-Off Underwhelms

This story features WOOLWORTHS GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: WOW

-Shopping Centres Australasia debut subdued
-Rents heavily dependent on Woolworths
-Earnings growth outlook weak
-Spin-offs usually outperform parent eventually

By Eva Brocklehurst

Woolworths' ((WOW)) has finally completed the spin-off of its property assets, with Shopping Centres Australasia Property Group ((SCP)) strutting the ASX boards this week. The new property company represents an in-specie distribution of 69 retail assets developed by, and principally leased to, Woolworths. Two brokers on the FNArena database immediately initiated coverage of the stock – one took a Sell tack and the other a Hold. According to Macquarie Bank's recent analysis, a 'child' entity typically performs in line with the market for the first few weeks following the spin-off. This is then followed by underperformance.

SCP debuted at $1.405 and closed its first day of trading at $1.44. SCP consists of $1.1bn of completed trading centres, and $300m of centres in various stages of development. Despite a portfolio of 69 assets, there is asset concentration, with 38% of value in just nine centres. This concerns JP Morgan, which also feels these assets hold a higher share of the risk and growth potential. As well, despite Woolworths underpinning all initial vacancy and paying 61% of gross rent, initial distributions are pumped up by presumptions on rent guarantee, covering all initial specialty vacancy and site access fees. Here, JP Morgan has a problem. These fees underpin development income as if a proportion of the centres being constructed (24% of the assets) are already built and fully leased.

The broker sees no earnings growth in FY15 and FY16 and does not forecast any dividend growth until FY18. Moreover, the leases appear to favour the tenant, perhaps not surprising given they were written by Woolworths. From this, JP Morgan takes the view that some of the gross rents could be flat for five years without significant sales growth. So the outlook for income growth near term is weak. The broker has initiated coverage with a Sell rating and the target price is $1.36.

UBS also finds the leasing structure overly favouring, and dependent on, Woolworths. It initiated coverage with a Hold call and $1.41 price target,. It said the company is unlikely to achieve equivalent sector earnings growth. SCP will most likely look to acquire assets in the near term, the broker believes. This could be done by further gearing up the portfolio and buying neighbourhood centres, or selling the lower yielding freestanding assets in the portfolio and reinvesting the proceeds in higher yielding neighbourhood centres. It could also fund an acquisition through an equity raising but this is only feasible if the stock is trading at a premium to net tangible assets.

The SCP portfolio contains 21 freestanding assets (16 in the completed portfolio and 5 within the development portfolio) for a total book value of $256.7m and management has suggested divesting freestanding assets over time. However, UBS says this is an asset class which is particularly attractive to high net worth individuals (having the characteristics of a Woolworths bond) with potential to sell at a premium to book value. The broker calculates that $250m of freestanding assets sold at a 5% premium and reinvested into neighbourhood centres would be 1.5% accretive to earnings.

Macquarie has made a general analysis of de-mergers and notes the short-term underperformance in the child company is soon reversed. The analysts found that the parent company (that retains the price history) and child company tend to develop differently afterwards. Of the 28 spin-offs in Macquarie's dataset since 1995, 54% of the child entities had positive returns on the first day of trading (from open to close). This did not appear to impact the short-term returns, however, in the longer run those companies with negative first-day returns typically underperformed.

Another statistic: based on turnover on the first trading day child entities with greater than 5% turnover typically outperformed in the two months following a split. These stocks outperform those with lower trading volume in both the long and short term. When the data is split to examine the performance of the parent entity compared to the child entity behaviour varies quite consistently. The child entity can underperform by up to 9% in the six months following a de-merger. It is not until 12 months after the split that the child entity typically outperforms.

 For the parent entity, the performance is typically flat leading into a de-merger but Macquarie recognises that many de-mergers have been in cyclical industries and the results might be related to the market cycle. However, when comparing such stocks to respective industry performance there is still longer-term outperformance of de-merged entities. 
 

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