Woolies’ Property Fund Underwhelms

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-Deutsche initiates with Sell
-Lower growth profile vs peers
-Deutsche prefers CQR
-Price not justified

By Eva Brocklehurst

Shopping Centres Australasia Property ((SCP)) has received a cool reception from brokers in the first three months on the ASX. Deutsche Bank has initiated coverage on Woolworths' ((WOW)) shopping centre spin-off, noting there are challenges despite the quality of Woolworths as a tenant. When the stock commenced quotation on the ASX last November, two brokers initiated coverage on the FNArena database. JP Morgan retains a Sell rating while UBS has a Hold. Macquarie was also unimpressed at the stock's debut and rates it a Sell.

The investment case is appealing at first glance, according to Deutsche. After all, there's an opportunity to gain exposure to one of only two supermarket-based Australasian retail investment trusts (A-REIT), with over 60% of underlying gross rent underpinned by Woolies. However, the rent guarantees roll off after two years. So, while this tenancy is the most marketable attribute, it limits growth potential according to the brokers. Deutsche expects rent guarantee roll-off to be compounded by a lack of anchor tenant rent growth, and this is likely to be outpaced by growth in property expenses. UBS finds the structure of the Woolworths leases unfavourable, even though income looks assured, joining JP Morgan in expecting sub-sector earnings growth.

SCP’s $1.4 billion portfolio (including developments) comprises 69 sub-regional (30%), neighbourhood (52%) and freestanding assets (18%). In aggregate, Woolworths leases account for 61% of portfolio gross income, comprising 50.7% from Woolworths/Countdown supermarkets, 8.7% from Big W and 1.8% from Dan Murphy’s. The remaining 38.7% is derived from specialty tenants. Overall, the asset grade and income source composition is most comparable to Charter Hall Retail ((CQR)), which Deutsche prefers as a supermarket-based, non-discretionary retail offering.

Deutsche has set its price target at $1.53 for SCP, equal to the fund's net asset value calculation. Deutsche tops Macquarie's $1.40 target on the FNArena database, JP Morgan's $1.43 and UBS' $1.41.

Deutsche finds the planned independence from Woolworths after 12 months surprising, given Woolworths has around $4 billion in residual property. However, irrespective of management structure, SCP should be one of two natural acquirers within the A-REIT sector of further Woolworths property stock. While the separation of the parties creates some short-term transition challenges, Deutsche welcomes the introduction of SCP as the only internalised, supermarket-based A-REIT in the sector.

Prior to practical completion of development assets, Woolworths will provide SCP with a site access fee, calculated by applying the on-completion cap rate to the initial SCP investment. This allows Woolworths to partially release capital prior to completing development, albeit at a relatively expensive cost of 7.9%, according to Deutsche. This effectively brings forward the yield associated with future acquisitions, enhancing the initial yield profile. The broker estimates the site access fee arrangement enhances SCP's FY13 and FY14 earnings by around 4% and 1% respectively.

However, Deutsche just struggles to see how SCP can trade on almost as tight a yield as Westfield Retail Trust ((WRT)) and materially below CFS Retail ((CFX)) and Charter Hall Retail. Trading on a price to net asset value ratio of 1.05 times, against the peer average of 0.95 times, the broker does not believe the stock offers a growth profile premium to justify such relative pricing strength. SCP can generate a reasonable distribution growth profile, on the broker's estimates, but it is still the lowest of its peers. Hence, the broker's preferences lie with WRT and CFX, primarily on fundamental valuations, as the overall quality of their assets warrants a tighter trading yield versus the A-REIT sector average.

FNArena's Stock Analysis shows a consensus forecast yield for SCP in FY14 of 6.6%.

See also Woolworths Spin-off Underwhelms on November 29.
 

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