Australia | Jun 07 2013
-Further simplification of syndicates
-But how much is warranted?
-Proof of development value is required
By Eva Brocklehurst
Federation Centres ((FDC)) continues to simplify the legacy syndicates it inherited from the previous incarnation as Centro Property. This is seen by the broking community as a positive development but some are wondering whether the logical extension to the trend is… too simple.
The Australian real estate investment trust has sold 50% interests in six shopping centre assets for $602 million, delivering a 7.4% passing yield. The assets include two from the balance sheet – Bankstown and Toormina – and the rest from expiring syndicates – Roselands, Karratha, Lennox and Sunshine Marketplace. Federation Centres will also acquire 50% stakes in two assets from syndicates that are winding up – Lennox and Sunshine Marketplace. Net proceeds are $314 million. Consistent with previous asset sales Federation Centres will remain the manager of these assets. Gearing has now declined to 22% which leaves the business well funded for the medium term development pipeline. Brokers anticipate the JV transaction with Challenger's ((CGF)) funds will dilute the near-term earnings by around 1%.
The deal, which had been flagged, was largely construed positively and, on the FNArena database, the consensus target price is $2.45, signalling 1.2% upside to the last share price. This target has ratcheted up around five cents from a week ago. The dividend yield is 5.7% on FY13 consensus earnings forecasts and 6.1% on FY14. There is one Buy recommendation (UBS), three Hold and two Sells on the database.
UBS believes, while asset quality has been diluted, Federation Centres has able to reduce its exposure to major assets, along with spreading the development risk in the future. All this has been achieved while generating management fees. The simplification of the syndicate process is well underway, with the business targeting a reduction from the current 19 syndicates to just five by December 2015. This is a reduction in total assets from $1.5 billion to $330m and a reduction in Federation Centres' equity invested from $400m to $90m. BA-Merrill Lynch does not see a pressing need for this to happen, as there was sufficient liquidity created by the prior disposal of $1bn in assets.
It appears the company is focused on reducing risk with this transaction. Merrills suspects, while it may reduce the discretionary retail risk, as regional malls are now just 30% of the portfolio, it comes at the expense of earnings, given the marginal cost of funding is well below the yield on assets and development projects. Management expressed a desire to reduce the weighting to the potential development spending at Bankstown and Roselands, but no firm plans have been advanced as to the scope or timing of such. Delays which peers have incurred, and the relative demographic positions of these two malls, gives rise to the question of whether these projects can be launched in the near term.
So, retail risk is reduced but execution and timing risks remain. Federation Centres may have outlined a $600m development pipeline but Merrills notes 40% of this is major projects at The Glen and Galleria Morey and there is significant execution risk here, particularly in the current retail environment.
Federation Centres' share price has pulled back to a more attractive level, but as it trades at a 40 basis point lower dividend yield compared with Westfield Retail ((WRT)) and the latter remains Merrills' preference in the sector. The company has done the job of reducing gearing but the next stage is more challenging, in Merrills' view. It may have lower rents compared with peers but the current subdued retail environment is also forcing other landlords to reduce rents on new deals. Also, acquisition of assets from syndicates should be accretive as equity co-investments earn a yield around 5% and the syndicates often have high debt costs. Merrills suspects competition for these assets is increasing and might reduce the scope for the company to bring these on balance sheet.
Merrills has a Neutral rating. To become more positive about the stock, the broker wants to see confirmation of developments beginning and further progress on syndicate acquisitions, ahead of base case expectations.
JP Morgan is one of the more bearish on the stock (Underweight) and struggles to find value. Federation Centres may be proving up net tangible assets (NTA) with asset sales at book value, yet the stock is trading 10% above NTA relative to the sector average of a 1% discount, ex fund managers. Execution is the key for this broker as well. Value in the development pipeline needs to be proven, without reducing exposure via sale of stakes in pre-development assets. JP Morgan takes note of the fact that, from the initial portfolio at amalgamation of Centro, 36 of the 43 assets were 100% owned. As at December 2012, Federation Centres' property portfolio comprised 47 properties, 40 of these being still 100% owned. After the latest sales, a further five assets will be 50% owned, reducing the number fully owned to 35.
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