Shopping Centres Australasia Needs Dressing Up

This story features SCALARE PARTNERS HOLDINGS LIMITED, and other companies. For more info SHARE ANALYSIS: SCP

-Question of specialty leases
-Woolworths a stumbling block
-Citi initiates on Neutral
-Asks what can drive earnings?
 

By Eva Brocklehurst

Shopping Centres Australasia Property ((SCP)) has struggled to deliver since its inception late last year. Or rather, it has struggled to appear like it's delivering. The portfolio of shopping centre assets from the spin-off of Woolworths' ((WOW)) properties has definitely not set the world on fire. Nevertheless, if you take a rising broader equities market in the first half of the year the stock has outperformed and it is one of the better performing Australian real estate investment trusts (AREITs). Maybe grey is the new red.

Citi has initiated coverage with a Neutral rating and believes the stock can offer a relatively stable income stream but with more modest growth than peers. Citi is a lone Neutral rating. The rest of the brokers (4) that cover the stock on the FNArena database have Sell ratings. The consensus target price is $1.54, which suggests 6.2% downside to the last share price. Targets range from $1.44 to $1.66. The distribution yield is 3.6% for FY13 consensus earnings estimates and 6.5% on FY14.

At current levels Citi finds the stock's valuation fair and believes investors need to form a view on two key issues. The first is the specialty leases, as vacancies are well above those of SCP's peers. The impact of this is mitigated in the near term by the rental guarantee provided by Woolworths, which provides 60% of SCP's income stream. This rental guarantee rolls off after two years. Thereafter Citi sees the potential vacancy impact as – moderate.

The company retains a conservative approach to distributions and the broker believes the specialty vacancy rate is unlikely to affect this, except at very high levels. Specialty stores contribute a disproportionate share of centre rent. For a simple vehicle like SCP this means there are few other major earnings drivers. On the plus side, the guarantee has the effect of improving near term earnings, allowing time for the portfolio to be leased up. On the negative, the fact that income will be received on vacant space through the lease-up period substantially reduces the near-term upside from signing additional leases.

Deutsche Bank initiated on the stock back in February with a Sell rating, noting that there were some growth challenges. The fact that there is a rent guarantee from Woolworths for two years is the most marketable attribute but when this rolls off and there is no anchor tenant rental growth, what then? UBS does not like the whole leasing structure that has been developed with Woolworths, despite the income assurance. There is distribution upside potential from a higher pay-out ratio over time as the company has been quite conservative. The FY14 guidance is for distributable earnings per share of 12.2c, with a distribution of 10.8c, reflecting a payout ratio of 89%. Citi thinks a reluctance to incorporate 100% of income in the distribution – supported by Woolworth's rent guarantee in the near term – in assessing distributable earnings may prove to be prudent.

The second issue Citi considers is the rental growth. Slowing retail rent growth and lower growth in non-discretionary retail property classes is affecting not only SCP but others in the industry. The portfolio may generate lower rental growth than most peers simply because of a focus on neighbourhood and sub-regional centres. The company bought some neighbourhood shopping centres in June in Victoria and Queensland. These acquisitions, for $136 million, were funded with a $90m placement and plans for a $20m unit purchase plan. The acquisitions did little to impress the brokers. JP Morgan noted the deal was 1% accretive to earnings but diluted net tangible assets by 2c, because of transaction costs. Deutsche Bank believes occupancy rates are solid at these new centres but there's a few expiries coming up so they're only slightly accretive at present. Deutsche Bank finds the stock's valuation too stretched against peers.

The likelihood of earnings growth below peers raises the question of what SCP management could do to help this state of affairs. Citi considers four possibilities. A buyback is unlikely at current levels in the near term but could provide reasonably good accretion because of solid earnings yield and low marginal debt cost. The disposal of some low-yielding, low dollar value assets, with the reinvestment of proceeds into acquisitions, is possible and could help. This initiative has the advantage of being essentially neutral to gearing. Other opportunities for development activity, while potentially limited in the near term, may offer the strongest yields. Beyond sale of properties, acquisitions are likely to offer reasonable accretion, with the main limitation being the gearing level that is required.

The stock does not have a track record and this may account for the subdued nature of broker commentary, given the outlook for retailers, in particular, is not exactly booming. Citi notes the absence of a track record from other relatively recently formed AREITs has not precluded their strong performance. It's probably a case of more "wait and see".
 

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