Asset Sales In The Vicinity

This story features VICINITY CENTRES, and other companies. For more info SHARE ANALYSIS: VCX

-Substantial low-quality asset divestment
-Issue now of where funds are redeployed
-Some way to go with merger synergies
 

By Eva Brocklehurst

Vicinity Centres ((VCX)) is streamlining its business, having recently undergone a merger with Novion and being formerly known as Federation Centres. The company will undertake asset sales of $750m to $1bn by the end of 2016.

JP Morgan was most surprised by the quantum of sales, which are in addition to eight prior sales and the ACCC-enforced off-loading of the company's stake in Karingal. The broker estimates these future sales will be 1-2% dilutive to earnings but meaningfully accretive in terms of portfolio quality and long-term growth.

The company's merger implementation is on track to achieve 75% of targeted synergies by June 2016. There will be no impact on FY16 earnings and guidance of 18.8-19.1c per security has been re-affirmed. The company is targeting through-cycle earnings growth of 3.0% and total returns of 9.0% going forward.

Now is a good time to trade up the quality spectrum, in JP Morgan's opinion, because retail cap rates are converging, in that the yields do not adequately reflect the greater long-term growth in high-quality assets. A cap rate is the ratio of book value to the income produced by the asset. JP Morgan also expects a meaningful premium to book value from the non-core asset sales.

To the extent acquisitions are possible, the broker believes they are likely to be sub-regional, or outlet assets. Management has stated that timing of sales to coincide with opportunities for redeployment of capital, while ideal, is not always possible Management has also signalled a preference to own assets entirely, although joint venture will be pursued selectively to gain access to quality and as a means of mitigating risk.

The $1.8bn bridging finance facility will be closed by the end of 2015. UBS welcomes this news and notes the main outstanding project is the full integration of the IT platform, which is expected to take 12 months. The broker calculates the market is only attributing 16% of the stock's value to long-term growth, which compares with around 28% for Scentre Group ((SCG)).

This means the market is attributing twice the amount of long-term growth to Scentre Group compared with Vicinity Centres, something UBS considers is unrealistic over the medium term. Still, the broker does not anticipate the gap will close quickly as there are lingering concerns over Vicinity Centres' debt, development pipeline and merger integration.

Morgan Stanley expected this announcement would be an opportunity for management to update its major growth drivers, portfolio strategy and capital management strategy. The latter two were adequately covered but the broker believes growth drivers for the near-term need to be clarified further, in addition to providing conservative long-term targets which highlight the potential for valuation upside.

The broker is underwhelmed by the growth target (3.0%) particularly since the company has undergone such large corporate restructuring and incurred around $500m in costs over the past two years. The growth target seems conservative to Morgan Stanley, particularly over the short to medium term.

With potential upside from ancillary income, further savings in procurement and revenue synergies from improved quality the broker still expects free cash flow growth over the next three years in excess of the sector average of 5.2%.

Macquarie expected Vicinity Centres to be aggressive on asset sales, as it now has a larger earnings base. The exact assets being included for sale were not disclosed but Macquarie has identified around $2.3bn in real estate that is lower quality, with a combination of low sales productivity and high occupancy costs.

The main question is over the redeployment of funds. With development returns likely to be under pressure the broker considers deployment into the current pipeline is unattractive, particularly from an earnings perspective.

Factoring in the recent fall in the share price relative to the Australian Real Estate Investment Trusts (A-REITs) index, Macquarie observe valuation appeal is emerging. However, with a complex integration process under way and dilutive asset sales on the horizon, the broker suspects the stock will lose its appeal against a backdrop of rising long bond yields. Hence, an Underperform rating is maintained.

Credit Suisse is also of the opinion value may be emerging, given the stock has underperformed the sector by 10% in the year to date. The broker supports the shedding of weak, low-growth assets and redeploying funds into higher-returning assets. Still, consensus estimates need to be trimmed, in the broker's opinion.

There are three Buy ratings, two Hold and one Sell (Macquarie) on the FNArena database. The consensus target is $2.95, suggesting 7.1% upside to the last share price. The dividend yield on FY16 and FY17 estimates is 6.4% and 6.7% respectively.
 

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