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The tale of 3 malls

History has shown that the listed AREITs markets can over-react, particularly relative to unlisted markets, because they are liquid and can fully reflect investor uncertainty. A strong case can be made that this is exactly what is happening to REIT mall landlords today. This presents a potential opportunity for active long-term investors.

Lockdowns, travel restrictions and social distancing are clearly not the friend of ‘bricks and mortar’ shopping and the take-up of online shopping in the immediate term has been nothing short of staggering. In the depths of the lockdown in the UK, for example, online shopping as a percentage of total jumped significantly. Online fashion and footwear sales jumped from a little under 20% of total in February to nearly 50% in April according to Unibail, which owns the 2 premier malls in the UK.
 

Markets hate uncertainty

But Unibail also notes that the level of online take-up has since receded back towards that 20% level (as of July) as enforced restrictions were eased. But investor concern, manifest in the languishing share price, continues.

Part of that concern may be driven by Unibail’s level of gearing, which is higher than peers, though still well below covenant levels. Management is now looking to address those concerns with a €9bn RESET plan that was announced in mid-September this year. A key component, a €3.5bn capital raise, is to be voted on at an EGM on 10 November with a view to having it completed before year-end. Other components of the RESET plan include a DRP (€1bn), capex deferral (€0.6bn) and ongoing asset sales (€4bn).

A challenge to this Unibail RESET plan has since emerged, led by an activist consortium of Unibail shareholders and dubbed REFOCUS. The consortium has said that they will vote against the €3.5bn rights issue – which they deem as unnecessary – and advocate instead to dispose of the US portfolio (at the right time) and refocus Unibail as the leading pan-European player. Experienced long-term investors are weighing up the merits of both proposals.
 

RESET or REFOCUS?

Successful completion of the RESET plan will see covenant gearing fall to 30.9%, leaving asset devaluation headroom of nearly 50%. This seems overly conservative given the recent sale of the SHiFT building in Paris (Nestle’s new French HQ) at a premium to the book value of 30 June 2020. While it would be wrong to assume that all of Unibail’s assets can be sold at a premium to book value, this sale does suggest a more positive view for long-term investors than currently priced in by the market. Investors appeared to agree, pushing Unibail’s share price up by 7.5% on the news.

The market may also be troubled by the resurgence of COVID in the UK and certain European countries, key markets for Unibail’s flagship stores. And while we don’t know when COVID will be sufficiently under control – and that lockdowns can damage occupancy, rents and asset values - experience from elsewhere also suggests that once conditions improve, footfall and consumers do return.

But even if the return of the consumer takes a little longer, maybe this is already sufficiently discounted – after factoring in a 30% decline in earnings in 2021 (vs pre-COVID level of earnings in 2019), the stock is trading on a price-to-earnings multiple of mid-single digits.
 

Uncertainty can also bring opportunity

What has been the experience of other stocks in the AREITs universe that have opted to reduce gearing uncertainty? Gearing levels overall across the universe have been in far better shape than during the GFC, though market participants are concerned that asset values could be marked down if the COVID environment extends, prompting some balance sheet attention from certain AREITs.

A recent example is Scentre Group, which issued a 60-year USD3.0bn subordinated hybrid at a blended coupon of 4.93% in mid-September. This will be treated as equity for covenant purposes and while 4.93% is more expensive than bank debt (@2%), it is much cheaper than the bottom of the cycle earnings yield. Even though Scentre’s share price has bounced by over 5% since the hybrid was announced, it still trades at a significant discount to NTA of nearly 40%.

But the hybrid issuance largely removes the uncertainty regarding the level of gearing, which falls from 38% to 28%. Investors can now focus on the underlying business operation, namely the level of customer footfall in malls and the extent of rent collection, which has clearly been under pressure through the worst of the lockdown. During the most recent earnings season, we learnt that rent collection for malls in Q2 was a paltry 35%, primarily hit by hugely constrained activity in NSW and Victoria. But what has been the experience elsewhere?
 

Focus on the foot traffic

Carindale, which is solely exposed to the Queensland market via its stake in Westfield Carindale, is perhaps a reasonable example. In the first half of the year, gross rental billings collected was only 71% (including ‘COVID-free’ January and February). However, the announcement in early September that rental collection had jumped back to 98% saw the stock price advance by over 40% in the following few weeks. Given its Queensland location, Carindale is not representative of the wider mall industry, but maybe investors are again being too pessimistic in their long-term outlook. It’s interesting to note that Carindale continues to trade at a meaningful (@40%) discount to NTA.

A key factor supporting rent collection – and rent levels post-COVID – will be how quickly foot traffic returns to malls as economies re-open. The recent reporting season showed that foot traffic in malls rebounded to between 75% and 90% of pre-COVID levels as malls re-opened. The lockdown-driven spike in online should not be viewed as permanent. Retail sales remain cyclical, with consumer appetite primarily driven by the underlying economic conditions. It may take a little while yet for COVID-19 to be sufficiently suppressed in Australia – or for a credible vaccine to emerge - but the evidence points to shoppers going back to the malls as and when conditions allow.

The significant discount being applied across these 3 malls and the sub-sector in general suggests investors are largely pricing mall landlords similarly. But malls do differ, whether by location, by quality of tenants or by quality of management. The best malls will survive and the stronger centres will thrive in the long term. Perhaps the real story here is the opportunity for long-term investors that are willing to take a more active approach.

Important information: The content of this publication are the opinions of the writer and is intended as general information only which does not take into account the personal investment objectives, financial situation or needs of any person. It is dated October 2020, is given in good faith and is derived from sources believed to be accurate as at this date, which may be subject to change. It should not be considered to be a comprehensive statement on any matter and should not be relied on as such.  Past performance is not a reliable indicator of future performance and should be used as a general guide only. Neither Zurich Australia Limited ABN 92 000 010 195 AFSL 232510, nor Zurich Investment Management Limited ABN 56 063 278 400 AFSL 232511 of 5 Blue Street North Sydney NSW 2060, nor any of its related entities, employees or directors (Zurich) give any warranty of reliability or accuracy nor accept any responsibility arising in any way including by reason of negligence for errors and omissions. Zurich recommends investors seek advice from appropriately qualified financial advisers. Zurich and its related entities receive remuneration such as fees, charges and premiums for the financial products which they issue. Details of these payments can be found in the relevant fund Product Disclosure Statement. No part of this document may be reproduced without prior written permission from Zurich. Past performance is not a reliable indicator of future performance. GINN XYY9MQ.00000.SP.03. CSTT-016124-2020