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A Look At Unibail-Rodamco-Westfield (OTCMKTS:UNBLF)

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Via SeekingAlpha.com

Unibail-Rodamco-Westfield (OTCPK:UNBLF) is a true shopping center leader with a top tier portfolio of 93 shopping centers in Europe and the US with a combined gross lettable area of 91.2 million square feet, 1.2 billion visitors in 2019 and $1.6B of net rental income in 2019.

UNBLF trades with a stapled share structure that allows to keep the efficient REIT structure of the real estate portfolio in the US and in Europe. Investors should be aware of fiscal treatment of their investment in URW as different withholding taxes might be applicable to the company’s dividend distribution which by nature will be relevant in this investment.

I will not make a full review of the company’s business and assets because there is little to gain from that effort in this case. The company has been the European Shopping Center reference player for decades and it has devoted to becoming a pure player company with top quality portfolio in Europe and the US, after the merger with Westfield.

I will also not enter in the endless discussion between retail and on-line business. I do not deny the continuous eroding of market quote from the on-line business and the less leverage it leaves to physical retail operators as URW. It is a factual headwind that these companies must fight. But I also won’t discuss the fact that after 20 years of on-line retailing, appealing shopping centers continue to perform with constant growth in footfall and tenant sales.

It is not as positive as in the past, it is not the case for any shopping center of any nature in any place, but it certainly is the case for the UNBLF portfolio.

Besides the opportunity that we’re dealing has to do with share price, more than asset performance, quality or the like.

NAV and Share Price evolution since 2008 crisis

With the 2008 crisis, the share price of UNBLF went from the $220 level down to $110 per share in anticipation of all the suffering that consumers would have to face. The $110 minimum in less than a year implied going from a premium-to-NAV-territory to a 40% discount.

The reality is that the NAV of the company never went down so much as the share price had anticipated and instead of a few months it took three years for the portfolio value to get to the minimum of $137 in Dec10.

By that time, share price was back to the $150 level, or back to a slight premium over NAV, probably in anticipation of the recovery that was to come.

Therefore, in 2008s the market was very effective in anticipating the downward pressure in rents and values but in the middle of the storm it was inclined to overshoot it somehow.

What this shows to me is that you should better trust what the market is signalling but you don’t need to believe all of it. The market, in its search for a new balance, needs to overdo it a little before a contrarian view finds enough return potential to step in and help to find price stability.

By end of 2014, share price was at its maximum of $275 in comparison to a $166 NAV per share at that time. The NAV had been consistently growing since 2010 at 3-6% rate p.a., but the best was still to come, and in 2015 to 2018 the NAV went up 39%, up to $232 per share.

Again, by the end of 2014 the market was at the right side but was inclined to overestimate the great perspectives of the company’s assets.

By the end of 2016, the share price had been in roughly the same range since Dec14 as the market started to realize that maybe the best years of NAV growth were over.

By the end of 2018, the negative mood had clearly set in and the share price closed the year at $165 in comparison to a $232 all-time maximum NAV per share. In four years, it had gone from a 65% premium to NAV to a 30% discount.

Obviously, the market does not care about the NAV level, it does care about the future variations of the NAV as well as other variables like yield, leverage, asset quality, etc., that we’ll leave aside by now.

If at the end of 2018 we looked at the share price and its discount to NAV, we would have to assume that a peak in NAV had been left behind, and that the market anticipated a cycle of falls in gross asset values (GAV) wither from lower rents, higher cap rates or a combination of both.

Share price in 2019 stayed in the $130-165 range while the NAV of the company had started to come down, decreasing 5% in that year, mostly due to increases in capitalization rates. While rent growth was still positive (1.5% impact in GAV), cap rates had a -3.5% impact in GAV.

Again, the market had shown capacity to be on the right side in anticipation of what was to come, but it was still early to know if it had found the bottom or was still in transition to it.

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After some recovery in the last quarter of 2019, share price went down to the bottom of the previous range and then, by the end of February, hailstorm broke loose as Coronavirus risk become too evident to ignore in the Europe.

From the $132 on the 21st of February share price went down 58% to $55 and most of the fall happened in a handful of market sessions. After a brief recovery back to $80, the depth of the crisis was beginning to be measured more deeply and share price went back down to the previous lows, after a rating downgrade and a dividend payment.

Where the market is trading now and what it implies

Let’s take the $55 price reference. This share price implies a 75% discount to the Dec19 NAV, and by that I refer to the triple net NAV as calculated by EPRA standards and reported by the company (EPRA NNNAV).

This is by far the highest NAV discount that I have seen in a company of this size and quality.

In the 2008 crisis, the share price found a minimum that was 40% below the previous cycle NAV watermark before stabilizing. In other words, this discount is implying that the impact in the NAV will be almost two times (1.875x) the one that took place in the aftermath of 2008 financial crisis. Adjusting for different leverage now and back then, this discount implies a GAV adjustment that is 1.5x the one that took place in the 2008 crisis.

At the current share price, the dividend paid by the company in 2019 would yield 22% and even after cutting 2020 dividend by half, as the company has rightfully done, it would yield more than 10%.

In line with the dividend, the adjusted recurring income per share (AREPS) of 2019 would yield, if it was to be repeated in 2020, an incredible 25%. Again, a 50% decrease in AREPS would still leave a very interesting yield for shareholders investing at this price.

What to expect

The fact is that it is way too early to determine which will be the actual impact in the recurrent cash flow, GAV or NAV of the company. It is even too soon to determine how the impact will take place, at least it is for me.

We can list the possible direct and indirect effects, but we cannot be sure the list itself is complete and even less sure of which will be the impact from each item in the list.

The effects that I can anticipate as of now are the following:

  1. Temporary rent discontinuation from the COVID-19 confinement measures in most regions where the company is present. Obviously, the tenants in the closed centers will demand rent payment suspension, if not rent and charges, for the period that confinement measures are in effect and maybe for a longer period, until a decent level of activity is recovered by the center. So, we’re not sure for how long and how deep the impact from this will be.
  2. This situation will certainly cause a wave of bankruptcies in an unknown percentage of the company’s tenant base, especially the ones with less comfortable financial situation which are probably the smaller emerging brands. In the case of UNBLF this might be limited, but again, nobody knows for sure.
  3. During and well after the crisis is over, it will certainly take more time for new tenants to take lease decisions. In any case all tenants, current or future, will have more leverage than in the past in the negotiation table and this typically translates into less effective net rental income. Therefore, some unknown impact should be expected in the level of rents for the immediate and mid-term before all of this is forgotten.
  4. As the crisis impacts the whole of the economy it will certainly have its toll in employment and consumption of the typical shopping center visitor which again translates in a deep, maybe short, maybe not so short, impact in terms of shopping center sales figures for the tenants which translates into less variable rent and afterwards into lower base rent income for the operator.
  5. Finally, as all of this evolves, it is quite reasonable to expect an increase in the yield that investors ask from an investment in the shopping center class within the real estate. The assets of the company have become less liquid by now and if and when the company needs to tap the market, it will certainly find a tougher buyer market ready to be more selective in the asset and more demanding on the initial net yield and cap rates it requires.

All of these direct and indirect effects add to the foregoing narrative of online vs. physical prevalence that of course is intertwined with the NAV cycle change and the negative share price performance of the last 3 years.

Possible business impact

It becomes obvious after so many unknowns why the price for the share of the company is so depressed. It simply cannot find the trough because it is very difficult for any investor to try to establish return-reward scenario for the company.

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I have tried to imagine which is the impact that can come from that list of potential and very probable events and then try to see what is the reward that I can get under my initial base-case scenario.

We can also use this backwards, and try to see what is the implied effect that the market is assuming. My list of effects and its assumptions is the following:

  1. Rent suspension, I have assumed that the whole Shopping Center portfolio has a full 4-month downtime for 95% of the GLA. The probable confinement effective period won’t extend beyond 2 months and in many regions, it will be closer to 1-month, but I just want to make a conservative scenario and I cannot say this is my worst-case scenario. I have assumed that some part of the GLA remains open and therefore still pays rent. I have assumed that all the shopping centers are affected equally in all regions. Again, this is probably overdone since some regions have been more affected than others. I have also assumed 4 months downtime for 100% of the convention GLA and 1 month for 50% of the office portfolio. This would reduce 2020 NRI by $777M only in shopping centers and $824M in total.
  2. Bankruptcies. I have assumed an additional 5% effect from bankruptcies and that it will take an additional 4-month downtime period to replenish. I have assumed a 5% effect in office and a 3-month period added downtime. I have not assumed any effect for conventions in this front. This would reduce 2020 NRI by $41M.
  3. Permanent rent declines. I have assumed a 5% permanent base-rent adjustment on the whole of the shopping center portfolio which would take place as of 1st of July, that is 50% in 2020 and 50% in 2021. This adjustment is independent from indexation. The effect in NRI in 2020 and also in 2021 would be $61M.
  4. Impact on asset values. I have assumed a 100bps cap rate increase (more than 20% increase) which on a constant rent basis would yield a $10.85B adjustment in GAV, according to the URW reported sensibility. In addition to that and in coherence with the new permanent rent level I have assumed a 5% decrease in GAV that adds to the previous impact. All in all, GAV would decrease by $13.7B or 20% vs. Dec19 valuation. This is highly improbable but despite the appraisal might not move that much at year end it is a good proxy for what the market might think it is the true market value of the portfolio.
  5. Lower indexation, I have also assumed a 1% indexation for the coming years, compared to the 1.7% achieved in 2019 and in line with the average indexation of the 2010-2017 post-crisis period.

It is worth mentioning that all the impacts outlined before and the consequences foreseen in the company KPIs are rough estimates since I did not take the time to make a full detailed model for the company.

As rough estimates are perfectly valid but they are not an accurate and do not try nor pretend to be.

Recurring earnings impact and shareholder yield

With all these assumptions in mind and adjusting for the $3B asset sale announced in Feb20, I estimate the 2020 recurring earnings in $906M, vs. $1,883M in 2019, equivalent to a 52% decline. Apart from the asset sale I’m not considering any other change in the portfolio perimeter.

Fig.1: Recurring Net Income Estimates

I’m not considering any reduction in debt interest payments, not even from the asset sale. This provides some cushion in my assumption for some interest cost hikes that could happen in shorter term debt. I am considering that the company will reduce overheads and other expenses by 5% in 2020 and by 2% in 2021 in line with the cost reduction program after the Westfield merger but also as an effort that they’ll probably do in these difficult years ahead.

The estimated ARE would recover substantially afterwards, back to $1,696M in 2021 (+87%) and $1,717M in 2022.

Assuming no changes in the number of fully diluted shares, 2020 AREPS would be $6.54 in which would yield 11.9% at the current $55 share price. In 2021 and 2022, AREPS yield at current share price would jump up above 22%.

For me, this is the key variable, as it shows what the current portfolio yields to the shareholder irrespective of dividends or NAV discount.

NAV scenario

If the GAV adjustments took place as outlined, GAV would come down to $56.4B, equivalent to a 20% fall in one single year.

Fig.2: GAV impact

The probabilities of this happening are very low since the appraisal works looking at future cash flow and future exit cap rates for the whole portfolio. Appraisals are forward looking and despite how negative things might look at one moment, the long-term values tend to be more stable.

But despite how appraisals are made, this is probably the way the market is thinking right now and in that sense I’m making the exercise; not because I believe that Dec20 appraisals will show a $13.7B decline.

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NAV would come down even more, given the financial leverage, to $121 per share, a 44% decline vs. Dec19 NAV. The current share price would still be 45% below the adjusted NAV, which would still show a very pessimistic view on future NAV evolution.

Fig.3: NAV impact

There might be some problems on the leverage side. LTV would jump up to 47% (51% if the perpetual hybrid debt is included – I think it shouldn’t) and operating income to debt cost, ICR proxy, would fall from 4.9x in 2019 to 3.2x in 2020. In this case I did include the hybrid cost.

The company holds a A- rating from S&P, after a recent one-notch decrease. The debt of the company is at an average 8-year maturity and an average 1.6% cost and fully hedged (in part with caps-floors).

In my opinion, that is a comfortable position to face this crisis. You might ask for a little less LTV but it is what it is. Obviously, nobody was predicting this scenario. The company may face some tensions, but it should do fine.

Comparison to 2008 crisis

After the 2008 crisis, LFL rental growth of the portfolio fell 4x, from 8% to 2%, but remained in positive territory. Indexation came down from the 4% to almost nothing, but again remained in positive territory.

The impact of the crisis in terms of GAV was more severe. In 2008-2009 GAV decreased by 7.7 and 9.5% on a like for like basis, which implies a combined fall of 17% in two years. With leverage that implies a 25% fall in NAV (dividends and ARE apart).

Fig.4: GAV Like For Like Changes

Looking at this in terms of accumulated effect we can look at an index made from annual LFL changes in GAV in total and from rent and yield variations. Yield impact drives the GAV change in the short term but in the long term it’s rental growth from indexation and management of the shopping centers that wins.

GAV LFL changes index

It is also important to see that the deep fall in the first two years took more than 4 years to be compensated. Obviously, the depth and duration of that crisis made for a long and painful recovery.

I honestly don’t think that this crisis can be compared in terms of absolute relevance to the 2008 financial crisis. The magnitude is less relevant but it has developed very rapidly and is very hard to imagine what can be the long-term effects on very subjective issues as consumer behavior after a crisis which we still don’t know how much it will last.

But a 1-4-month stall in the economy of a significant part of the world cannot have the same effect that the previous crisis had, at least in my opinion.

What I know is that I have worked out a scenario where:

  1. Significant downtime periods (4 months) are assumed for the whole of the portfolio.
  2. Rent is haircut by 5%, which is way more than it happened in the 2008 crisis.
  3. GAV is cut by 20% which is more than what took place from 2007 to 2009 all combined as a result of the rent decrease (3% impact) but more importantly by a 17% yield impact in GAV.
  4. Consequently, NAV would fall by 45% to $121.

After all those hard-line assumptions, and even assuming an additional fall from 4-month-downtime from the confinement and from tenant bankruptcies, that would take 2020 ARE down by 52% vs. 2019, the current share price would offer a 12% yield from adjusted recurring earnings.

If you recall from the beginning of the article, the market placed itself at a 40% discount to previous NAV watermark and it overshot the decline that took place in the following two years by 15 percentage points.

Right now, if my base-case scenario is not too far from reality, it would imply that the market might be overdoing the correction by more than 55 percentage points since even after assuming a 45% decline in NAV, the share would be trading at a 55% discount to NAV.

Conclusion

I think that the scenario in rents could be more difficult than the one outlined since as of now is very difficult to have a feeling of how conservative is conservative.

On the other side, I think that the impact in GAV and NAV will be way less relevant in the short term, despite it is more difficult to know the long-term impact. I think we will forget the Coronavirus but I cannot base my investment decisions based on that.

I simply think that on the scenario I have outlined, a 12% yield growing potentially to 22% with an NAV that is almost 4 times current share price and a super-stressed-NAV that would be more than two times the current share price is good enough proposition for me to step in.

Disclosure: I am/we are long UNBLF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.




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