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Morningstar | Kiwi Property’s Solid Retail Sales Faces Medium-Term Pressures. FVE Increases to NZD 1.40

Kiwi Property Group reported fiscal 2019 earnings (on a fund from operations, or FFO, basis) of NZD 106.9 million down on the NZD 111.3 million in the prior year. Asset sales were the key reason for the decline, with rent income falling NZD 6.8 million from the sale of North City and NZD 6.0 million from the sale of the Majestic Centre, both in Wellington. Rental growth across narrow-moat-rated Kiwi Property’s portfolio was slightly ahead of expectations and recalibrating for higher base rents is the primary reason for the upgrade to our fair value to NZD 1.40 from NZD 1.35. Kiwi screens as slightly overvalued, currently trading around NZD 1.54. Guidance is for fiscal 2020 distributions of NZD 7.05 cents per security, implying a yield (before imputation credits) of 4.6%.

The retail portfolio performed slightly better than expected, with like-for-like retail sales up 2.4% over the year to March 2019. Key drivers include sustained growth across most parts of the New Zealand economy, and helped along by significant down-time at Westfield Newmarket as it undergoes major redevelopment. Rents for the retail portfolio were around 0.5% ahead of expectations, with Sylvia Park the standout. However, the late 2019 opening of Newmarket will take foot traffic and sales from Sylvia Park, reducing the rental growth trajectory. Our forecast for long-term annual rent growth remains at 2.8% for Sylvia Park and 2.2% for the remaining retail assets. The lower rental growth for the smaller retail assets reflects their location in smaller cities where income and population growth are expected to trail that of Auckland. Key drivers underpinning these forecasts are annual New Zealand population growth of circa 1% and inflation of 1.5% to 2.0%, with detractors being a loss of sales to digital sales channels and intense competition among centres.

The office portfolio delivered a weak result for fiscal 2019, mainly due to a vacancy at the Vero Centre in Auckland. Nonetheless, Kiwi reported new leases at the Vero Centre were negotiated at a 9.3% premium to previous rents. Office vacancy in Kiwi’s two office markets of Auckland and Wellington of 1.4% are well below long-term average of 7%-8%. This bodes well for growth in market rents, but Kiwi will get little benefit from this for the next seven years as most of the office portfolio are on long-term leases with fixed increases. Even though rents are not rising particularly fast for the long-leased office assets, these assets will increase in value as values are linked to market rents. The Vero Centre is the only major office asset that will benefit in the near term from rising market rents and falling vacancy, and this asset will be the major driver of office rent growth in fiscal 2020.

Leverage remains at modest settings, with gearing (finance debt over total tangible assets) of 31% at end March, in the middle of the firm's target range of 25%-35%. The interest coverage ratio is healthy, with net rental income 4 times the firms net interest expense, well above the covenant of 2.25 times.