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Morningstar | SCA Property Buys AUD 573 million of Vicinity’s Noncore Malls. FVE Unchanged at AUD 2.30

Shopping Centres Australasia Property Group, or SCA Property, is acquiring 10 shopping malls from Vicinity Centres for AUD 573 million. The malls are 98% occupied and generate a yield of 7.24%, but the yield will be temporarily propped up to approximately 7.47% as the vendor is providing a two-year rental guarantee, capped at AUD 8 million. SCA Property has guided for the annualised pro forma uplift to fiscal 2019 funds from operations, or FFO, to exceed 5% from the transaction. Accordingly, FFO guidance for fiscal 2019 increases to AUD 16.2 cents per security, or cps, from AUD 15.6 cps. Distribution guidance is also increased to AUD 14.7 cps from AUD 14.3 cps.

Our revised forecasts align with updated guidance, but our fair value estimate is unchanged at AUD 2.30 as earnings accretion from the transaction is countered by the AUD 40 million of transaction cost and a slight increase in portfolio risk. The weighted average cost of capital in our discounted cashflow valuation increases to 8.25% from 8.1% previously.

In many respects, the acquired assets fit with SCA’s strategy to own malls that offer convenience to shoppers. All the acquired malls are anchored by either Coles or Woolworths and anchor rents make up 38% of gross rental income. The downside from the transaction is many of the malls are in locations where there is strong competition nearby, making it challenging to grow rents and secure good-quality tenants. Due to strong competition in the surrounding area, we see limited scope for upside from redevelopment, such as mall expansion to accommodate additional supermarkets.

The AUD 93 million subregional Warnbro Centre, south of Perth, faces tough competition from Stockland Baldivis, which is double the size and approximately 8 kilometres away, and Rockingham Centre 7 kilometres away and triple the size. The AUD 91 million Currambine Central, a neighbourhood mall, is less than 5 kilometres from Lakeside Joondalup, one of the largest malls in Western Australia and 2 kilometres from Beaumaris City, a dated but IGA-anchored neighbourhood mall. Similarly, the AUD 52 million Lavington Square in Albury has competition nearby and due to a dated and convoluted layout is likely to retain the current mix of weak specialty tenants for the foreseeable future.

The earnings accretion comes from three major sources. First, the acquired assets have a yield of 7.47% (inclusive of a rental guarantee), which is 18% above the 6.33% weighted average captialisation rate of SCA’s existing portfolio. Second, SCA expects some operating synergies, advising the group’s management expense ratio (corporate costs divided by assets under management) is expected to decline from 0.43% (43 basis points) to below 0.40%. Third, the rental yield of 7.47% is around 85% higher than expected borrowing interest rate of 4%. Post the transaction SCA’s leverage will increase by 2% to approximately 34% on a pro forma basis. Total acquisition costs of AUD 613 million (inclusive of AUD 40 million of taxes and transaction costs) will be initially funded by an AUD 259 million institutional equity placement at an underwritten floor price of AUD 2.29 and AUD 354 million of debt, but the debt component will likely net out to AUD 221 million as SCA plans to raise AUD 50 million from a unit purchase plan and divesting its 5% stake in Charter Hall Retail for AUD 83 million.