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Morningstar | Little to Cheer About in Unibail’s Result and Outlook; Fair Value Estimate Declines to AUD 12.00. See Updated Analyst Note from 15 Feb 2019

Unibail-Rodamco-Westfield reported 2019 earnings per security, or EPS, of EUR 12.92, a whisker above guidance. The negatives greatly outweighed the positives in the result and outlook. We’ve cut our rental growth outlook for all the retail assets and slightly raised rental outlook for the French office assets that are benefiting from low levels of vacancy. Given retail spending across Europe and the U.S. has been vastly buoyed by stimulatory interest rate settings, the eventual move up in interest rates will hurt household disposable income and discretionary retail spend. Customer visits (or footfall) was mixed across geographies. Malls that had recently undergone major expansion reported strong footfall growth, but the performance elsewhere was disconcerting, with declines in Germany negative 1.9%, Austria negative 1.4% and the Netherlands negative 1.3%. We are far less optimistic than management for rent growth across the retail portfolio. Our fair value estimate for narrow moat-rated Unibail’s Australian CDI’s declines to AUD 12.00 from AUD 13.30, with Unibail screening as fairly valued at current levels. We see no clear catalysts that will close the gap between our fair value estimate of Unibail Australian CDI’s at AUD 12.00 and the Net Asset Value per security of AUD 17.75.

Retail tenant sales were respectable, up 3% across continental Europe, but the minimum guaranteed rental uplift for leases signed fell to 11.7% in 2018 from 14.7% in 2017, implying falling rental tension. It would appear sales are increasingly clustering in a small portion of popular tenancies--such as high spend electronic stores--which flatters the performance of other retailers that are suffering sluggish sales. Unibail is working hard to remix its malls toward more contemporary categories, particularly dining, however, these tenants have lower rent paying capacity than traditional fashion tenants and generally require landlord assistance in the investment in the shop fit-out.

A longer-term challenge faced by Unibail is the eventual increase in borrowing costs, which have an average rate of 1.6%. Given the firm has an EBITDA to interest coverage ratio of 6 times, a gradual movement to more neural interest rate settings will weigh heavily the firm’s future operating cashflow and distributions. Unibail is taking steps to address this risk by upping the value of property it plans to sell from EUR 3 billion to EUR 6 billion. And EUR 2 billion of assets were sold in 2018, with Unibail in the process of market the remaining EUR 4 billion of assets, which we expect will be sold by end December 2020. Management didn’t specify the assets to be sold, other than to advise it won’t include the U.S. regional malls, where acquirers will be challenged to secure financing.

The earnings outlook is underwhelming, with management guiding for 2019 adjusted recurring earnings per security of EUR 11.80 to EUR 12.00 (equivalent to AUD 0.94 to AUD 0.95 per CDI) and unchanged dividends of EUR 10.8 per share (equivalent to AUD 0.86 per CDI), representing a yield of 7.5%. The midpoint of guidance implying earnings to decline by EUR 1.0 per security or 7.9%. Most of the decline is due to loss of income from anticipated sales of EUR 3 billion to EUR 4 billion of property with yields of 4.5% to 6.5%, with proceeds used to repay debt which has an average cost around 2%. Unibail has also suffered from extremely weak performance of the smaller U.S. malls (4% of group assets) acquired as per of the Westfield acquisition. There is negligible investor interest in these malls individually or as a portfolio.