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Morningstar | Vicinity Has Work Cut Out Turning Around Portfolio. FVE Cut 9% to AUD 2.60

Vicinity Centre’s first-half fiscal 2019 was worse than expected, with the majority of the malls across the portfolio reporting sluggish sales and rent performance. New management are trying to extract value, but it will be difficult as trading conditions are changing far faster than the three to five years it takes for a landlord to revise its in-mall offering. A case in point is the fanfare surrounding the opening of Victoria's Secret’s first full-line Australian store in Chadstone (Vicinity’s 50%-owned premium mall in Melbourne), a stark contrast to its home market in the U.S. where the brand is struggling to attract shoppers. We’d been expecting Vicinity to offload around AUD 1.9 billion of its weakest malls by June 2019, but to date only AUD 670 million have been sold. Management expressed optimism in selling the remaining assets post June 2019, but it seems they’ll need to discount further as there is a wave of vendors trying to sell and few cashed-up buyers.

We pushed out the settlement date for the 12 assets flagged for sale back a year and assume Vicinity will need to take a haircut of circa 10% to its original price expectations. The fast evolution in consumer spending patterns has seen Vicinity and other landlords scramble to remix to more contemporary categories such as medical and beauty services and dining. The challenge is these categories are labour-intensive and hence have less operational leverage than legacy categories such as fashion. Revisions to asset sales timing and price expectations plus reduced rental growth expectation results in a 9% reduction in our fair value estimate to AUD 2.60 from AUD 2.85. At current levels, narrow-moat-rated Vicinity screens as fairly valued.

The major bright spot was the growth Vicinity was achieving in ancillary income from car parking, electricity generation. While not to be sneezed at, the bulk of revenue comes from rents and the trajectory here is weak, with net property income up just 1.3% on a like-for-like basis.

The development pipeline has undergone a major shake-up, with Vicinity deferring a major upgrade project at the Galleria in Perth as trading conditions apparently do not warrant the planned investment. Vicinity has numerous ambitious developments in the pipeline, which look set to make better leverage of the location of malls close to major transport infrastructure--for example, Box Hill train station, that Vicinity will likely convert into a mixed use asset combining offices, retail, and apartments. Progress on obtaining planning on a few of these will be a share price catalyst, but we are reluctant to incorporate all of these mooted projects in our outlook given the look lead times and complications of developing over and around inherently complex rail infrastructure.

The portfolio of 62 shopping malls comprise 12 challenged assets that Vicinity is having difficulty selling leaving 50 that have now been optimistically defined as "market leading destinations." Of these, 14 (or 50% by value) have been denoted as "flagship" assets (a term borrowed from Westfield) composed of Chadstone shopping centre, seven premium CBD malls, and six DFOs. The remaining 36 have been given the optimistic euphemism of "high potential" portfolio. We think it quite a challenge for Vicinity to turn around the performance of the "high potential" portfolio.

Trading data released revealed a very mixed outcome across mall types. The best performing assets include the recently revitalised Chadstone (21% of portfolio to be retained) and the direct factory outlets, or DFO, (12% of portfolio to be retained) where specialty and mini-major sales were up 12% and 7%, respectively. The remaining premium CBD and "high potential" malls achieved comparable sales growth of just 1.3%. This level of sales growth makes it hard to raise rents and also reduces the upside from investment to revitalise each asset.