EUR 850.00 For Business Accounts Only

Morningstar | Vicinity to Purge a Further AUD 2 Billion in Malls. FVE Increases to AUD 2.85

Narrow-moat-rated Vicinity Centres' fiscal 2018 earnings on a funds from operations, or FFO, basis of AUD 18.2 cents per security, or cps, were in line with guidance. Our fair value estimate increases 5% to AUD 2.85 from AUD 2.70 as we raise long-term rental growth projects as a further AUD 1.9 billion of lower growth assets are planned to be sold over the year to June 2019. This is a very significant sales program, representing 11.5% of the portfolio by value. Gearing will fall materially from 26.4% at June 2018 to approximately 18% on a pro forma basis. Capital released from the sales will be redeployed initially to the retail development opportunities. In around three years, the first of the flagged 12 mixed-use opportunities are likely to commence, generating yields on capital deployed and raising the amenity in the underlying assets.

We are supportive of the strategy to enhance shopping centres by building office towers, hotels, or apartments in areas of the mall that don't adversely impact the main retail trade areas. Mixed-use developments of this type are very common in densely populated cities throughout Asia and are especially successful in Japan. The most logical locations for mixed use are at sites adjacent to rail stations as these provide high operational leverage and are likely to be looked upon favourably by city planners. So it is not a major surprise the Box Hill Central, which sits on a major rail line, is likely to be one of the first major mixed development opportunities to progress. Given the sites for the mixed-use developments are notionally acquired at very little cost, development returns are expected to be superior to that of most property developers who have to competitively bid for development sites.

Most of Vicinity's best and biggest assets have recently undergone or are about to undergo development and are excluded from the sales metrics, making it difficult to get a clear picture as to how tenants across the portfolio are trading and hence an insight into medium-term rental growth. High rent paying specialty stores were reporting generated sales growth of just 0.9%, but this would be less than the overall portfolio due to the exclusion of the better malls from the official sales metrics. That said, there are presumably numerous malls with very weak sales reflecting an out-of-date tenant mix or structural problems. The worst performers are undoubtedly being flagged for sale. Given the structural problems with these type of assets, there is a residual risk that Vicinity may have to sell some of the assets at a discount to book value.

Major forecast revisions include the divestment of AUD 900 million of properties to seed the new Vicinity Keppel Australian Retail Fund, or VKF, and modest earnings upside in fiscal 2020 from funds management. Our forecasts align with fiscal 2019 guidance for FFO of AUD 18.0 cps to AUD 18.2 cps.

Vicinity has already sold AUD 1.9 billion of assets in the three years since the merger of Novion and Federation Centres and this will increase to AUD 3.8 billion assuming there are buyers for the remaining malls that are deemed noncore. assets. Still to come are AUD 1 billion of noncore assets to be marketed for sales over the course of fiscal 2019. There is a further tranche of malls that are planned to be transferred in March 2019 to a new wholesale fund, the VKF seeded with AUD 1 billion of existing Vicinity assets and jointly managed. Vicinity and Keppel will initially hold up to 10% in the fund, with the balance sourced by Keppel Capital. Nonetheless, it wouldn't be a surprise if the number of assets to be sold increases further in a few years.