EUR 850.00 For Business Accounts Only

Morningstar | URW's Reweighting to Larger Malls Gains Steam. FVE Increased to EUR 180

Unibail-Rodamco-Westfield reported first-half 2018 earnings per security, or EPS, of EUR 6.58, up 6.8% on the previous corresponding period and putting the firm on track to achieve reiterated 2018 EPS guidance of EUR 12.75-12.90. Our fair value estimate increases slightly to EUR 180 from EUR 177 on slightly upgraded rental growth outcomes for the French malls and currency movements. Narrow-moat-rated Unibail-Rodamco-Westfield screens as fairly valued, currently trading around EUR 185.

Management were more tight-lipped than we'd expected, declining to provide detail on the performance of the former Unibail and Westfield businesses on a stand-alone basis or whether the Westfield business was accretive. This doesn’t provide confidence that Unibail-Rodamco-Westfield management are fully across the recently acquired malls in the United States and United Kingdom. That said, promised merger synergies were reported to be running ahead of schedule, with EUR 74 million of costs taken out from the business compared with the budgeted amount of EUR 60 million. Management continues to expect revenue synergies, but not for another three to five years.

We remain supportive of Unibail-Rodamco-Westfield's strategy to reweight the portfolio towards larger malls that dominate the catchment area. Over the longer term, these assets--generally in areas with high household disposable income--should benefit from superior sales productivity and hence rental growth. There is nothing particularly innovative about this strategy, but it is only possible with a select few assets in each city. Fortunately, Unibail-Rodamco-Westfield has a first mover advantage, with 86% of the combined retail portfolio being a dominant force in the catchment area, a key factor underpinning the narrow moat rating.

The near-term challenge ahead is to manage the deleveraging of the business without unduly impacting earnings. The main deleveraging lever is the flagged
EUR 3 billion of asset sales, and of this, EUR 1.2 billion has been contracted, but none of this settled in the first half. As the assets being sold generate cash yields of 5.5% to 6.5% the sale of these assets will be earnings-dilutive as returned funds will be initially used to repay debt which has an average cost of 1.5%. Assuming assets sold on average yield 6.0%, the EUR 3 billion of sales will have a full year negative EPS impact of EUR 0.98. We don't expect this to fully materialise in earnings as Unibail-Rodamco-Westfield is expected to redeploy part of sales proceeds to its retail development pipeline. A positive is agreed prices for asset sales has averaged 6% above last appraisal values.

As expected, sales performance across the European portfolio was choppy as the smaller shopping centres struggled while the larger shopping centres shone. Management's strategy is in many respects exacerbating the divergence, as the out-of-favour smaller assets are largely starved of investment while the large in-favour malls--denoted flagship malls--are reinvigorated via expansive redevelopment initiatives. The difference is born out in the sales numbers, with overall European retail tenant sales up 2.6% as the solid 3.2% sales growth for the flagship malls was dragged down by weaker performance of the smaller malls. European like-for-like net rent growth was up 4.3%, again driven by the flagship assets, where rents were up 5.7%. Country-by-country performance was very mixed, with central Europe and France achieving like-for-like net operating income, or NOI, growth of 6.5% and 5.3% respectively, but Germany and The Netherlands NOI growth was 0.4% and negative 1.6%, respectively.

NOI for the malls in the U.S. increased by 6% as development projects at Westfield Century City and Westfield UTC become income generating. Comparable figures (which exclude development assets) show a weaker picture, with comparable NOI down 3% and down 2.6% for the flagship malls. The driver of the decline was bankruptcies and closure of some big box stores, pushing down portfolio occupancy by 1.4% over the half to 94.3%. We forecast a gradual recovery for the U.S. malls as vacant space is gradually let up and Unibail-Rodamco-Westfield benefits from growth in base rents as new leases negotiated for the half year were up 6.9% on prior rents.