Unibail-Rodamco-Westfield: 9% Sustainable Yield From The Best Shopping Centers In Europe

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Those who already follow me know I have a long-term bullish outlook on high-quality retail REITs in Europe, and I believe the recent take-over of Atrium Real Estate (OTCPK:ATRBF) has proven there is value in the sector. Mall REITs remain cheap vs. historical averages both from an NAV and P/FFO multiple perspectives, and I see several reasons to be contrarians here. Part of the investment thesis overlaps with US high-quality players like Simon Property Group (SPG) and Taubman Centers (TCO), but I believe there are a few geographical reasons as well for optimism when it comes to European REITs. Among the motives, I’d cite the lower amount of retail space per capita and the more brick-and-mortar friendly senior demographic.

I have reviewed a few notable players following their H1 2019 releases, and I consider both Klepierre (OTCPK:KLPEF) and Unibail-Rodamco-Westfield (OTCPK:UNBLF) good buys at the present levels. This article focuses on Unibail-Rodamco-Westfield, which I will call by its Amsterdam-traded ticker “URW” for convenience.

I am a bit surprised to see URW receives so little coverage on Seeking Alpha since the company is the largest listed REIT in Europe. Born last year from the merger of Unibail-Rodamco with Westfield, URW owns assets worth more than €65 billion. The portfolio is highly skewed towards retail, with 92 owned mall/shopping centers, but the company has a 10% diversified exposure to office and convention centers as well. The stock has recently tested new 52-weeks lows, trading for the first time since the merger below €120 per share, and it seems increasingly a screaming buy for below reasons.

#1 – Best assets in Europe

Source: Unibail-Rodamco-Westfield investor presentation – June 2019

Accounting only for countries where URW is present, the company owns almost two-thirds of the Top 30 assets by footfall, four out of the best five shopping centers. Class A malls represent an outstanding 94% of the gross market value of URW’s assets.

During the last investor days, the company has provided a peer comparison in which URW showed its superior assets, Klepierre was among the listed peers (number 5). There is little doubt the vast majority of URW assets are expected to survive the “death of retail,” as next-generation retailers compete for high-footfall spaces to showcase their products and generate omnichannel sales.

Source: Unibail-Rodamco-Westfield investor presentation – June 2019

#2 – H1 results above expectations

URW reported half-year results on July 31st, and the company delivered a robust 3.3% like-for-like net rental income growth, aided by a strong performance of office and convention centers. The fall in adjusted EPS, anticipated by URW at the beginning of the year, was lower than expected and allowed management to raise FY guidance by 2.5% from €11.80-€12.00 to €12.10-€12.30.

Source: Unibail-Rodamco-Westfield Q2 earnings presentation

URW comparable results were stronger than the 3.1% like-for-like increase reported by Klepierre and the 1.5% by Eurocommercial (OTC:EUCMF). Wereldhave (OTC:WRDEF) was able to pull a positive 0.6% variation as well, while back in May peer British Land (OTCPK:BTLCY) reported a 1.5% contraction. The overall situation in England appears worse than in continental Europe, at least pending a final resolution for the long-time stalled Brexit.

#3 – Fortress balance sheet

One reason I am a big fan of SPG is that thanks to David Simon’s conservative leadership, the company maintains an “A” rating from S&P. The ability to tap into cheap financing and maintain profitability with a lower amount of leverage is a critical advantage as both a recession and sector consolidation are increasingly anticipated events at this point.

URW retains the same “A” rating, the only retail-related REIT in Europe (that I am aware of) with the same level of safety. Best runner-up Klepierre scores an “A-,” although the company has a straight “A” from Moody’s. British Land has an “A-” from Fitch. Wereldhave has a Baa2 rating also from Moody’s, Eurocommercial is unrated: the balance sheet is a bit weaker with a 46% LTV ratio and ICR below 5.0x, but still the company has access to cheap funding. URW, Klepierre, and Wereldhave have voluntary best practices in place to maintain their LTV below 40%. What stands out in URW’s case is the company’s ability to stretch funding beyond peers:

Source: Unibail-Rodamco-Westfield Q2 earnings presentation

#4 – XL-sized dividends

URW has declared 2019 dividends of €10.80 per share, distributed semi-annually. Based on €120 per share, it equates to a very compelling 9% yield. The distribution coverage appears, however, tight as almost 90% of Unibail-Rodamco-Westfield fwd-2019 EPRA EPS (a measure similar to NAREIT FFO but based on IFRS rather than GAAP) is paid out to shareholders. Nevertheless, URW has remarked in its latest presentation it considers the dividend sustainable and has committed to a minimum payment of €10.8 per year for the entire 2019-2023 business plan. The goal, while challenging, seems attainable, as the company has a significant €10 billion pipeline (half retail, half mixed-use including office, residential and hotel) of new projects coming online.

Management has historically targeted and achieved growth in recurring EPRA earnings (FFO) of 6-7% per year, on par with the other best operators in the space, Simon and Klepierre. URW also expects to maintain a CAGR between +5% and +7% during the entire 2019-2023 period. The growth will help provide additional legroom to reduce the payout or fund dividends increase. Despite recurring EPS having declined in 2019, this was a pre-announced plan. After the merger, URW decided to dispose of several non-core properties to achieve strict deleverage targets. Dispositions were made at a premium to NAV. The company is still growing on a like-for-like basis and is set to increase recurring EPS again from 2020.

#5 – Significant discount to NAV, low P/FFO multiple

The EPRA NAV is assessed for each company by a third party at a single-property level, usually by an international real estate service provider like Cushman & Wakefield (CWK) or CBRE Group (CBRE). Although all analyzed names show a certain level of discount, there were significant differences within the group. It is essential to note initial assumptions are different. URW net initial yield was 4.3%, Eurocommercial and Klepierre 4.8%, Wereldhave 5.5%.

There are no notable surprises as the URW portfolio, as shown above, is predominantly made of class A and A+ properties, which, therefore, rightly commands higher valuations. Klepierre and Eurocommercial stand in the middle, owning a mix of class A and B properties. Wereldhave has the lowest portfolio quality in the group, and most of its shopping centers fall within the B and C class: 5.5% could be tight.

Despite the differences in NAV, it seems complicated to argue that one company is more undervalued than the others. The whole group has performed poorly YTD, and all these names trade at a sizable discount versus their historical averages. The better risk/reward choice will depend on the outlook for weaker retail assets. If a “full market recovery” happens, Wereldhave is the name with the most significant upside, like Washington Prime Group (WPG) in the US. This possibility seems less remote in Europe than in the US, as even Wereldhave posted an improved direct result per share vs. last year.

However, in a conservative scenario with some mall closures happening, URW is the most likely winner (together with Klepierre). I frankly do not see the most bearish “apocalypse” situation (with a shift to online so pronounced to jeopardize Class A malls viability) playing out anytime over the next 20 years.

#6 – Conclusion

Retail is in constant evolution, and there have been several periods marked by a heightened number of store closures and bankruptcies in the past. The digital era presents a challenge for retailers and landlords to survive, but it also represents an opportunity for best-run businesses to renovate and create new sources of competitive advantage. URW seems well-positioned to profit from the new omnichannel strategies because the relative attractiveness of high-footfall destinations is likely to continue increasing. Urban areas already show a high demand for experience-led retail, leisure, dining, and services to customers.

Source: Unibail-Rodamco-Westfield investor presentation – June 2019

Substantial investments will be needed to modernize malls and create such experiential destinations. Landlords will need to commit significant CAPEX amounts to succeed in this challenge, and for this reason, I believe the best-capitalized players have a considerable advantage. Therefore, the market is correctly considering high discounts on financially leveraged small players who might not make it through the next recession. However, I also think investors have been in a rush to reach for the emergency exit without considering the positive results reported by best-in-class REITs. The reliable profits of these companies give me confidence that well-positioned players like URW will successfully enter 2020 and beyond.

Disclosure: I am/we are long SPG, UNIBAIL-RODAMCO-WESTFIELD, BRITISH LAND, AND ATRIUM COMMERCIAL REAL ESTATE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.