Shopping Centres Australasia Property Group (SCP) provides exposure to a ~100 shopping centre portfolio. 70% of income is derived from groceries, fresh food, and healthcare – which provides the group with a defensive income profile. We see SCP as a defensive REIT with the most significant risk to the share price being expected movements in bond yields.
SCP has relatively limited development opportunities leaving the group hostage to higher bond yields over the next 1-2 years. SCP has shown to be acquisitive since listing in 2012, having doubled the asset base and increasing tenant diversification.
Periods of rising long-term bond yields have historically seen the SCP share price underperform the S&P/ASX200. In 4 of the last 5 periods of rising long bond yields, SCP has underperformed the market by an average of 11%.
Balance sheet has low interest rate hedging into FY25E. The relatively low hedging profile (one of the lowest in the sector) results in a 2-3% point decrease in distribution per share for every 1% increase in bond yields. Movements in bond yields are likely to remain the key influence on the SCP price over the 2022/23.
A wider range of growth options are being pursued. Since listing in 2012, SCP has largely been a ‘rent box’ with limited ability to organically grow earnings outside of rental growth and development opportunities.
In 2021, SCP took steps to move into property funds management which would allow SCP to accelerate asset recycling, whilst still retaining a level of fee income. The market currently attributes no value to this opportunity.
SCP is currently targeting $750m of assets to be sold into a JV with Singapore-based GIC. This has the potential to free up $600m of capital (SCP to retain 20% ownership of assets), which could be used to accelerate centre acquisition/ development or capital management. Assuming reinvestment of capital at the same return on assets for the Group, this could potentially add 1-2% to growth over the next 3 years.
Near-term distribution growth is expected to be flat into FY25E, driven by higher interest costs that are unlikely to be offset by retail income growth. Retail trading conditions boomed through Covid as consumers favoured small format shopping centres close to home. Speciality retail turnover is currently running at +10% higher than pre-covid levels which suggest SCP can still achieve rental growth, albeit offset by higher interest costs.
Investment view. We rate SCP a Hold. SCP offers a reasonably attractive dividend yield, offset by low distribution growth. SCP’s rental income stream is highly defensive, although the lack of interest rate hedging at this point in the cycle leaves the outlook flat for distribution growth into FY25E.
SCP trades at a 25% discount to NTA, which is in line with the sector ex- Charter Hall (CHC) and Goodman Group (GMG). The addition of a capital-light funds management business offers medium to long-term prospects to accelerate organic earnings growth from 2-3% pa to +3% pa.
In the short term, the SCP share price is likely to remain hostage to rising bond yields with little ability for management to accelerate income growth. The prospect of peaking interest rates in early 2023 could see the pressure on the SCP share price alleviate.
The key near-term catalysts are; 1) balance sheet deployment into acquisitions; 2) additional growth from Funds Management; and 3) interest rates peaking.
Asset Structure and History
SCP’s asset structure has shifted in the past 10 years. SCP originated as a Woolworths centre manager and over the years has turned into one of Australia’s largest neighbourhood-focused shopping centre operators and managers. The Group is internally managed.
The rental income profile has historically been driven by the anchor rentals (major grocers) but has since shifted to be majority specialty driven. The diversification away from Majors provides less risk towards a downturn in conditions from a single partner. In 2013 Woolworths Group was 63% of gross rent, today it makes up only ~30% representing the focus on building specialty strength and a diversified portfolio.
Figure 1: FY13 tenants mix has a high dependency on Woolworths.
Figure 2: FY22 tenants mix, specialty exposure has moved significantly higher.
Over the same time frame (2013-2022), SCP strengthened its domestic focus by selling its NZ exposure (2016) and expanding its network of centres interstate (now covering 6 states and 1 territory).
SCP has almost completed its move away from freestanding centres which once represented ~30% of gross rent back in 2013. Now the portfolio is predominantly neighbourhood centres with a small sub-regional exposure. Minimal overlap. which allows the group to not face direct competition from dominant peers SCG and VCX. The increase in neighbourhood centres has allowed for the group to be less reliant on Woolworths group.
Figure 3: SCP has moved away from free-standing assets, by growing neighbourhood and sub-regional exposure which offer larger more diversified income streams.
Consumer Staples Focus
The group remains well-positioned for a period of weaker consumer environment given its large consumer staples exposure. ~70% of group income is derived from everyday spending/consumer staples exposure. SCP largest tenants include: Woolworths Group (WOW), Coles Group (COL) and Wesfarmers (WES) which represent 45% of group regional income.
The consumer staples focus also means that these centres are unlikely to feel the same pressures from online that peers Scentre Group (SCG) and Vicinity Centres (VCX). Occupancy costs are half what is found in the SCG/VCX centres.
Figure 4: Specialty exposure is overweight consumer staples.
Earnings and Strategy
Over the medium-longer term, SCP targets adjusted funds from operations (AFFO) growth of +2-4% pa.
Since listing in 2012, SCP has delivered 3.7% AFFO CAGR growth, with ~1% point of this growth derived from acquisitions.
Organic rental income growth has averaged 2.6%-2.8%. This is split between 3.9% annual fixed rent reviews for retail specialty stores (~50% of group rental income) whilst we estimate the anchor tenants (Coles, Woolworths, Big W have) have lower rent escalators of ~1.9% (47% of group rental income).
The current high inflation environment exposes SCP’s overreliance on fixed rent reviews with ~5% of rents linked to CPI. This can result in earnings being squeezed if interest expenses are also on the rise, which is the case at present.
Strategically, SCP has started to move anchor tenants to turnover-based rent payments. This provides an indirect link to inflation, and direct link to the tenants’ performance. In time, this should provide higher levels of rental growth vs the current fixed growth mechanism (which has averaged 1.9%). ~40% of anchor tenants have moved to turnover-based rent.
Figure 5: SCP annual rent review mechanisms. Benefits from lower inflation environments.
Acquisitions and Capital Management
SCP’s strategy actively pursues acquisition growth, to lift earnings and increase diversification.
The prospect of higher bond yields could lead to falling valuations for neighbourhood centres. Capitalisation (cap) rates (discount rate for property valuations) for neighbourhood centres have from 8.25% to 5.35% since 2013. Over the same time, SCP Group cap rates have fallen from 8.0% to 5.4%.
SCP flagged that they remain diligent in looking for opportunities that arise and are well-positioned to take advantage of the change in market conditions. The balance sheet would allow for an additional ~A$250m of acquisitions without lifting the gearing above the ~35% limit. This could be boosted to ~A$650m if proceeds from the asset sell down into the GIC JV a directed at acquisitions.
Historically, SCP has raised equity to fund the acquisition of new shopping centre portfolios.
Over the past 6 years, the shares on issue (SOI) have increased 1.5x whilst the number of assets has grown by ~1.6x (dollar value of assets, cap-rate adjusted). AFFO per share increased only ~1.3x, reflective of higher asset valuations that the sector has seen since 2015, as well as the capital-intensive nature of SCP.
Figure 7: SCP have been active in acquiring assets over the past 10 years, including the 10-asset portfolio from Vicinity (VCX) in 2019
Figure 8: SCP has raised equity four times since listing for acquisitions.
Asset recycling – JV with GIC + Development
SCP is looking to expand its earnings by growing its asset-light management fee income.
To facilitate this, SCP has established a long-term strategic partnership with GIC, with the hope to expand into lower-yield/high-value metropolitan neighbourhood centres.
The first step of this will be through the SCA Metro fund which has a target size of A$750m. The ownership split of 80% (GIC)/20% (SCP) could potentially free up A$600m (~13% of group assets) of capital to be recycled into new assets.
The SCA Metro fund (GIC/SCP) commenced in April 2022 with 7 seed portfolio assets for A$285m. In July 2022, SCP acquired a metropolitan neighbourhood shopping centre in Beecroft (NSW). This lifted the gross fund asset values up to ~A$350m, equating 47% achieved of the target A$750m fund size.
In our view the move into a Funds Management model is a positive for SCP, facilitating SCP’s expansion into higher-valued metropolitan assets which typically have higher growth rates/development opportunities than regional assets. The ability to recycle capital more quickly under the FUM model has the potential to lift SCP’s ROE and earnings growth to >4% pa.
Valuation
Bond yields vs share price
Historically, the SCP share price has performed poorly versus the S&P/ASX 200 in periods of rising 10-year bond yields.
Since listing in 2012, SCP has underperformed in 4 of 5 periods of rising bond yields. The average underperformance is 11%. In the current period of rising bond yields, the underperformance is -17% since SCP was at all-time highs in April 2022, ahead of the RBA’s first rate rise this cycle.
Our view is that bond yields are nearing a peak in this cycle, with many leading indicators of inflation point to slower rates of price change.
If bond yield peak, some of the pressure on the SCP share price should alleviate, and we would expect the SCP to recoup some of its relative performance vs the market.
Figure 9: SCP has underperformed the S&P/ASX 200 in 4 out of 5 periods of rising 10-year bonds yields since listing in 2012.
Price to NTA
SCP currently trades at a 10% discount to NTA. The broader A-REIT sector (ex Charter Hall Group (CHC) and Goodman Group (GMG)) trades at a 25% discount to NTA.
Currently, SCP’s narrower discount to NTA reflects the consumer-stapled focus and more regional focus of the portfolio. We also believe that the Group has a greater ability to lift rents vs the sector given the under-renting across the portfolio. These factors could help mitigate any rise in cap rates and lower property valuations.
Historically, SCP has traded around NTA (1.0-1.1x), given the Group’s traditional tenant/landlord business model.
Figure 10: REIT sector P/NTA vs FFO growth. Medium term investment considerations rather than near-term growth rates weigh on price to book valuations across the sector.
Hedging and Gearing
SCP’s debt balance is ~80% hedged for FY23E, falling to 21% by FY25E, one of the lowest levels of hedging across the REIT sector. This creates an earnings headwind if interest rates were to continue to rise.
In-terms of sensitivity, in FY25E for every 0.5% increase in interest rates would reduce AFFO by 3.8% This would make AFFO growth very difficult to achieve across FY23-25E if interest rates continue to rise.
Gearing for the Group currently sits at 30%, bottom of the 30%-40% target range. SCP is aiming to keep gearing below 35% at this point in the cycle given the prospects for downward pressure on shopping centre valuations.
A 10% fall in property valuations would place gearing closer to the mid-point of the range.
We remain comfortable with SCP’s level gearing, in part as they are willing to sell assets, which would lower gearing if need. In the short-term the sell-down of assets in the GIC JV will lower gearing. Our base case is that SCP will not need to raise equity to protect the balance sheet.
Figure 11: SCP has one of the lowest levels of debt hedging across the AREIT sector, limiting the ability to grow AFFO into FY25e.
Figure 12: Sensitivity to movement in interest rates. For every 0.5% move higher in interest rates, AFFO falls by ~4% in FY25e.
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Investment view
We rate SCP a Hold. SCP offers a reasonably attractive dividend yield, offset by low distribution growth. SCP’s rental income stream is highly defensive, although the lack of interest rate hedging at this point in the cycle leaves the outlook flat for distribution growth into FY25E.
SCP trades at a 25% discount to NTA, which is in line with the sector ex-Charter Hall (CHC) and Goodman Group (GMG). The addition of a capital-light funds management business offers medium to long-term prospects to accelerate organic earnings growth above the +2-4% pa range.
In the short term, the SCP share price is likely to remain hostage to rising bond yields with little ability for management to accelerate income growth. The prospect for peaking interest rates in early 2023 could see the pressure on the SCP share price alleviate.
The key near-term catalysts are; 1) balance sheet deployment into acquisitions; 2) additional growth from Funds Management; and 3) interest rates peaking.
Figure 1: SCP P/FFO low end of historic range.
Figure 2: scp P/NTA is lowest since listing
Figure 3: SCP ROE has fallen in recent years as acquisitions have become more expensive.
Figure 4: SCP dividend yield vs 10yr bonds.
