Investment View
The result was more positive than what the market was expecting with a slight beat on earnings, however it was largely driven by a A$25.1m reversal of a prior year’s leasing provision. The provision also contributed to the 8% upgrade to FY23 FFOps guidance. Stripping away the leasing provision, it suggests that the underlying growth for FY23 is likely to be closer to 3-4%.
Retail sales remained notably resilient for the period, particularly in luxury which makes up a decent portion of Chadstone’s stores. The market was expecting a significant slowdown, but it appears that it’s yet to come. Management did suggest that over January and February, sales are likely to be lower, but we are yet to see it have a material impact on earnings. VCX should be able to largely offset some of the slowing consumer demand as occupancy costs shrunk during the first half.
Capital partnerships were addressed as a key growth opportunity for the group. Management indicated that the search for capital partners will commence over the 2H FY23, starting with 3 projects which represent A$471m on the groups book value.
The development pipeline remains in a healthy position. The pipeline is currently ~A$2.8bn with a strong mix of Retail, Office, and Residential developments. These developments will open the door to further capital partnership opportunities which should help drive the multiple expansion in the longer-term.
Cap rates didn’t see the expansion the market was expecting, remaining largely flat for the period (0.03% increase). This was driven by the Chadstone (VIC) centre as it had a valuation uplift due to strong income growth and the recent approval of One Middle Road (VIC) and the fresh food and dining precinct.
The groups balance sheet is in a strong position. Gearing is at the lower end of the 25-35% range and the hedging remains substantial enough to carry the group through a higher interest rate period.
We are upgrading our rating for VCX as the share price is yet to fully represent the improving operating conditions for shopping centres. The longer-term earnings recovery looks well intact, and we believe the market is currently overstating the impacts of cap rate expansion. Capital partners should be a key catalyst to lift the multiple over the next 12-18 months.
We upgrade our rating to Buy.
How Strong is the Upgrade?
The FFOps upgrade had the benefit of a A$25.1m leasing provision reversal in 1H which accounts for ~0.55cps of the 1cps upgrade (given all things are held equal in 2H23).
This suggests the upgraded 2H23 FFO is actually an implied ~3-4% improvement in underlying earnings (although could be less as up to an additional ~A$12m could be reversed for 2H). Whilst it’s not necessarily as flashy as the 8%, it’s still an upgrade in the face of what the market was expecting to be extremely sour market conditions.
The key drivers for the underlying earnings improvement are:
- Stronger than expected re-leasing spreads at -0.1% (vs -6.4% 1H FY22) which appears to have significantly outperformed both the markets and management’s expectations.
- Strong occupancy at 99% (vs 98.2% 1H FY22) and falling occupancy costs (down 1% from 2H22).
- Retail sales strength particularly in Luxury which the key Chadstone asset operates a large portion off.
Figure 1: Unpacking the FY23 FFO guidance upgrade.
Figure 4: Leasing spreads improving
Figure 5: Occupancy improving post-COVID
Retail Sales Strength
Group retail sales remain resilient, growing 20% on 1H20 at a CAGR of 6.3%. Centre visitation continued to improve, increasing to 88.9% of 2019 levels (vs 74.8% 1H22). The average spends per visit held steady at 1.28x (multiple of 2019 levels), in-line with prior quarters.
Luxury sales, which accounts for 11% of mini major and specialty sales, grew 56% on 1H20 (CAGR of 16%). Chadstone has a large portion of the luxury exposure and is expected to remain strong through 2H FY23 as tourism from China re-opens.
Management suggested that retail sales have started to slow through Jan and Feb and with an expected further two interest rate hikes to come, it’s likely that this trend continues. We expect that the improving occupancy costs should be able to offset some of the impact from the consumer slowdown. The strength of centre store sales also suggests that fears of a structural shift away from shopping centres might not be as severe as what was previously anticipated.
Figure 6: Centre visitation rates improving
Figure 7: Retail sales recovering post COVID. Although VIC & NSW ex-CBD growth slowing.
Capital Partnerships and Funds Management Opportunity
Management indicated that VCX would become active in searching for a capital partner for Box Hill (VIC), Buranda (QLD), and Victoria Gardens (VIC) properties over 2H23 (~A$471m of assets).
This will be the key short-term growth opportunity for VCX, and we expect may help drive a re-rate in the multiple. It’s still too early to definitively state the benefits which will be provided from the capital light model, but management seem to be making it a point in the company’s vision.
Greater clarity on the scale of any deals or funds will be a key positive catalyst for our longer-term view.
Multiples and Growth Outlook
VCX is trading slightly above its long-term average P/FFO of ~14x (trading at ~14.4x). We expect the multiple will come down as earnings recover post pandemic and the opportunity for capital partners is proven up.
The earnings growth outlook remains robust on a longer-term basis, consensus estimates suggest a 3-year FFOps CAGR of ~5% (highest of the AREITs) with peer Scentre Group (SCG) at second place (~3.2%). The market is expecting flat earnings growth for FY24 due to the impact of rising rates.
Post 1H23 result, the market is putting through mid to high EPS upgrades for FY24, implying the market may be relaxing fears towards the structural shift away from retailers.
A dividend yield of 5.7% (~75% payout ratio) provides some appeal for those looking to gain some REIT exposure. The ~75% payout ratio provides the company with some flex as market conditions shift.
Figure 8: VCX earnings growth vs AREITs over next 3 years
Figure 9: Analyst revisions for FY24 post 1H23 Result (~8% upgrades to EPS).
Development Pipeline
The development pipeline continues to churn away with the Box Hill Central (VIC) and Bankstown (NSW) retail projects completing over the period.
In 2H FY23 VCX is expecting completions in Chadstone’s; 1) Social Quarter and 2) Officeworks as well as Box Hill Central’s (VIC); 3) Hub Australia project. These projects only account for A$95m of the A$2.8bn pipeline. The markets focus on the development pipeline will be the mixed-use towers being built in Box Hill Central which is due to commence in FY24 as it accounts for A$800m of the A$2.8bn pipeline (~29%).
The company is clearly looking at methods to offset any structural risk on shopping centres by introducing service-based areas (social quarters & dining areas). Management also indicated that the development pipeline opens the door to further capital partners which we view as a longer-term growth opportunity. The development pipeline is likely to be partially funded through debt although JV partners and divestments are expected to also contribute.
Figure 10: VCX’s ~A$2.8bn development pipeline is in a strong position, a strong mix of assets.
Where Do Cap Rates Go?
Over the period, group cap rates only increased 0.03% (to 5.33%) which was significantly less than what the market was pricing in. Our view is that cap rates still have some way to go, expecting they reach the mid-range of 5.5%-6%. The current share price is implying a ~0.75% expansion of Weighted Average Capitalisation Rate (WACR).
The market is hesitant around the impact of cap rates on asset valuations. VCX and peer SCG both remain at a discount to NTA of 15% and 16% respectively. In our view, operating conditions from Australian retail centres implies that these discounts are likely too large.
Balance Sheet
The balance sheet remains in a strong position. Gearing is 25.7%, up only 0.6% and at the lower end of the 25-35% range. The Weighted Average Cost of Debt (WACD) only increased 0.3% to 4.3% and hedging for the group was 81% for the period.
Overall, it appears that the balance sheet remains in a resilient position. Management indicated that they would aim to maintain gearing under the midpoint of the target range which still gives the balance sheet plenty of flex as cap rates expand.
We see no clear and current issues with the balance sheet. Management is taking a conservative approach to its operations given market conditions and aren’t overextending be any means.
Risks to Investment View
Investment Thesis
Our upgrade to Buy is based off the recovery in conditions post pandemic and the possibility for multiple expansion due to capital partners. We are willing to take a longer-term view, looking through the risks of short-term slowdown in retail sales demand.
The ~15% discount to book value is too large given the strength in shopping centre operations. The AREIT’s continue to recover back to a normalised P/NTA post pandemic, and we believe it’s unlikely we see this fall back to FY22 lows given bond yields have started to unwind and shopping centres are reporting improved operating momentum.
Retail centres are shifting to service-based operations through developments such as the Fresh food and dining areas. This is an opportunity for VCX to lift the centre traffic and to become increasingly defensive towards the shift to online trading. Structural shift in the retailers is unlikely to be felt as significantly as office providers.
We are upgrading our rating for VCX as the price to book valuation remains depressed off the back of difficult pandemic conditions. In our view VCX can further re-rate given strength in operations. The gearing provides strong flexibility, and the hedging remains high at 81%.
VCX’s dividend yield of 5.5-6.0% and 3yr FFOps CAGR of ~5% holds appeal.
The development pipeline remains robust with key projects in the Chadstone centre expected to drive valuation uplift and earnings growth in the longer term. Leasing spreads are improving, and the occupancy rate remains ahead of the sector.
We are upgrading our Rating to Buy noting that we are taking a 12–18 month view, looking past the rate hike cycle.
Figure 10: PER
Figure 11: PER vs ASX200
Figure 11: PER vs ASX200
Figure 13: Price to book value
