Unibail-Rodamco-Westfield: speculative purchase; Revaluation Potential (UNBLF)
Unibail-Rodamco-Westfield (OTCPK:UNBLF), which I will refer to as URW hereinafter, is emerging as a speculative buy as I estimate the running rate of adjusted recurring earnings per share (AREPS) is likely to decline to around 6 EUR/ Share once US Operations will be reduced significantly only to improve to 7 EUR/share as recovery projects and normalized operational performance kick in, shares will yield a higher cash flow multiple once the balance sheet is in order. Therefore, I think a multiple of 12.5 on my mid-term AREPS target of EUR 7/share could push the shares up about 25-30% over the next 3-4 years. However, that upside potential is dependent on US selling at a 20-25% discount to estimate and keeping interest rates under control, both of which are somewhat uncertain.
URW is divided into four main segments with a total portfolio value of 54.5 billion. The US shopping center portfolio is valued at approximately EUR 12 billion as of December 31, 2021 and represents approximately 22% of the total portfolio value.
URW saw continuous operational improvement in the second half of 2021, with vacancy improving by 1.9% to 7% and tenant turnover reaching 93% of 2019 levels. However, with a market capitalization of EUR 9.5 billion versus net debt of approximately EUR 22 billion at the end of Q1 2022 (My estimate for IFRS net debt as of Q1 2022. The prorated net debt representing ownership interests in Joint Ventures is even higher at c. EUR 24 billion), the company remains heavily focused on deleveraging. Therefore, despite the strong cash flow guidance in terms of Adjusted Recurring Earnings Per Share (AREPS) of around EUR8.2-8.4/share for 2022, investors are cautious about waiting to see the nature and shape of the excited expected reduction in US portfolio seen in 2022 and 2023.
Market implied valuation of net initial yield
To calculate the market implied net initial yield, I use the EPRA Net Disposal Value (NDV), which I estimate to be EUR 112.5 at the end of the first quarter of 2022:
Market Implied Net Initial Yield = Valuation Net Initial Yield / Division Factor where:
Division Factor = Price/NDV Ratio * (1 – Mortgage Lending Value) + Mortgage Lending Value
Replace with my estimates for Q1 2022, namely:
1. EPRA-NDV = EUR 112.5
2. LTV ratio = 42%
3. Valuation Net initial yield = 4.2%
4. Closing price at the time of going to press = EUR 68.58
You get a price/NDV ratio of 68.58 / 112.5 = 0.61, a split factor of 0.774 (0.61 * (1-0.42) + 0.42 ) and a market implied net initial yield of about 5.43%. For comparison, I estimate that largest competitor Klepierre (OTCPK:KLPEF) is currently trading around an implied market yield of around 5.66%, while smaller competitor Wereldhave (OTCPK:WRDEF) is trading at 6.64%.
Valuation based on current cash flows
I think the current cash flow valuation is not very suitable for URW as the capital structure is very debt heavy. Still, URW is one of the cheapest retail REITs at just 8.3x management’s guidance of EUR8.2-8.4/share for AREPS. Its closest competitor, Klepierre, is trading at about 10.3 times its cash flow forecast. Oddly enough, you have some smaller competitors like Wereldhave Belgium, which are trading at 12.65 times their cash flow outlook. However, the difference is largely explained by a diametrically different capital structure, ie Wereldhave Belgium has a market capitalization of around EUR 522 million against a net debt of around EUR 240 million.
After the recent sale of a development parcel in Los Angeles, I estimate that the remaining US portfolio is currently worth around €11.85 billion after transfer taxes:
As you can see from the Investor Day presentation, even a 50% discount to appraisals will not prevent URW from achieving the 40% loan-to-value target:
Combining the scenario analysis above, a 2% cost of debt ratio, an average management outlook of EUR8.3/share for AREPS (Adjusted Recurring Earnings Per Share) and my estimate of EUR3.6/share Impact of US Selling on AREPS (11 EUR .91 billion multiplied by the 4.2% net initial yield divided by 139,013,166 shares) compensated by interest savings between EUR 1.71 and EUR 0.86/share brings us to the following impact on AREPS under the 6 scenarios for the valuation discount:
|Percentage discount||Negative impact on AREPS due to lost earnings||Positive impact on AREPS due to reduced interest expense||net impact|
As you can see from the table above, the larger the discount on US ratings, the smaller the interest savings and therefore the net impact of the disposals on AREPS grows in line with the discount.
In summary, the current outlook is revised from EUR 8.3/share to EUR 6.41/share in a 0% discount scenario or EUR 5.56/share in a 50% discount scenario could. Based on my above market implied net initial yield estimate, the market is currently pricing in a discount of around 23% with the most likely net impact on AREPS being a potential US disposal of around EUR2.23/share, bringing AREPS to EUR6.07/ share is brought. Split.
While the above scenarios are purely theoretical and do not take into account rental growth, new developments, higher costs of US financing (as of December 31, 2021, borrowing costs were 1.5% for EUR and SEK denominated debt and 3.9% for USD and debt denominated in GBP). respectively) and new revenue streams, I think the scenarios outlined are a good mental experiment about the options surrounding a potential sale of US businesses.
The calculations above are a bit conservative in that they don’t take into account the growth opportunities outlined at Investor Day 2022. What I think will actually happen is that some of the capital released from the US operations will fund the identified growth opportunities in Europe. As stated in the Investor Day 2022 press release:
By 2024, URW will deliver €2 billion of its committed pipeline, which will generate €125 million of stabilized NRI. In addition, URW will continue to pursue further development opportunities embedded in its assets during the plan period, with a potential of EUR 1 billion of projects to add to its controlled pipeline, with limited pre-development costs.
Source: Press release Investor Day URW 2022
If we assume that these EUR 3 billion worth of projects are developed over the medium term at a cost yield of 6.25% versus a 2% cost of debt ratio, we can estimate an increase in AREPS of around EUR 0.92/share.
The final result
I think the current AREPS run rate of around 8.3 EUR/share is likely to take a hit in the next 1-2 years once the US footprint is reduced dramatically. Therefore, I estimate that the AREPS running rate should bottom out around EUR 6/share and gradually improve to EUR 7/share once the clean-up opportunities are completed and operational performance returns to 2019 levels:
URW expects rental revenue to return to pre-COVID levels in 2022, occupancy and variable income throughout 2023 and retail NRI on a run-rate basis in 2023, with full effect in 2024. In In 2024, Group NRI forecasts retail sales of €1.56 billion and EBITDA of around €1.9 billion for its streamlined European portfolio.
Source: Press release Investor Day URW 2022
In addition, current inflation rates could support higher AREPS numbers if sustained in the medium term. Likewise, advertising revenue should limit the negative impact on ongoing cash flows.
While I think a lot of things could go wrong at URW, my base case is that AREPS should stabilize at around EUR 7/share in the medium term and as long as investors see the new capital structure as sufficiently robust, the shares should be valued higher around the higher asset quality of the underlying portfolio. Personally, I will continue to monitor the stocks and open a position on weakness.
Thank you for reading.