Unibail-Rodamco-Westfield: assessment of the impact of the price increase
Unibail-Rodamco-Westfield (OTCPK:UNBLF), which I will call URW hereafter, is caught between rising rates and the need to deleverage. The firm’s implied market return premium has historically commanded over the largest peer Klepierre (OTCPK:KLPEF) has eroded this year. Nonetheless, I believe the strong liquidity position and long average debt maturity of around 8 years will allow URW to reduce the size of its US portfolio in due course. US and German 10-year yields have risen around 150 basis points this year, which is quite substantial compared to the 4.2% net initial yield used by URW for valuations. Nonetheless, the implied market yield of around 6.43% provides a good margin of safety.
I think the stock is a buy despite the uncertainties surrounding the US sell-off, with a potential long position to buy, a very attractive risk-reward opportunity at current prices given the recent price decline. If you fear a capital increase if the exit from the United States fails, you can opt for a long straddle. I think both options strategies are excellent given the company’s highly leveraged capital structure.
URW operates in four main segments with a total portfolio value of €54.5 billion as of December 31, 2021, namely retail properties (86% of total), offices (6% of total), convention centers and exhibition (5% of the total) and services (2% of the total). URW is active in a total of 12 countries.
URW continues its recovery to 2019 operating levels, with tenant sales at 93% of 2019 levels in the first quarter of 2022. March figures were already at 95% of 2019 levels, boding well for the second quarter 2022 and beyond. The company also confirmed its forecast for AREPS (Adjusted Recurring Earnings Per Share) of 8.2 to 8.4 EUR/share for 2022, which is a little disappointing given that some peers have raised their forecasts. Looking below the surface, however, the company still has small assets in Europe such as Center of Almere in the Netherlands for EUR 155m, in line with the latest appraisal value, and Gera Arcaden in Germany for EUR 116m, above the last appraisal value, which will weigh on AREPS. In essence, I think that in the absence of these divestitures, an uplift in guidance would have been on the table. Finally, the recovery in footfall compared to 2019 continues to lag tenant sales:
The elephant in the room is of course downsizing in the United States, which remains an open question. Since the start of the year, 10-year US government bond yields have risen by around 150 basis points, which is quite significant given that US assets are on the books at a net initial yield of 4.2% as of December 31, 2021. On the other hand, the Consumer price index for urban consumers (CPI-U) stood at 278.8 in December 2021 before climbing to 292.3 in May 2022. A 0.7% month-on-month rise in June would take it to about 294.4. Essentially, URW evaluators in June 2022 will have to weigh a rise in yields, normalizing post-COVID operating performance and year-to-date inflation of around 5.6%.
A parallel 150 basis point shift in the net initial yield on US assets (i.e. from 4.2% to 5.7%), which I believe is highly unlikely given expectations normalization of inflation in the future, would affect valuations by around 26% or 20% taking into account inflation since the beginning of the year. Obviously, this would be a huge problem for URW given the heavily leveraged capital structure. My base-case scenario for US valuations in the first half of 2022 is stable at 5%.
Market Implied Net Initial Yield Valuation
To calculate the market implied net initial yield, I will use the EPRA Net Disposal Value (NDV) which I estimate at EUR 114.5 at the end of the second quarter of 2022:
Market Implied Net Initial Yield = Valuation Net Initial Yield / Division Factor where:
Split factor = Price/NDV Ratio * (1 – Loan-to-value ratio) + Loan-to-value ratio
Substituting with my estimates for Q2 2022, namely:
1. EPRA NDV = EUR 114.5
2. LTV = 42%
3. Net initial yield valuation = 4.4%
4. Closing price at time of writing = EUR 52.02
You get a price/NDV ratio of 52.02/114.5 = 0.45, a split factor of 0.683 (0.45 * (1-0.42) + 0.42) and an implied net initial yield of the market of around 6.43%. Interestingly, this is very similar to where I think Klepierre is currently trading, which looks like a buying opportunity given the historical premium that URW has ordered on Klepierre.
The implied market capitalization rate of approximately 6.43% is also higher than the 5.7% shown above in a scenario of adverse parallel change in net returns. To reach a yield of 5.7%, the stock would have to rise to around EUR 70/share, or 34.6% above current levels.
Sensitivity to higher levels
Net debt in the first half of 2022 is expected to be approximately €21.5 billion after taking into account operating results and disposals. I think the company has done a great job of locking in lower rates for extended periods given that all bonds are trading well below par, sometimes substantially:
In addition, URW is in a very comfortable liquidity position, in line with the 2021 budget Universal Registration Document:
As a result, the Group has a very solid liquidity position with €2.3 billion in available cash and €9.9 billion in undrawn credit lines(1) as of December 31, 2021, covering its financing needs for next 36 months, even without any other ongoing fundraising or divestitures. The Group’s average cost of debt was 2.0% in 2021 and the average debt maturity was 8.6 years.(2)
Source: URW 2021 Universal Registration Document
To illustrate interest rate sensitivity, I will use the May 2033 1.375% bond, which is currently trading around 70.54% of par. The yield to maturity is around 4.9%, which is quite significant considering the bond was trading at par as recently as December 2021. To be fair, the 11-year maturity is quite long and given the recent rise in yields, corporate treasurers may think twice about locking in such a high rate.
In total, in my scenario analysis, URW needs to absorb a 2.9% rise in yields over 8 years, with the current average cost of debt being 2%. Taking my net debt estimate of 21.5 billion euros and the number of shares of 138,594,416:
|Year||AREPS||Impact on AREPS of the refinancing|
Source: Author’s calculations based on a total impact on AREPS of 4.5 EUR/share and without rent indexation
Obviously, if the rates remain at high levels, it will be necessary to take into account a rent indexation of 2% over the period:
|Year||AREPS||Impact on AREPS of the refinancing||Impact on AREPS of indexation||
Source: Author’s calculations based on a total impact on AREPS of 4.5 EUR/share, partially offset by an annual indexation of rents of 2% (2 EUR/share)
As you can see in the table above, the net impact of the rate hike is reduced to around 2.5 EUR/share thanks to the indexation and the long maturities of the debt.
Key takeaway for investors
US valuations will be a focus area in H1 2022 results given the need to deleverage. That being said, I think the recent price drop creates a buying opportunity, whether it’s a pure long position, a buy long position or alternatively a straddling long position in case where U.S. divestitures would not materialize, and the company must raise equity. Personally, I will continue to monitor stocks and perhaps initiate a position in the coming weeks.
Thanks for the reading.