Scentre Group Hybrids

Scentre Group is supported by a portfolio of high-grade retail assets that have been traditionally very high-performing. While Australian retail property centres were impacted by COVID-19, rents picked up in H1 2021 and are likely to start picking up over H2 2021 as restrictions are lifted, making this a good ‘reopening trade’. Scentre Group is a world-class owner, manager, and developer of retail assets. Asset values have started to stabilise and its net operating income (NOI) appears to be rebasing to a level higher than expected.

Scentre Group’s earnings are likely to rebound, with retail sales growth potentially outpacing pre COVID-19 levels over the next year. There is a huge amount of pent-up demand as well as households who want to revisit retail assets again to interact outside of work and home. The continued economic recovery in Australia and prudent response by Scentre Group — who focused on collections and liquidity as well as managing gearing — is favourable to a credit investor.

The hybrids are rated Baa1/BBB+ (Moody’s and S&P) or two notches below its issuer credit rating of A2/A (Moody’s and S&P) and provide the best risk-return opportunity in the investment grade corporate bond market. A 4% yield for the SCGAU 5.125s (callable 24/06/2030) looks cheap compared to other BBB AUD investment grade corporates.

Despite there being no step-up after the non-call (NC) period, the coupon reverts to H15T5Y+4.685% (after 2030) and H15T5Y +4.379% (after 2026) respectively, which will act as a deterrent to the issuer to keep the debt outstanding.

For example, 5 year USTs are likely to be significantly higher than the c.1.2% they are currently, meaning the issuer will likely be better off refinancing at a lower rate when the call comes due, based on the underlying economics.

Just over a year ago now, Scentre Group issued c.USD3bn of hybrids at a time when markets were still coming to terms with the COVID-19 pandemic and associated impacts. The hybrids were comprised of a USD1.5bn 60NC6 at 4.75% and a USD1.5bn 60NC10 at 5.125% respectively.

The hybrids are not convertible into SCG AU equity, just relatively expensive debt. Scentre Group isn’t particularly leveraged, so the funding was more about getting through COVID-19 without risk to its liquidity or credit worthiness.

All of its maturing debt is now covered through to 2024. The hybrids can only be redeemed at the issuer’s discretion after the NC periods, so they are treated by credit agencies as quasi-equity, with 50% equity credit and 100% equity credit for debt covenant calculations.

For Scentre Group, a 5% interest rate might look like expensive debt, but the company’s cost of equity is closer to 10%. The interest costs are also tax deductible, so the after-tax cost of debt is more like 3.5% — or only a third of its cost of equity.

The coupon is discretionary, but no dividends can be paid out (if the coupon has not been paid). Despite there being no step-up, after the NC period the coupon reverts to H15T5Y+4.685% (after 2030) and H15T5Y +4.379% (after 2026) respectively — which will act as a deterrent to the issuer to keep the debt outstanding.

For example, 5 year USTs are likely to be significantly higher than the c.1.2% they are currently, meaning the issuer will likely be better off refinancing at a lower rate when the call comes due, based on the underlying economics.

Scentre Group’s H1 2021 illustrated a better underlying result and metrics. H1 2021 funds from operations (FFO) was up 28% on the previous corresponding period (PCP) to AUD463m. Retail conditions improved within the Scentre Group portfolio in H1 2021, though restrictions did come into play over the period.

Sales and visitation data showed its centres rebounded rapidly once restrictions were eased. H1 2021 rent assistance accounted for 5% (or AUD45m) of net property income (NPI), which was down from 26% in H1 2020. Cash collections improved 37% during H1 2020, to average AUD200m per month.

Leasing volumes were strong with 1,515 deals in H1 2021 versus 596 in H1 2020. Re-leasing spreads also improved from -13.1% in H1 2020 to -8.6% in H1 2021. Incentives were 8.1% of total rent billed across all deals, but only offered on around 30% of new deals.

Total sales (not comparable) growth or moving annual turnover (MAT) was 6.5% lower than in 2019 or -0.8% excluding cinemas and travel. For H1 2021, these numbers improved to -5.1% and +0.9% respectively. For specialties, the MAT was -0.8% and +2.3% in H1 2021.

Source: J.P. Morgan and Company Presentation

Source: J.P. Morgan and Company Presentation

Scentre Group booked AUD41m or 0.1% in H1 2021 in positive valuations, following -10.8% in H1 2020. The Australian portfolio is valued at AUD32.2bn or a 4.83% capitalisation rate. The New Zealand portfolio is valued at NZD1.6bn or a 6.10% capitalisation rate. Gearing was relatively stable at 27.9% or c.38% if one includes the USD3bn of hybrids as debt. Scentre’s average cost of debt was 4.8% up 80bps in H1 2020.

Source: Bloomberg

Source: J.P. Morgan and Company Presentation