Alto Palermo: Sell into Strength

| About: Alto Palermo (APSA)

That Alto Palermo (NASDAQ:APSA) is unique in the Argentine market is a point that we would have to concede. It is unique most especially in that it is the only shopping center company in the Argentine stock market. Few other economies of 37 million people would be so deprived as to have only one listed property company in this space.

Argentina has no shortage of retail property owners, they have just not found it attractive to take its portfolios to the market. The addition of more competition might take the glow off APSA, however, with the other main shopping center operators (Unicenter/Von Paul and the Falak group) both in private hands, APSA has the stockmarket all to itself in its specialty (at least for now).

Alto Palermo – the Jewel in IRSA’s crown

Alto Palermo is the majority owned subsidiary of IRSA that operates their shopping malls in Argentina. IRSA currently holds 61.67% of APSA. Minority partner “Parque Arauco SA” holds 29.6% with the rest floated mainly on the NASDAQ and a little in the Buenos Aires stock market [BCBA]. The shopping center division appeared at IRSA around five years after the Elsztain family moved into IRSA. This division has its origins in the redevelopment of the Mercado de Abasto project. In fact, until recently, most of APSA’s centers were actually purchased by the company already completed. Only the Abasto was an IRSA management creation. Most notably the Alto Palermo and Buenos Aires Design centers were built and owned by the Perez Companc group in its days of glory.

The Parque Arauco group is a Chilean-listed shopping mall operator, controlled by the Arab-Chilean Said Family. It was dealt a severe blow by the near-collapse of APSA after the 2001 economic earthquake in Argentina. However, this situation was ultimately reverted. The company owns a large mount of convertible stock in APSA that could potentially lift the Chilean company’s stake in APSA to around 32%.

Alto Palermo has two major sources of income, namely the leasing of mall space to retail outlets and via its 80% stake in the shopping malls’ in-house credit card, “Tarjeta Shopping” or Tarshop. All revenue figures quoted for APSA are in Argentine Pesos (P$).

Tarshop – the credit card division

It may seem strange to start off this coverage of a shopping center stock with mention of its credit card division rather than its properties. However this is the fastest growing activity and the one that gives us most cause for concern. The Tarshop business grew out of loyalty programs for the shopping centers. It was founded in 1995 by the former proprietors of the Alto Avellaneda center.

In 1998, APSA acquired 80% of the shares of Tarshop. Currently the card has 18,000 retailers (including the large hypermarket chains like Coto, Walmart, Disco and Carrefour) who accept the cards and it has 18 branch offices for servicing clients. While working as a credit card for use in the stores that belong to the program the cards also facilitate that curiously Argentine purchasing technique of “cuotas” where multiple slips are generated dated at various periods in the future for the retailer to collect in installments. The cards also work at ATMs.

Most recently the Tarshop card has grown in the vacuum caused by the retreat by the retail banks from the riskier lending categories after the crash of 2001/2. However, it is with good reason that they retreated. Defaults soared when clients defaulted on dollar debt and then the government unilaterally converted that debt to pesos while the lenders had securitised the debt on their side into dollar bonds that weren’t pesoised in the government sweep. It was a misery for the banks and is still not fully resolved over half a decade later.

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Tarshop seems to be doing well in the white-hot consumer mood of the moment. However, as their receivables have soared so have the accounts in arrears that are shown in the chart above. We would note that the sales are in absolute pesos while the arrears are a percentage of total receivables that appears to have doubled over the last two years.

We would note in passing that recent results showed a 9.8% short-term delinquency rate at Tarshop. The credit portfolio, including securitized coupons, as of December 31, 2006 amounted to AR$558 million, 125.5% higher than the AR$247.5 million portfolio a year earlier. This growth is obviously coming at a price for credit quality as we noted earlier.

The shopping center portfolio

At year end FY06, APSA operated the following properties totaling 212,709 square meters of gross leasable area:

Alto Palermo, City of Buenos Aires. Alto Palermo Shopping is a 150-store shopping center that opened in 1990 and is located in the well-known and densely populated neighborhood of Palermo in City of Buenos Aires. Alto Palermo Shopping has a total constructed area of 64,672m2 that consists of 18,077m2 of gross leasable area. The shopping center has a food court with 22 restaurants. Tenants in this shopping center generated average monthly retail sales of approximately P$2,029 per square meter for the fiscal year ended June 30, 2006.

Alto Avellaneda, Avellaneda, Greater Buenos Aires Area. Alto Avellaneda is a 148-store shopping center that opened in October 1995 and is located in the densely populated neighborhood known as Avellaneda, on the southern border of the City of Buenos Aires. Alto Avellaneda has a total constructed area of 97,655m2 with 27,251m2 of gross leasable area. Tenants in this shopping center generated average monthly retail sales of P$1,014 per square meter for the fiscal year ended June 30, 2006.

Paseo Alcorta, City of Buenos Aires. Paseo Alcorta is a 113-store shopping center that opened in 1992 and is located in the residential neighborhood of Palermo Chico, one of the most exclusive areas in the City of Buenos Aires, and has a total constructed area of approximately 54,728m2 that consists of 14,704m2 of gross leasable area. Tenants in Paseo Alcorta generated average monthly retail sales of P$1,533 per square meter for the fiscal year ended June 30, 2006.

Abasto Shopping, City of Buenos Aires. Abasto Shopping is a 172-store shopping center located in City of Buenos Aires opened in November 1998. The principal building is a landmark building which during the period 1889 to 1984 operated as the primary fresh produce market for the City of Buenos Aires. The property was converted into a 115,905m2 shopping center with approximately 39,473m2 of gross leasable area. Tenants in Abasto generated average monthly sales of P$903 per square meter for the fiscal year ended June 30, 2006.

Patio Bullrich, City of Buenos Aires. Patio Bullrich is a 85-store shopping center located in Recoleta, a popular tourist zone in the City of Buenos Aires a short distance from the Caesar Park, Four Seasons and Hyatt hotels. Patio Bullrich has a total constructed area of 28,211m2 that consists of 10,780m2 of gross leasable area. Patio Bullrich is one of the highest income shopping center in Argentine, with average monthly sales of P$1,546 per square meter for the fiscal year ended June 30, 2006.

Alto Noa, Salta, Province of Salta. Alto Noa is a 85-store shopping center located in Salta City, the capital of the province of Salta. The shopping center consists of 41,700m2 of total constructed area that consists of 18,779m2 of gross leasable area. Tenants in Alto Noa generated average monthly sales of P$468 per square meter for the fiscal year ended June 30, 2006.

Buenos Aires Design, City of Buenos Aires. Buenos Aires Design Center is a 59-store shopping center intended for specialty interior, home decorating and restaurants that opened in 1993. Alto Palermo owns Buenos Aires Design through a 53.7% interest in Emprendimientos Recoleta which owns the concession to operate the shopping center. Buenos Aires Design is located in Recoleta and has a total constructed area of 31,645m2 that consists of 14,598m2 of gross leasable area. Tenants in Buenos Aires Design Center generated average monthly sales of P$541 per square meter for the fiscal year ended June 30, 2006.

Alto Rosario, Santa Fé, City of Rosario. Alto Rosario is a shopping center of 145 stores, located in Rosario City, in the Province of Santa Fe. It was inaugurated in November 2004 and has 53,928m2 of fully covered surface and 30,013m2 of gross leasable area. Tenants in this shopping center generated average monthly sales of P$418 per square meter for the fiscal year ended June 30, 2006.

Mendoza Plaza, Mendoza, Province of Mendoza. Mendoza Plaza is a 146-store shopping center located in the City of Mendoza in the Province of Mendoza. It consists of 39,065m2 of gross leasable area. Tenants in this shopping center generated average monthly sales of P$626 per square meter for the fiscal year 2006.

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FY06 End of Year Results

In FY06, APSA reported a 46.9% YoY growth on revenues. FY06 revenues stood at P$338.1m, this compared to revenues of P$230.1m for FY05. The reason for this healthy boost in revenues was mainly due to a P$48.1m increase in lease revenues and a P$58.4m jump in revenues at Tarshop. The credit card revenues were worth particular note, as they represented an increase of 90.5% YoY and emblematic of the consumer’s increasing ability to afford lines of credit a mere four years after the Argentine financial meltdown.

The headline figures were robust, and highlighted that the growth story of IRSA in recent years has its roots in APSA’s performance. The shopping center operator’s total revenues accounted for nigh on 50% of IRSA’s total revenues in FY06.

All very strong figures and one cannot but applaud the revenue growth posted by IRSA’s money spinning subsidiary since the Argentina meltdown of 2001/2002. Looking deeper into the figures, we note that the revenue growth cannot be attributed to occupancy rates. Occupancy of 99.1% has been stable for the last two years and is basically as good as it gets in the industry. Lease rates have increased 30% and account for approximately 66% of square meters sales at the major malls.

Costs were up accordingly. FY06 costs rose 30.6%, mainly due to the servicing charges made on credit card sales as well as higher salary costs at the credit card arm. Included selling expenses were also up as were admin fees, mainly due to salary hikes at the director level. All in all, barring the possibly excessive board level bonuses, costs were in line with the revenue growth.

Payroll has increased steadily since the FY02 slump. From 600 employees, APSA now employs 966 personnel. This figure accounts for roughly one third of all IRSA employees.

Revenue breakdown for shopping centers in FY04 to FY06 shown in the chart below clearly indicate the predominance of the Buenos Aires market in APSA’s fortunes. Over 90% of revenues come from the city or province of Buenos Aires.

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Earnings Year To Date

APSA most recent quarters bear some examination. The company has some seasonality with the December quarter, no surprise, being stronger than the others generally, while noting that the change is not as dramatic as in the US for example as Christmas present buying is more subdued culturally in Argentina. The current fiscal year showed net profits of AR$19.3mn in the first quarter, $20.9mn in the second and $13.06mn in the latest (the quarter ending March 31st). Net revenues swung around wildly because the 2nd quarter included an “other income” number of $60mn that we had found rather strange at the time. This was a gain from selling the land for the new Saavedra shopping center from APSA to its subsidiary. Instead of showing this as an extraordinary gain, it was classified at the sales line on the P&L. Obviously we weren’t alone in our displeasure as the measure was reversed in the 3dr quarter. Discounting this effect, revenues were $101mn in Q1, $121mn in Q2 and $124mn in Q3 showing progress but at a more muted advance. Closer examination shows the progression of credit cards revenues, $40mn, $49mn and $60mn was the main driver. We are looking for net profits of around AR$20mn in the 4th of the current fiscal year. This gives $74mn for the full year. Beyond that in FY08, we are estimating $85.5mn as interest costs continue to rise to service the growing credit card portfolio.

Expansion Now Underway

We would note that APSA is not resting on the laurels of the positive earnings trend. In December 2006 APSA completed the P$41.2m purchase of Cordoba Shopping Villa Cabrera, a 35,000m2 mall with 160 separate retail outlets, 12 movie theaters and parking for 1500 cars in the provincial capital of Cordoba. Cordoba is Argentina’s third largest city in terms of population and fourth largest in terms of spending power.

More substantially, the company has recently begun building a new shopping mall in the Gran Buenos Aires district of Saavedra and located next to one of the main trunk roads entering the city, the Avenida General Paz. This area is of strategic importance to the future of the city, as it connects the traditional middle class Zona Norte region with the growth of out-of-town private housing becoming increasing more popular with the higher socioeconomic groups.

On June 29, 2006, the company acquired from Phillips Argentina S.A. the plot of land, on which the center is being developed, covering a surface area of 28,741 square meters. APSA is the 80% controller of the subsidiary company in charge of the project and has so far contributed an aggregate of P$98.4m to the project. The company projects that another cash injection from APSA of up to P$117m will be needed to bring the new project to start-up and operation. The 20% minor partner will also contribute capital in proportion.

Once completed, the complex will incorporate a supermarket, a shopping center, cinemas and office space for rental, as well as necessary car parking space and will be the biggest in the APSA family of centers.

Competition

APSA’s main direct competitor in shopping complexes in terms of total surface areas as properties is Cencosud SA, which operates the Unicenter shopping centers as well as various other malls. Cencosud has a little over 414,000m2 of property space compared to APSA’s 293,000m2. These two industry players together account for 56% of all shopping mall surface area in Argentina.

However, APSA does not suffer from an intense struggle for market share with Cencosud and others. Cencosud mainly operates out-of-town hypermarket type of operation, whereas the core of APSA’s business comes from the malls located in the Buenos Aires city centre. APSA recognize that, although this situation may change in the future, for the moment there is not much more than friendly rivalry between the two entities.

Scope for expansion or competition

While the macroeconomic situation continues to improve in Argentina, APSA’s future looks rosy. Sales and revenue growth should begin to slow, but will surely stay at healthy multiples in the near to medium-term future. Their recent acquisition of the Cordoba shopping center along with the grand plans for the Saavedra mega-complex which promises to be the largest in the APSA stable shows that the company is confident of what lies ahead.

While IRSA’s share of the hotel and office market is good, it is not dominant. However the company’s position in shopping centres, via APSA, is overarching and this is its real triumph. There are no enormous barriers to entry but several of the locations that IRSA has grabbed put it in a commanding lead. What are the prospects of new boys appearing on APSA’s block?

We would not see the threat being local. As APSA has scooped up centre after centre the only real competitors are the Chilean Cencosud group that owns the Unicenter and the Sutton interests that own the Galerias Pacifico downtown. Most of the shopping centres constructed in Greater Buenos Aires have been narrowly focussed on the upper middle class segment. There is scope still within the urban area for more centres.

We would note though that Argentine retailers might be resistant to spreading themselves thin. Argentines are not consumers in the American style and a Gap of every corner is not the way. There are not a plethora of main street chains, such as one sees in the UK or US markets. Moreover, shopping centres in Argentina are not anchored by department stores (except for the late addition of a Falabella store at the Unicenter). There are NO indigenous department store chains left in Argentina. This has led to the curious practice of having hypermarkets as anchor tenants in quite upscale shopping centres. These food oriented purchase centres with cinema complexes are the secret to getting customers to linger in the mall. We would also note that the malls are not necessarily a car-based culture as in the US with Alto Palermo, Paseo Alcorta, Buenos Aires Design and the Patio Bullrich (and to some extent the Abasto) drawing their success from walkability for nearby residents. To reach consumers beyond the upper middle classes shopping centres in Argentina need to have walkability or strong public transport feeder access.

With these factors in mind we would say that APSA is in a strong position but by no means an unassailable one. However, the densely built upper middle class areas of the city are held in a headlock by APSA that is almost impossible for anyone to break. Thus only less attractive areas will be left for potential competitors.

Takeover babble

Back in March there was some low volume babble in BA that IRSA was either going to be taken over by Sam Zell or taken private by management in league with Zell. We would discount the Zell component, but we would not put it past IRSA management to try to buy out all or part of the structure. A deal could be effected by leaving APSA public (as it is the tail that wags the IRSA dog) and then taking IRSA private and then selling off the balance of the office buildings and hotels. The problem with this plan is that even bridging finance would be difficult to obtain no matter how sexy (or guaranteed) the deal may seem due to Argentina still being in the doghouse. Local banks would neither be able nor inclined to finance the deal. We could see reasons why the Elsztain crew might be disposed to exit the office building area. Unless they can see buyers coming down the track they could be very long term holders in a marketplace where they are usually on one side of virtually any deal. The temptation at the moment for the IRSA ownership must be to re-enter the banking field where there are so many opportunities. This moment will pass, but at least currently they appear to be fully financially committed via their IRSA stake, which must be somewhat frustrating.

Another alternative in the short term might be for the rest of Banco Hipotecario to be sold and then APSA demerged from IRSA. The problem with the demerger concept is that IRSA’s earnings alone are somewhat anaemic and it might be exposed to a sell-off from investors jumping to the better vehicle.

Potential dilution

Dare we mention it? After all if investors don’t know about it they shouldn’t be in the stock except for the shortest of short term trades. To put it simply, the company has around 782 million ordinary shares on issue and the diluted share count is nearly three times that at 2.24bn shares. We are not talking General Electric here but the numbers look awfully large for a company that only made AR$13mn in the latest quarter. Caveat Emptor.

Conclusion

The IRSA group is not to everyone’s taste. It tends to have fans that are holders at that time but we have seldom heard of investors who are repeat players in the names. The secret with IRSA is to go with the flow. The same holds true for APSA. There is no reason for its recent run-up, so one’s caution has to come into play. While it may appear simplistic the best strategy is “buy low, sell high” because when you buy IRSA/APSA low you can be guaranteed that at some point the ramping operation will come into play and then one just rides it higher being sure to depart before management do! This may sound a flippant description of a trading strategy but frankly when management loses interest in the stock price, watch out! The stock will dive and remain down for a prolonged period. This will be irrespective of whatever perceived discount to the net asset value of the portfolio there might be. Frankly, IRSA is a trading stock and the true value-building and irreplaceable franchise part of the business is the Alto Palermo structure. At this time we would recommend selling into strength in Alto Palermo with a 6-month target on the ADR of $15.

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Disclosure: none