Unibail-Rodamco-Westfield: Capital Structure Creates A Good Entry Point For Long Calls

Summary

• Q3 results demonstrate operations can stabilize at a level around 10% lower than 2019. I estimate the current run-rate for Adjusted Recurring EPS to be around 7 EUR/share, absent restrictions.
• Higher cost of debt and lower valuation net initial yield make for a tough comparison with European peer Klepierre.
• The Loan-to-value should dip below 40% even if assets are disposed of at around the current marked-implied net initial yield of around 5.75%.
• The current Adjusted Recurring EPS multiple of around 8.3 is very attractive but is likely to be watered down by disposals.
• The most attractive way to position in the shares seems to be via long call options or via a long straddle.

MediaProduction/E+ via Getty Images

Investment Thesis

I believe Unibail-Rodamco-Westfield (OTCPK:UNBLF), which I will refer to as URW here after, offers an interesting long call opportunity at the current share price, driven by a weak performance over the past 6 months, down some 20%, and a capital structure with a lot of debt relative to market capitalization ( around 2.8 times), which make for a volatile share price given the expected disposals over the next year or more. Alternatively, investors worried about a capital raise next year may opt to go for a long straddle options strategy, which will come into play should the disposals fail to materialize. Overall, I believe that just as 2021 COVID restrictions were less than 2020, in 2022 we will see even less on the restrictions front, which makes for a good entry point at the current share price, with options being the best way to take advantage of the situation. For buy-and-hold investors looking for quality Klepierre (OTCPK:KLPEF) looks like the better pick at the moment, with a more balanced capital structure and a lower cost of debt.

Operational Overview

Q3 saw continued improvement in operations and provided a glimpse what the new normal will look like at URW:

Source: URW Financial Information as at 30 September 2021

Tenant sales at 93.1% of 2019 levels were very much in line with largest European peer Klepierre which stood at 94%.

Rent collection is also in line with Klepierre (90%), coming in at 88%:

Source: URW Financial Information as at 30 September 2021

One thing to note from the above data is that despite the US exceeding 2019 sales levels rent collection was no better than European assets, with lower footfall (down 24.6% from 2019) clearly having an impact. Nevertheless, should the strong US performance continue I expect rent collection rates to follow suit. This is confirmed by the strong vacancy improvement for US assets YTD:

Source: URW Financial Information as at 30 September 2021

Valuation based on Adjusted Recurring Earnings per Share

Before the latest COVID flare-up, URW released the below outlook:

In light of the current COVID situation in the Group’s major regions, which has included no new full lockdowns during Q3, and the return to a normalised level of activity leading to improved key performance indicators for the Group, URW expects to achieve an Adjusted Recurring Earnings per Share of at least €6.75 for FY-2021. Adjusted for a c. 65 cent impact of disposals completed in both 2020 and 2021, this equates to a level slightly above FY-2020, despite the increased cost of debt, resulting in particular from the additional liquidity raised by the Group.

This forecast is premised on the Group’s current expectation of no reintroduction of strict sanitary measures impacting the operation of the Group’s centres between now and the end of the year.

Source: URW Financial Information as at 30 September 2021

In H1 2021 Adjusted Recurring EPS came in at 3.24 EUR/share, which in a normal operating environment, taking into account the 6.75 EUR outlook, would mean that the current run-rate is around 7 EUR/share per year when there are no major COVID restrictions in place. I think 7 EUR/share is a good number to work with given that arguably restrictions in 2022 will be less than in 2021, as we have largely seen that 2021 restrictions were less than 2020.

Looking at the current share price of 58.14 EUR/share this provides for a cash flow multiple of around 8.3, which is quite attractive. In comparison, in my Klepierre article I assumed, with a high degree of uncertainty, that Klepierre is operating at a current run-rate of about 2.35 EUR/share of cash flows per year, which would bring the cash flow multiple at Klepierre at around 8, which is even more attractive than URW. Smaller peer Wereldhave (OTCPK:WRDEF) appears the most expensive, trading at a 8.4 cash flow multiple relative to my estimate of 1.4 EUR/share. Of course the capital structure and cost of debt should also be taken into account, with Klepierre having the lowest cost of debt at around 1.2% and a more balanced capital structure, with a market cap of 5.36B EUR against a net debt of 8.56B EUR in Q3 2021(net debt/market cap at around 1.6). In comparison, URW had a net debt of 23.467B EUR in H1 2021 against a current market cap of 8.06B EUR, with a cost of debt at 1.9%. Even post disposals executed in Q3 2021 the net debt should be around 22.6B EUR at year-end, bringing the net debt/market cap ratio at around 2.8. In my opinion, based on Adjusted Recurring EPS Klepierre comes out ahead, largely due to higher valuation net initial yield (5.5%) and a lower cost of debt.

Valuation based on market implied net initial yield

Below I will provide my year-end estimates for URW with the caveat that they will most likely be off by at least several percentage points, with the main uncertainty being year-end valuations, which I assume will be largely flat, with improved rent levels offsetting slightly higher net initial yields.

Market-implied net initial yield = Valuation net initial yield / Division factor where:

Division factor = Price/NDV Ratio * (1 - Loan-to-value ratio) + Loan-to-value ratio

Using my year-end estimates for H2 2021:

1. EPRA NDV = 111 EUR (107.5 EUR in H1 2021)

2. Loan-to-value = 43% (43.7% in H1 pro-forma for disposals)

3. Valuation net initial yield = 4.2% (4.16% weighted estimate in H1)

4. Market price at the time of writing = 58.14 EUR

You get a Price/NDV Ratio of 58.14/111 = 0.524, a division factor of 0.729 (0.524 *(1-0.43) + 0.43) and a market-implied yield of 5.76%.

In comparison, using my estimates for Klepierre for year-end 2022 I think Klepierre is currently trading at a market-implied yield of roughly 6.7%.

All in all, Klepierre still looks more attractive, especially if my estimate that the COVID situation improves in Europe over the next month and deteriorates somewhat in the US, which admittedly is too short a time span to base investment decisions on.

Another thing to note is that the current market-implied yield is around the pessimistic disposal scenario for US assets outlined in my previous URW article. Nevertheless, even in that scenario the LTV should drop below 40%, which should limit the need for an equity capital raise. However investors should keep in mind that should disposals fail to materialize, URW is likely to do a capital raise sometime next year to bring its capital structure in order.

How to position in the shares

Material uncertainty remains as to the proceeds from the disposals needed realign the capital structure. In this regard I think the best way to take advantage of the situation is either to go long medium to long-dated call options, which with the stock down around 20% over the past 6 months looks like the most sensible thing to do:

Source: URW Investor Relations

Alternatively, investors can enter into a long straddle, with the put option coming into play should the company need to do a capital raise next year, which I consider somewhat unlikely but still very much in the realm of possibility. With its debt-heavy capital structure and exhibition center exposure (5% of total assets) URW remains the go-to recovery play in European real estate.

Investor Takeaway

Cyclical stocks have taken a beating lately, with URW being one of the more severely affected. In light of overall weak performance among European mall REITs lately I believe the share price development is largely justified, given that URW was trading at a premium both to large and small peers, and continues to do so at present. Nevertheless, I think the recent developments and URW fundamentals have created a limited risk opportunity in terms of a long options strategy, most preferably via an outright long call position, or more conservatively, via a long straddle position. Personally, I will continue to monitor the shares and may initiate a long call position.

Thank you for reading.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of WRDEF either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Comments

[Darren McCammon]

France just voted to require proof of vaccination to go into bars and restaurants (maybe malls too?).

I don't find comparing Debt/Market Cap very useful as it penalizes a firm for being rated too cheap by Mr. Market. I'd use LTV to compare debt levels between Klepierre and URW.

[Ivo Kolchev]

@Darren McCammon the passport will for sure create some near term uncertainty, we'll see, as for the debt to market cap you are right, it may point to that the company is undervalued, using several measures is always the best approach, LTV is also nice as long as valuation assumptions are comparable, the yields used for LTV calculation at URW are among the lowest in the sector, somewhat justified by premium assets, but still something to be aware of. So far restrictions in the US seem rather limited so it should create a favorable disposal environment in 2022 and 2023.

[tonor]

Nobody will buy URF’s malls today. Brookfield is tired of the game, Blackstone isn’t interested, Starwood failed miserably. My view is Simon is waiting for URW’s US mall pain to feel more severe, then in a few years negotiate a deal.

[Bitzap]

Their plan is to divest a large chunk of the portfolio, which will most likely keep bringing NAV down for years. Avoid. Buy Klepierre instead.

[SmartInvestments]

The overleverage means this company is a sinking boat. You have to be quite skillful to make money out of this situations so is probably for the few rather than for the many. Plus there is no dividend. If you want to make a sound investment in this area I would stick with Klepierre, which has much lower leverage and is showing strong signs of being able to recover pre-Covid earnings. I would not be surprised if we see Klepierre getting close to 40 euros in 2 to 3 years which means a 100% upside + dividends.

[Croogie]

URW is a desaster. Only a bet of getting better. But "hope dies at last" says a russian wisdom.