TEXT-S&P summary: Westfield Retail Trust
WRT is a publicly listed Australian real estate investment trust (A-REIT) formed in late 2010, following the initial public offering of a 50% share of Westfield Group's (WDC; A-/Stable/A-2) Australian and New Zealand regional shopping centers (92% and 8% of the portfolio respectively at June 30, 2012). The trust owns a portfolio of stable and very competitively positioned retail assets that we believe will produce returns that are in line with, or better than, similarly rated peers. At June 30, 2012, WRT had an interest in 52 major shopping centers, which are valued at about A$13.5 billion, and had an exposure to 15 of Australia's top-20 performing shopping centers by annual sales (prior to the recently announced restructure - see below). The high-quality asset base yields 5.9% from its Australian portfolio and 7.5% from its New Zealand portfolio. Specialty occupancy costs are relatively high at 19.0%, but can be accommodated while retailers maintain their operating margins. The gross lettable area of 3.9 million square meters is one of the largest shopping-center portfolios in Australasia, with the trust benefiting from high occupancy levels of 99.5%.
WRT recently announced the restructure of seven joint-venture assets owned by property trusts related to the AMP group. This included the acquisitions of Knox City (Melbourne, 10%); Warringah Mall, (Sydney, 12.5%); Mt Gravatt (Brisbane, 12.5%); and Casey Central (Melbourne, 50%), as well as the divestments of Booragoon (Perth, 12.5%); Macquarie Centre (Sydney, 27.5%); and Pacific Fair (Gold Coast, 22.0%). Net proceeds to the fund are about A$180 million. In addition, WRT divested its 50% (NZ$41.8 million) interest in Westfield Shore City, New Zealand, and has agreed to sell its 50% interest (NZ$45 million) in Downtown, New Zealand. The combined proceeds will be used to fund an on-market securities buy-back of up to A$200 million, with the residual applied against debt. Prior to the asset swap, about 92% of WRT's properties by value were managed by WDC, with the remaining 8% managed by AMP. The recent asset sale and swap is indicative of the desire by the manager to undertake active asset management of the centers and to exercise a high degree of autonomy, in concert with WDC, over its development activity (the Casey center provides the most obvious development opportunity). Moreover, the acquisitions are consistent with the manager's intention to maintain a portfolio of high-quality assets.
WRT's large asset base provides it with an enhanced opportunity to optimize its development activity. For new and redeveloped properties, the risk of design and construction is assumed by WDC via fixed price contracts. Standard & Poor's expects that WDC's development activities will continue to support WRT's operating strategy, and we expect that WDC will continue to maintain this operational relationship with WRT. WDC currently provides the following services: property development; design and construction; leasing; property management and tenancy co-ordination. For example, the Westfield Fountain Gate redevelopment (WRT's share A$170 million) opened in September 2012, making it the second-largest shopping center in Australia after Chadstone. We expect that WRT management will continue to pursue appropriate strategic joint ventures, either to mitigate exposure to a particularly large asset, to tap property sector expertise, or to source new re/development opportunities.
In our view, supporting WRT's operating stability is a sound leasing profile. The anchor tenants provide an unexpired weighted average lease term of 9.9 years and the specialty tenants provide 3.3 years (collectively, a weighted total of 7.0 years). The majority of specialty shop leases contain annual contracted rent rises, with either CPI + fixed percentage increase or fixed percentage increases. The specialty tenants' leases are generally renegotiated every five years. Although WRT's rental streams are relatively stable, reflecting its exposure to the less-volatile retail market, retail sales have been soft and new specialty leases are being transacted at lower rents than that negotiated five years ago.
Challenging retail trading conditions, particularly in New South Wales where the portfolio is concentrated (50% by operating income and 52% by asset value), are likely to temper revenue expectations. With comparable moving annual turnover (MAT) growth currently at anaemic levels (0.7% in Australia and 2.6% in New Zealand), we believe that WRT's management will be pressed to sustain historical comparable net operating income growth levels (annual average of about 4.75% over the four years to Dec. 31, 2011 and 3.3% over the year to June 30, 2012). While the structure and term of specialty leases will afford WRT some revenue stability during cyclical downturns, they will also act as a drag during any corresponding upturn. We note, however, that the quality and scale of WRT's assets place them in a better position than many of their peers to manage soft retail trading conditions.
The trust's manager adopts a comparatively conservative financial policy that results in low leverage, solid debt coverage measures, and robust free-operating cash flow to debt. With the net proceeds from the asset swap, the manager has elected to undertake a A$200 million share buyback that will result in a small increase in gearing. We believe that this shareholder-friendly action is measured and is tagged to an asset sale, thus ensuring that debt levels are not increased. We expect that WRT's capital structure will be managed such that its debt-to-assets ratio will range between 20%-30%; in addition, we expect the trust would seek to reduce leverage in a timely manner at a peak gearing level. At Dec. 31, 2011, the reported debt-to-assets ratio was 21.0% and the trust exhibited funds from operations (FFO)-to-debt ratio of about 22% and FFO interest cover of about 4.7x. At June 30, 2012, reported gearing had modestly increased to 21.8%. At peak gearing levels, we would expect that WRT will exhibit a FFO-to-debt ratio of about 13% and FFO interest cover of about 3x. These coverage metrics incorporate our expectation that new debt will be refinanced at a higher interest cost over the longer term.
WRT has successfully managed a sizable refinancing task since listing. To date, it has raised A$900 million of medium-term notes (MTN) in April 2011 (due October 2016) with proceeds used to repay the A$900 million bridge facilities, and, more recently, A$30 million in July 2012 and A$150 million in October 2012 with proceeds used to repay existing borrowings drawn under the trust's revolving credit facilities. About A$2.47 billion of new bilateral bank facilities were also executed, enabling repayment of the A$1.34 billion Westfield Sydney facility upon the practical completion of Westfield Sydney in April 2012. At June 30, 2012, and after adjusting for the repayment of the Westfield Sydney facility, WRT had A$1,994.9 million of drawn debt from unsecured bilateral bank facilities. At June 30, 2012, about 90% of its net interest payable exposure was hedged by way of fixed rate borrowings and interest rate swaps (of varying durations).
The short-term rating on WRT Retail is 'A-1'. We consider liquidity to be "adequate", as defined in our criteria. We expect that over the next 12 months, the sources of funds will exceed the uses by more than 1.2x. We also expect that WRT will achieve positive sources-less-uses in the short term, even if EBITDA falls by 15%.
We view WRT's ability to meet its short-term commitments to be constrained by the trust's requirement to distribute its assessable income. Effective from the August 2012 distribution, the fund will increase its payout of distributable earnings from 90% to 100%, subject to general business and financial conditions, working capital requirements, capital expenditure considerations, and other factors considered relevant by the Board. Nevertheless, at June 30, 2012, this is offset by WRT's access to A$481.5 million of undrawn committed bank facilities and no outstanding debt maturing until early 2014.
The financial covenants that govern the trust's bank debt facilities and the recent MTN issue provide WRT with considerable flexibility to embark upon a debt-funded acquisition or redevelopment program. WRT has a large forecast capital-spending program to maintain and improve its pre-eminent position, and has identified A$1.3 billion of development opportunities over the next 5-7 years. In June 2012, WRT sold its 50% (NZ$41.8 million) interest in Westfield Shore City located in Takapuna, Auckland, and used the proceeds to repay its New Zealand denominated debt. The on-market securities buyback of up to A$200 million will be funded by the net proceeds of the AMP asset swap and the Downtown New Zealand divestment.
The outlook is stable. We expect WRT to maintain its excellent business profile through a measured redevelopment of its shopping center portfolio that will enable the trust to maintain superior asset quality and operating stability. We expect that at WRT's peak gearing level of 30%, the adjusted credit metrics are likely to return an FFO-to-debt ratio of about 13% and FFO interest cover of about 3x. Accordingly, we assume that WRT will manage its coverage metrics comfortably above these levels in the medium term.
The rating could be raised if the trust adopts a more conservative financial policy. In particular, the policy would pre-suppose that FFO to debt is consistently more than 15% and FFO interest cover is greater than the mid-3.0x level. The rating could come under pressure if debt levels exceed the upper end of the trust's target for a prolonged period, such that FFO-to-debt and FFO interest cover were sustained less than 12% and 3x respectively.
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