Scentre Group has acquired 50% of the prestigious Garden City shopping centre in Perth although, in a depressed Australian retail sector, most brokers are lukewarm on the deal.?

-Caution prevails with regard the deal, given retail asset valuations in Australia
-Highly productive asset, although affected by redevelopment
-Smaller redevelopment improves the likelihood of some project income being generated
 

The broker jury is not unanimous about Scentre Group's ((SCG)) latest acquisition, a high-quality asset and one of the "Big Guns" in national rankings. The transaction for 50% of the property increases external assets under management by $570m and should provide ongoing annuity income.

Garden City shopping centre is in Booragoon, a suburb of Perth, and AMP Capital Diversified Property Fund, which achieved a 3.6% premium to the last valuation on the sale, will retain the remaining 50%.

The vendor had planned to divest 100% but then changed the process, which Morgan Stanley posits may have stemmed from a lack of interest from potential buyers. Or maybe the vendor simply decided against it.

Garden City was obtained at a fair price and relatively opportune time, given the negative retail sentiment at the moment. This is how Ord Minnett views the acquisition, which will be funded from debt initially and marginally accretive to earnings from 2020.

Development management fees, probably in 2021, are also on the slate. Scentre Group has deferred the re-development of its Stirling asset, also in Western Australia, which had involved a potential expenditure of $600-700m, as it prioritises Garden City.

Credit Suisse understands the strategic reasons behind the acquisition but suspects investors will be a little cautious about the deal, and retail asset valuations in Australia generally.

On the subject of structural and cyclical headwinds in retail, Morgan Stanley questions the investment, although being just a 50% stake somewhat proves the company's capital partnering ability. Nevertheless the purchase is consistent with the company's strategy of owning the most productive centres. In sum, Scentre Group has effectively traded out of the Sydney office segment and recycled money into Western Australian retail.

The passing yield is just 4.7%, partially because of the impact of pre-development works. Citi assesses the price was -5% below levels mentioned in recent speculation i.e. $1.2bn for 100%.

The broker considers a stabilised yield of 5.14% more representative, as this accounts for the centre's income being affected by previous redevelopment plans. On this basis the yield appears better than Burwood, which is a less productive Sydney asset, at 4.8%.

Garden City is highly productive, the best in Perth in Ord Minnett's view, and was jointly owned by Westfield and AMP ((AMP)) entities until 2012. Specialty sales per square metre are around $15,300, ranking the shopping centre fourth nationally in the 2018 Big Guns survey.

Development

The catchment area is highly affluent and there is limited competition. Scentre Group had potential to earn material project income providing design and construction services for a major expansion that was recently put on hold. Hence, Morgan Stanley acknowledges the company knows the asset very well. The exact timing and scale of the downsizing is anticipated by the February 2020 results.

A new development scheme will be unveiled and the company appears confident a project will ultimately proceed. This may reduce the maximum project income potential, Citi points out, but improve the likelihood of some project income being generated.

Some may consider the reduction in the maximum project income a negative, amid an increase in gearing, yet Ord Minnett asserts this is a sensible acquisition, given development leasing challenges and competition from a development at nearby Karinyup.

The broker would be unsurprised if Scentre Group sells down share and/or one of its wholly-owned assets to offset the impact on the balance sheet, as it did with Burwood following acquisition of Eastgardens, both in Sydney.

Scentre Group intends to continue its $800m buyback, which is 35% complete to date. The company has specifically stated that the Eastgardens scenario will not recur. In this instance management did not repurchase any more securities in the 2018 buyback after $720m was spent acquiring Eastgardens.

As the acquisition is to be funded by debt, other trade-offs are required, UBS highlights, such as the deferral of Stirling. Gearing remains elevated because of the current outlook for retail assets and potential for further declines in valuation.

Hence, UBS is lukewarm about the retail sector relative to office/industrial segments, given structural headwinds to income and the backlog of assets for sale. The broker suspects the market would have preferred outside capital was introduced alongside Scentre Group to prove up asset values.

FNArena's database has two Buy, one Hold (UBS) and three Sell ratings for Scentre Group. The consensus target is $3.87, signalling 0.7% upside to the last share price. The dividend yield on 2019 and 2020 forecasts is 5.9% and 6.0% respectively.

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