Scentre Group has decided to forgo a first half distribution to protect the balance sheet, and is waiting for stores to re-open before entering rent relief discussions with tenants.

-Gearing remains elevated, asset values are weakening
-Targeting a -25% reduction in operating expenses
-Business heavily exposed to the likely decline in asset values
 

The retail environment has perked up in the past couple of weeks and shops are now re-opening at Scentre Group's ((SCG)) shopping centres. Discretionary categories remain soft although staples continue to hold up.

To protect the balance sheet, the company will not pay a first half distribution but still intends to pay a final distribution at the end of 2020 after assessing the impact of the pandemic.

Gearing is elevated, and UBS suggests, in a period in which asset valuations are declining and income is weak, measures will need to be taken to limit the damage to the balance sheet, including the current decision not to pay a first half dividend.

Ord Minnett forecasts a 2020 distribution of 11.9c, which would be down -47% on 2019, while Goldman Sachs does not expect a final distribution, given the company's taxation status.

Removal of the first half distribution payment increases operating earnings per security by around 1% per annum over the medium term, in the broker's calculations. However, the impact on estimates is offset by lower assumed development volumes.

Rentals

Management will also assess the impact on retailers of the store closures before entering into rent relief discussions and will wait for stores to open and foot traffic to return.

The opening of stores is increasing, with 57% of tenants over 70% of the gross lettable area now open. Ord Minnett notes this is well up on the low of 39%, with a sharp rise in the past fortnight, centred on Mother's Day.

Only a minimal number of rent relief packages have been confirmed and Morgan Stanley suggests the desire to wait until stores re-open is a strategic move and explains why the company has been slow to offer deals to tenants.

April rent collections were not disclosed but channel checks suggest 20-30% of specialties paid their rent.

With reference to the tough negotiating positions being taken by some specialty retail chains with regard to non-payment of rent, Goldman Sachs asserts there is an increased likelihood that the company will not reach agreements with retailers.

Still, no specialty retailer accounts for more than 2% of the company's annual rental income. The broker, not one of the seven monitored daily on the FNArena database, has a $3.74 target and Buy rating.

Macquarie notes Scentre Group has a 30% exposure to small-medium enterprises and assumes these tenants receive a -50% rental abatement for a term of six months and assumes a three-month impact before shopping centres return to regular operations.

The company is targeting a reduction in operating expenses of more than -25% during the pandemic, although Morgan Stanley points out 60% of costs are worn by tenants anyway.

The board and senior management will sustain a -20% reduction in fixed remuneration while the roles of 80% of the workforce have been adjusted, in terms of rosters et cetera.

Gearing

To preserve long-term gearing, UBS forecasts a pay-out ratio of 70% that would allow $350m per annum in debt reduction prior to future development plans. This would put the stock on a distribution yield of 7% with minimal growth and still with considerable uncertainty remaining regarding sustainable rent and valuations.

While the balance sheet is protected by the non-payment of a distribution, Macquarie still warns the business is exposed to the likely decline in asset values. The broker remains of the view that retail valuations will decline by -15% and, if this happens, then gearing would increase to around 39%.

This would, in turn, increase the need to reduce financial leverage either through asset sales or an equity issue, although the broker observes neither of these strategies is a priority for the company.

The broker understands costs associated with developments are variable and increase in line with activity. Hence, assuming minimal development activity, the likelihood of changes in this area is limited.

The company has extended all bank facilities that were due to mature in 2021 and now has no bank debt maturing until January 2022.

FNArena's database has two Buy ratings, three Hold and one Sell (Citi, yet to comment on the update). The consensus target is $2.49, suggesting 14.8% upside to the last share price. The dividend yield on FY20 and FY21 forecasts is 5.5% and 8.6%, respectively.

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