Vicinity Centres (ASX: VCX) is either one of the great investing opportunities of 2020 or a real estate investment trust (REIT) in terminal decline. The company is trading at a price to book value (P/B) of 0.45 based on the results of the most recent quarter. At this price, you could theoretically buy the entire REIT, sell off all of the assets and make a 55% profit. In addition, the company pays a trailing 12-month dividend of 12.47%, which looks outstanding.
That is the positive side of the investment. A higher than average dividend and a share price that looks cheap. In fact, the company's share price is down by 47.9% in year-to-date trading. So, as this looks too good to be true, you have to ask – what's wrong with this investment?
Effects of COVID-19 on Vicinity Centres
Even with a cursory glance, I believe it's clear this is a well managed company. For example, over a period of eight years, the company has managed to grow its free cashflow by around 48.7% on average. That doesn't just happen by accident. Yet Vicinity Centres finds itself in dire straits today due predominantly to the fallout resulting from the coronavirus pandemic.
Vicinity's most recent valuation tells the story. The property evaluation, which was done in June, resulted in a property value reduction of 11.3% across the company's entire portfolio. For the REIT's flagship portfolio, the reduction was 8%. The company has spun this reduction to highlight the strength of its flagship assets, but for me that's a little hard to believe.
While there were a multitude of reasons for the revaluation, it was the real world impacts of the pandemic that made the most difference. These included waivers and deferrals of rent, higher vacancy allowances, and the capital required for new leasing. In addition, the valuers included likely lower rent and sales growth, and increased capital allowances for the re-purposing of centres.
The future of the sector
It is the concept of re-purposing the centres to meet customer requirements that I find particularly interesting. It begs the question; are we seeing the mega-shopping malls enter a new phase, or is this an industry in terminal decline?
The idea that lockdowns have hastened the move to online shopping has seemingly passed from theory to fact. Furthermore, revenues of companies like Nick Scali Limited (ASX: NCK), Temple & Webster Group Ltd (ASX: TPW), and Kogan.com Ltd (ASX: KGN) during lockdowns seem to support this.
In summary, we know Vicinity Centres is headed into a bad reporting year, we just don't know how bad. Moreover, large discretionary malls are likely to face revenue pressures from both the pandemic and the ongoing recession. Therefore, what should we be looking for in the company's report due for release next Wednesday 19 August?
Cash and equivalents
Vicinity Centres recently completed a $1.2 billion institutional placement on 2 June, as well as a $32.6 million share purchase plan for retail investors on 8 July. As a result, the company has considerably strengthened its balance sheet. Specifically, the REIT has reduced its amount of gearing from 34.9% to 26.6% and has cash and undrawn debt facilities of $2.6 billion.
In the FY20 report, I will be looking to see what is planned for these funds. Has the company been required to draw down on them much to date? Are they purely to get through an uncertain period? Or will they be used to pivot away from mega malls? If so, to where?
Vicinity Centres funds from operations (FFO)
FFO defines the cashflow of REITs. In Vicinity Centres' last pre-pandemic report in February, it had already noted that FFO was down by $12.5 million. This was largely due to the reduction in the price of equities held. Accordingly, the company had already downgraded its FY20 guidance for FFO by 0.4 cents per security. Moreover, it had also recently completed the acquisition of Uni Hills Factory Outlets in Victoria.
The two key figures we need to be looking at in the FY20 report will be statutory profit after tax and FFO. The company withdrew its guidance, but 17.2 – 17.4 cents was the last we heard from it on the issue. In these two figures, we will be looking to find out exactly how bad things are. How much has statutory profit after tax fallen? How much in FFO per security?
As above, it will also be very interesting to see what Vicinity Centres' future strategy is. Given everything that has happened, the 'sit and wait' approach may not be a good idea right now. In the February report, the company noted that physical stores were critical to the success of click-and-collect operations. Can this be further enhanced? Or could we be looking at new, click-and-collect only malls?
Foolish takeaway
Given Vicinity Centres operates in the retail sector, we know that there will be bad news, little to no FY21 guidance, and very likely no dividend. What we are looking to find out is what the company is actively doing to change the revenue and earnings picture. Is it purely in the 'sit and wait' category, or is it going to be actively pursuing mitigation or diversification of some form?
Our key metrics to look for are the balance sheet summaries, cash on hand, statutory profit after tax, and funds from operations. This will tell us how bad things are, and how far the company has to travel to get back to normalcy. Moreover, it may also tell us if this REIT still sees a long-term future in large malls.
