"Challenging" is the word U.K. retail property executives choose to describe the upheaval besetting the country's shopping sector.
The somewhat understated adjective was used no fewer than four times by Hammerson PLC's CEO and CFO during the company's recent 2019 first-half earnings call. Intu Properties PLC's new CEO, Matthew Roberts, agreed. "The first half of 2019 has been challenging for Intu," he said. So, too, Intu's CFO. "What a challenge!" he declared.
That challenge is to survive a deteriorating retail climate that increasingly appears to be an existential threat to at least one, if not both, of the U.K.'s largest listed retail-focused landlords. The struggles of U.K. retailers in recent years, which have stemmed mostly from the country's rapid adoption of e-commerce, have now fully filtered through to the two listed owners of many of the country's prime shopping destinations. Rental income from their U.K. retail properties is sinking, along with the value of their assets.
"Intu Properties is in severe financial difficulty, and may soon be an ex-REIT," said Mike Prew, real estate equity analyst at global investment bank Jefferies, in a July 31 note responding to the company's first-half results. "Opportunistic funds might be better off buying discounted malls directly rather than risk [Intu's] equity wrapper."
Intu Properties' Victoria Centre in Nottingham, U.K., is among the company's assets
facing extremely difficult operating conditions.
Source: Intu Properties
Intu, whose market capitalization is around a tenth of what it was five years ago, saw net rental income fall by 7.7% in the first half of 2019 compared to the same period of 2018. The company had forecast a drop in rental growth between 4% and 6% for 2019 when it announced earnings for the first quarter.
Meanwhile, the like-for-like value of Intu's portfolio fell by 9.6%, with the company's U.K. assets, which make up 92% of its total portfolio value, down 10.4%.
"Intu's 1H19 results continue to show stress," Tim Leckie, a real estate equity analyst at JP Morgan Cazenove, wrote in a July 31 note. "Overall, a very tough half," he added.
Content with the continent
Hammerson, whose extensive continental European portfolio means its U.K. portfolio makes up less than half of its total value, saw like-for-like net rental income fall 0.1% in the first half of the year. Still, net rental income from its U.K. flagship assets was down 6.8% in the period compared to the first half of 2018.
The company's exposure to better-performing continental European markets also saved it from suffering a larger like-for-like reduction in its net asset value, which fell by 4.4% during the first half of 2019 compared to the prior-year period. The sharp drop in the value of Hammerson's U.K. shopping centers, which fell by 9.1% during the period compared to the first half of 2018, and its U.K. retail parks, which plunged by 10.9%, was balanced out by a 4.5% increase in the value of its premium outlets business, which has 20 destinations across 14 European countries.
Analysts welcomed Hammerson's sale of its stake in the Italie Deux asset in Paris for £423 million, which accounts for a large portion of its £500 million disposal target for 2019. The sale will help the company reduce its headline loan-to-value ratio to 37% and its proportionally consolidated LTV to 43%, according to a calculation by Colm Lauder, real estate equity analyst at stockbroker Goodbody.
While Jefferies' Prew described the disposal as a "positive surprise," JP Morgan Cazenove's Leckie noted that "the U.K. weighting of the portfolio increases with the Italie Deux sale," which is among the factors that will "keep investors wary."
Brexit and beyond
Another factor scaring off investors is the looming Brexit deadline, Leckie said. The U.K. government has committed to leaving the European Union, with or without a deal, by Oct. 31. There is currently a stalemate as the EU refuses to amend the deal it offered the U.K. government in 2018, while the U.K. Parliament has refused to approve that deal. Economists warn that leaving the EU without a deal would have a severely negative impact on the U.K. economy.
Brexit concerns are adding to an already difficult climate for retailers in the U.K., which has the highest penetration of e-commerce as a percentage of retail sales in Europe at around 18%. Retailers have also struggled in recent years with slow consumer spending growth and stiff competition in an overcrowded market. The deteriorating operating conditions have caused a spate of insolvencies and store closures across the U.K. in the last year, forcing landlords to slash rents or face swaths of empty space.
While Intu's new CFO, Robert Allen, said during the company's first-half earnings call that he "hopes the worst is behind us," JP Morgan Cazenove's Leckie said that the landlord's outlook has worsened. The company’s 7.7% fall in net rental income is expected "to run at a similar level through the remainder of 2019 as the impact of recent administrations and [Company Voluntary Arrangements] are resolved," Intu said, referring to two forms of U.K. insolvency procedures.
Like-for-like net rental income is expected to be "moderately down" in 2020 with the overall run rate improving compared to 2019. Intu's management also expects the valuation of its U.K. assets to fall further in the second half of 2019 after a drop of around 10% in the first half of the year.
"Given [Intu's] heightened exposure to U.K. retail [compared to Hammerson's], we are less comfortable with Intu's capacity to adapt in the face of sector headwinds," said Goodbody's Lauder in a July 31 note on Intu's first-half results.
As for Hammerson, the company is approaching a crucial period that will be key to determining its fate, Jefferies' Prew said in a July 29 note. In the period to 2021, £161.9 million worth of Hammerson's leases, excluding its Premium Outlets business, will expire or face breaks, which represents 46% of the company’s £350 million of passing rent for full-year 2018, Prew said. "Although the valuers estimate open market rent of £180 million, we expect materially less," he added.
"Given our negative prognosis for shopping centers and retail parks, the risk of a self-inflicted dividend cut [for Hammerson] is high and rising," Prew continued. "The degree depends on what is sold, at what price and when, so it's a managed earnings decline the board should have been cognizant of years ago, in our view."
Or as Hammerson CEO David Atkins put it during the company's first-half earnings call: "Things are not easy, and they will not get easier soon."