Unibail-Rodamco-Westfield: Another Chance To Buy (Rating Upgrade) (OTCMKTS:UNBLF)

Introduction

Unibail-Rodamco-Westfield (OTCPK:UNBLF), or URW for short, has marginally outperformed the Vanguard Global ex-U.S. Real Estate Index Fund ETF (VNQI) so far in 2024, delivering a small single-digit loss:

I also last covered the stock in May 2024 arguing the shares were likely overvalued in light of strong outperformance at that point relative to peers. The shares have proven quite volatile this year, and as visible from the chart above, the outperformance relative to the sector has diminished to a great extent. While I expect the stock to remain volatile given its significant leverage (which entails that the common stock only represents a small portion of the enterprise value, thus to get a large valuation change the stock price needs to move quite a bit), I think the recent price drop presents a buying opportunity, with the market giving you another chance to take a stake in the company.

I think URW is an attractive investment due to its attractive free cash flow valuation multiple, rent growth potential, and laddered maturity structure which will delay the impact of debt refinancing.

Company Overview

You can access all company results here. Unibail-Rodamco-Westfield is a retail REIT (86% of assets) with some Office exposure (6% of assets), as well as Convention & Exhibition Centers (5%) and Services (2%):

From a geographic perspective, continental Europe accounts for 68% of H1 2024 gross rental income, followed by the United States at 25% and the United Kingdom at 7%:

Operational Overview

Unibail-Rodamco-Westfield reported Adjusted recurring EPS, or AREPS, of €5.14/share in H1 2024, down 2.7% Y/Y, impacted by asset disposals and higher interest expenses, partially offset by rent growth. The European Public Real Estate Association /EPRA/ vacancy rate stood at 5.8% at the end of H1 2024, improving by 1.2% Y/Y. Tenant sales and footfall were up 4.2% and 2.9% Y/Y respectively.

The company also confirmed its €9.65-9.80 AREPS guidance for the full year, implying the REIT will generate about €4.59 in AREPS in H2 2024:

Obviously, when you do the math, the current AREPS run-rate is about €9.18/share, highlighting the impact refinancing is having on current cash flows.

Debt position

Deleveraging remains a top priority for management, considering that the EPRA loan-to-value /LTV/ ratio stood at 54.7% in H1 2024. If we take the EPRA proportionately consolidated net debt of €23.7 billion, we see that net debt accounts for 72% of enterprise value, a very high amount. We should note EPRA figures are more conservative compared to the ones reported under IFRS:

As of H1 2024, the average debt maturity stood at 7.4 years, with an average interest rate of 1.9%. The company’s 10-year debt /1.75% bonds due in 2034, ISIN FR0013405040/ currently trades at yields of circa 3.6%, highlighting the further pain set to be absorbed as debt is refinanced:

Valuation and prospects

To get an idea of my original investment thesis, you may want to check out my January 2024 article “Assessing The Impact of ECB Rate Cuts” here. In a nutshell, ECB rate hikes have caused real estate cap rates to rise, and depending on the magnitude of ECB rate cuts, we will see a partial reversal of the trend, with URW’s share price rising to €73-95/share.

In this article, I will build on the analysis by analyzing the impact refinancing is likely to have on AREPS under scenarios for 3.1%-4.1% cost of 10-year debt. The results are shown in the table below, using the 139.36 million shares outstanding and net debt of €23.7 billion:

Scenario\Impact of AREPS	Cumulative Impact	Per share
10-year yield at 3.10% (Optimistic)	€284 million	€2.04/share
10-year yield at 3.60% (Base Case)	€403 million	€2.89/share
10-year yield at 4.10% (Pessimistic)	€521 million	€3.74/share

Click to enlarge

Source: Author calculations

We observe that under the base case scenario, the AREPS run-rate (€9.18) will be reduced by €2.89 to €6.50/share, which is still a 10 times cash flow multiple on the current share price – quite an attractive amount in itself.

We should further note that URW has bond maturities out to 2048, and hence the company will benefit from rent indexation in the meantime as well.

Finally, we should also consider that the company will gradually lose the current high 3.75% overnight EUR rate on the €4.8 billion it holds in cash as it pays down debt, which for 2025 EUR maturities only costs 1-2%. Hence, on a net basis (overnight rate minus cost of debt), the company will likely face a one-off cash flow hit as the ECB cuts rates either way. The impact on AREPS will likely be about €0.7/share.

Property Valuations

H1 2024 EPRA net initial yields were 5% for shopping centers and offices, although I would note there is strong growth in the pipeline, as topped-up EPRA net initial yields (which look at rents after the expiration of lease incentives) were 5.3% and 5.9% respectively:

I estimate the market-implied net initial yield currently stands at around 6.07%, in line with the largest European peer, Klepierre (OTCPK:KLPEF). However, the topped-up net initial yield difference for Klepierre is non-existent (both EPRA yield measures are at 5.9%), hence URW has a better growth pipeline already locked in.

Risks

The main risk facing URW is its extremely high leverage, making it highly dependent on central bank rate cuts. As markets are currently pricing in a substantial amount of monetary policy easing, rate cuts at a potentially slower pace will increase the interest at which URW has to refinance its debts.

The company also suffered an operational issue (water leak) relating to its Hamburg development project in H1 2024, resulting in an increase in the project’s costs from €1.64 to €2.16 billion. The opening had to be postponed to October 2024 as well. While I would view the matter as idiosyncratic, it may point to poor oversight of management over the REIT’s vast geographic portfolio.

Conclusion

Unibail-Rodamco-Westfield reported excellent H1 2024 results, but the stock has lost recent gains, giving investors a second chance to purchase the shares. While substantial, the impact of debt refinancing will be spread out over many years, allowing the REIT to benefit from rent growth in the process. Given the attractive free cash flow valuation and expectation for capitalization rate compression as central banks cut rates, URW may be one of the REITs to benefit the most thanks to its debt-heavy capital structure. As such, I rate the shares a buy.

Thank you for reading.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.