Australia | Jul 03 2008
By Greg Peel
Shares in real estate investment trust Macquarie Countrywide ((MCW)) are currently showing a yield of 16% on forward distribution estimates. While this figure looks rather impressive for one of the Macquarie Group satellites, one must also remember that such a yield usually labels a credit-based investment as “junk”.
When the Centro Properties Group hit the wall last December, sleepy REIT analysts got a very big wake up call. Suddenly the scramble was on to assess the gearing levels, potential asset values, refinancing obligations and debt covenants of every REIT, utility, infrastructure or other trust in the market. When analysts made their assessments, one of the names that kept coming up in the “don’t touch with a ten foot pole” category was Mac Countrywide.
MCW holds a portfolio of supermarket-based retail centres across Australia, New Zealand, Europe and the US. One of the big problems with Centro, as analysts suddenly came to appreciate, was a precarious “double-whammy” combination. Not only was the trust operating on excessive debt it would likely be unable to refinance, or at the very least would refinance at a prohibitive cost, it was also facing having to sell off assets to reduce debt and those assets were not necessarily highly sought after. Investors realised to their horror that Centro’s portfolios consisted mostly of lower-level retail malls and strips in the US, and that as the US economy was facing recession those retail facilities were also threatening to become ghost towns.
This realisation put Centro in stark contrast to say a Westfield – owner of top-end shopping mega-malls containing plenty of exposure to consumer staple facilities as well as consumer discretionary. Westfield’s malls were expected to ride out any recession intact, whereas Centro’s weren’t.
But then MCW is also a holder of supermarket-based malls – assets which one would presume would hold up under the weight of recession given their consumer staple nature. But for MCW the problem was not so much the quality of the assets, but rather the extent of gearing and the extent of debt covenants placed on that gearing. Debt covenants can take many forms such as – as we recently learnt – Babcock & Brown’s $2.5bn capitalisation limit. Often it’s gearing ratios that are given limits, and these ratios can be tricky because they are not only increased by further debt, they are increased by a fall in the value of the underlying assets.
So MCW was quickly placed in the “stay away from” pile by analysts who were still shell-shocked and wondering, like the rest of the world, just what depths the credit crunch might spiral to. MCW shares collapsed in price along with Centro in December, and then collapsed again in March in the lead up to Bear Stearns. They staged a brief rally as bargain hunters moved in, but have since collapsed again as bargain hunters found out they’d been caught in a bear trap, rather than a new bull market. At 90 cents today, they are as low as they have ever been. Pre-Centro, the shares traded above $2.00.
Yesterday MCW won a valuable reprieve from a significant Australian lender – a lender with which, in Citi’s view, the trust has had “a good ongoing relationship”. This lender had originally placed loan-to-value-ratio and interest cover covenants on its $325m multi-currency facility, and one reason analysts were shying away from MCW is because these covenants were at risk of being breached. If a covenant is breached, it usually means a debt facility must immediately be repaid. However both parties hope that covenants are never breached, because if they are it is usually because the borrower is in some trouble. In such cases it is often better for a lender to see if the problems can be worked through, such that the borrower can keep servicing and repaying the loan, rather than risking killing off the borrower and never seeing a cent repaid. We have seen this in the case of Babcock & Brown.
MCW now has a buffer from covenant risk on this facility and on the impending re-financing of two other US facilities, and as such only $45.5m of re-financing risk remains in FY09. What this means is that MCW can go out of panic mode, and start focusing its recapitalisation plans on the real estate portfolio rather than just the Damocles sword of covenants.
MCW is not, however, completely out of the woods. There are still in excess of US$2bn of MCW commercial mortgage-backed securities on issue in the US and Australia which will mature in FY10. Citi notes that $450m of Australian securities are valued only on credit margins only of 17-20 basis points, which is way below where credit spreads are now valued.
Citi also notes that MCW shares have been sold down hard – much harder than the 5% or so the analysts believe the MCW real estate portfolio has lost in value. MCW still needs to sell assets to reduce its debt levels (it has only won a reprieve, not a waiver) and it is very much now a buyers’ market as all sorts of assets come up for sale. But with a “cap rate” of only 8.5% at this level (a cap rate is the rate of net income produced by a property divided by the original cost of that property), “MCW could be seen as being at an attractive entry point”. That’s as long as management continues its de-risking program, Citi adds, through asset sales and debt reduction.
So should a bargain-hunting yield investor now look to snap up MCW? Not necessarily.
Analysts at Merrill Lynch have upgraded the REIT from Underperform to Neutral, but warn that MCW is still highly-geared and its distribution remains underfunded. The latter raises the risk of a reduction in distribution, which immediately puts at serious risk that 16% yield. Citi is remaining cautious on a Hold rating, and also points to distribution cut risk and the potential for a further softening in asset values.
UBS has also warned of various risks, but only in qualifying a Buy rating. UBS has set a target of $1.37 which it determines to be net asset value. Citi has set $1.15, while Merrills has today reduced its target from $1.15 to $0.95.
If you like a high yield, and have the stomach for the high risk that comes with it, then maybe MCW is for you. If you are at all concerned about the ongoing fallout in the credit crunch, cash rates look good.
