Centro Retail's painful rebirth

Centro Retail Trust is making painful but positive progress towards stability and next year's proposed restructuring and recapitalisation.

The results the troubled A-REIT announced today don't fully reflect an underlying improvement in its condition, with property income down from $625 million to $488 million, underlying profit falling from $186 million to $160 million and a net profit of $113 million only looking respectable because last year's results (a loss of $2.7 billion) were swamped by impairment charges.

The more encouraging aspects of the results were that the Australian portfolio continues to perform extremely well, while there were signs of improvement in the performance of the US portfolio in the second half. The Australian portfolio generated solid net operating income (NOI) growth for the year and is almost fully let, while the US properties showed an improving trend in NOI.

With 'only' $216 million of asset devaluations, which were largely offset by write-backs and exchange gains, net assets actually rose by $80 million, to $765 million and net tangible asset backing rose three cents per security, to 33 cents, as a result.

The apparent stabilisation of the US portfolio and the tentative signs of improvement in what remains a difficult and volatile market and the Centro group's continuing ability to refinance its massive borrowings – Centro Retail repaid or refinanced more than $1.1 billion of debt in the year to June and another $US1 billion was refinanced last month – offers some encouragement that it will be possible to restructure the group in time.

Excluding its Super LLC joint venture with Centro Properties in the US, which has $US5.3 billion of debt and negative equity, Centro Retail has a loan-to-value ratio of 74 per cent and the refinancing are steadily pushing up its funding costs.

At least, unlike Centro Properties, Centro Retail's exposure to Super LLC is limited to its $US480 million of capital, which has been written off. Cross-collateralisation of the properties in that portfolio means that while it is generating positive cash flows, Centro Retail can't get access to that cash.

The group does appear to believe there is some prospect, perhaps faint, that it might yet be able to salvage some value from that ill-timed and ill-fated plunge with Centro Properties into the US market just ahead of the emergence of the financial crisis.

The other problem created by that disastrous expansion is that the implosion in the value of the US portfolio has left Centro Retail over-hedged on its equity exposure.

While the stronger Australian dollar enabled the group to close out $837 million of hedging exposures during the year, it still has five remaining contracts with Centro Properties with a mark-to-market value of $234 million that injects volatility in to its reporting and which could have to be cash-settled if not closed out by the time they mature between December next year and mid-2016. At the moment, Centro Retail has $US540 billion of equity in the US and hedging of $US1.46 billion.

A restructuring of Centro Retail will be difficult and complicated, but the fact that there is substantial positive equity in the entity and upside provides some confidence that it will be possible to simplify and de-risk its messy structure and relationship with Centro Properties and recapitalise it in the process. The fragile condition of the US economy creates a degree of urgency for a task that Centro Retail thinks could be completed by the end of next year.