Stacked in Woolies' favour

Woolworths is the latest company to tap investors' insatiable demand for yield, announcing it is spinning off a $1.4 billion property portfolio

Woolworths is the latest company to tap investors' insatiable demand for yield, announcing it is spinning off a $1.4 billion property portfolio

into a new listed vehicle, Shopping Centres Australasia (SCA) Property Group. On a forecast unfranked distribution yield of 6.9 per cent

to 8.3 per cent backed by long leases, it is a ready-made sale

for brokers.

You, however, should not take the bait.

During the global financial crisis, when banks were not willing to lend for property development, Woolworths started to fund its own projects. The result? Woolworths's direct property investments exploded from $30 million in 2007 to more than $4 billion today.

With banks lending again, the company is spinning off a portion of its portfolio.

Existing Woolworths shareholders will receive one SCA security for every five Woolworths shares they own.

Others are being offered securities for between $1.26

and $1.50.

SCA will own 69 shopping centres in regional and suburban Australia and New Zealand, with Woolworths group businesses, such as its supermarkets, Big W and Dan Murphy's, signed up to pay 61 per cent of total rent received.

The remainder will come from specialty tenants with a focus on services and fresh food, and shorter, riskier leases.

It is a very different proposition from, say, BWP Trust, which owns Bunnings Warehouse.

Nor is SCA a Westfield Group-like business. It won't be able to charge specialty tenants premium rents because traffic will be lower and the locations are not as attractive.

That is why Woolworths is providing a rent guarantee for the first two years of operations.

After that, if SCA is unable to fill the 20 per cent of specialty tenancies that remain vacant, income and distributions might fall.

SCA is also much more dependent on supermarket rents.

These have two parts: base rent, which will increase by a minimum of 5 per cent every five years for the first 15 years, plus a bonus portion based on sales.

The prospectus does not disclose when these bonus rents might cut in, despite the fact the thresholds matter a great deal. There is a huge difference between rent increasing based upon a 1 per cent rise in sales compared with a 10 per cent increase.

If the deal actually favoured SCA, it would be highlighted in the first few pages of the document.

Instead, a reference on page 124 of the prospectus admits that "none of the tenants have achieved the required sales threshold in order to be required to pay turnover rents".

That means the risk of the current yield being eaten away by inflation is very real. That the Woolies rent might rise by only 5 per cent every five years means SCA's growth prospects are also poor.

Future growth plans are vague, too. Either way, a debt-to-assets ratio of 34 per cent means any expansion will most likely require investors to tip in more cash.

These shortcomings could be overlooked if the price were attractive. But on a forecast yield of between 6.9 per cent and 8.3 per cent, based on inflated occupancy figures, it isn't.

The fact that inflation might result in even these returns eroding further compounds an already weak case.

The deal is tipped firmly in Woolies' favour, so why not get on the right end of it? Woolworths' ordinary shares offer a 6.1 per cent grossed-up dividend yield and far-brighter prospects.

Not only are the yields from other trusts comparable, being more exposed to specialty rents with annual rent increases potentially equal to inflation plus 1 per cent or 2 per cent, they are likely to grow faster, too.

GPT Group, CFS Retail, Stockland and Westfield Group - all a tad too expensive to officially recommend - would be a better fit for investors focused on owning quality, lower-risk assets. They might offer lower yields today, but we would expect their dividends to grow faster than SCA's over time.

Everything about this offer is stacked in favour of Woolies and against the investors taking part in it.

Nathan Bell is the research director at Intelligent Investor, article contains general investment advice only (under AFSL 282288).

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