Huntley's Recommendation: Valad Property GroupRecommendation:...

Huntley's Recommendation: Valad Property Group

Recommendation: Speculative Buy

Valad Property Group (VPG) is one of Australia’s newer AREITs, being a stapled security comprising a unit in the trust and a share in the management company. VPG has two inter-linked business streams, property and funds management. Each is based on ‘value-add’ to investment property and supported by development, trading and capital services, with assets in Australia, Europe and the UK. While rental income and funds management fees form stable earnings for VPG (93% of FY09 total revenue), medium-term growth is dependent on the riskier businesses of development, trading and capital services. Short term price volatility is expected to be extreme. VPG is currently very high risk and should only be considered by investors willing to speculate on a positive medium-term outlook.
Event
11-Sep-2009

Full year headline or statutory loss under AIFRS of $1.49bn, reflecting an operating loss of $62.7m with write downs of $1.53bn. Gearing still high at 43.4% (net debt / total assets net of cash). NTA 24cpu and no distribution confirmed.

Business Impact: Full year result very significantly below expectation. Major restructuring currently underway likely to be positive in the long term but incredibly expensive short term leading to continued volatility. Valuation reduced to 20cpu.

Forecast Impact: --

Recommendation Impact: Recommendation reinstated as SPECULATIVE BUY.
Event Analysis
Definitively speculative

VPG is one of the few AREITs to have reported both an FY09 headline loss and operating loss. The headline or statutory loss under AIFRS was $1.49bn reflecting the operating loss of $62.7m and write downs of $1.53bn in property valuations, intangibles and derivatives. Gearing is 43.4% (net debt / total assets net of cash) and NTA fell to 24cpu with no distribution declared. VPG is, quite literally, a speculative stock which may outperform in the medium term if it can survive the minefield of the global financial and property market crises. Short term price volatility is expected to be extreme. Our recommendation is SPECULATIVE BUY. VPG is currently high risk and should only be considered by investors willing to speculate on a positive medium-term outlook.
Journey across the minefield

Since the end of FY09, VPG has survived two major explosions arising from the minefield of the global financial and property market crises. The enormous amount of unitholder funds spent acquiring the European business has effectively been lost through write downs, the DUKE reorganisation and Scarborough repayment restructure. The reorganisation to create the ‘Diversified UK and European’ (DUKE) 50/50 joint venture with Bank of Scotland had the effect of moving the fund assets and liabilities off VPG’s balance sheet in a deal with its banker, attributing nil value to VPG’s equity in the joint venture. However, VPG retained the fund management business with a 75bps asset management fee revenue stream and a platform that is scaleable when conditions improve, having an equity interest that will then grow in value over the medium term. Further, VPG is well positioned for work out jobs with its joint venture partner together with access to stock for opportunity funds. Having agreed to pay a big price for the Scarborough European business on deferred terms, settlement was looming but has been restructured at even further cost to unitholders. The remaining payment of $60.7m will be paid as a combination of 3m cash at the end of September, up to 19.9% of the units in VPG at 10cpu (unless rejected by unitholders, when this portion will be converted into a loan at 15%pa interest) and the balance as a loan at 9.5%pa interest. Simply incredible.
Property portfolio performing

While the industrial property capitalisation rate at 8.6% suggests continued risk of significant downward revaluations, the Australian property portfolio is generally performing well. Occupancy is 95.9% and the weighted average lease expiry is 4.2 years. The portfolio generated 4.8% like on like rental growth in FY09 with further growth underwritten by over 80% of rent reviews providing fixed increases over the next three years.
Exiting the minefield?

While investors may hope that the huge losses from the DUKE reorganisation and Scarborough repayment restructure may be the last of the bad news from VPG, they cannot be confident that it will be. As we have previously observed, the levels of prudence, conservatism and risk aversion required for the current downturn may not optimise the skills of the current Board and senior management. Without significant change in directors, such confidence is unlikely to return. While VPG’s multi-national funds management platform offers the prospect of medium term growth, the poor FY09 performance and expensive retreat from Europe weigh heavily on the stock with our valuation reduced to 20cpu. This offers a 16.7% discount to NTA with a weighted average cost of capital of 10.2% and cost of equity of 13.7%. Management did not provide FY10 guidance. It is stressed that VPG is currently high risk and should only be considered by investors willing to speculate on a positive medium-term outlook.