I remain very bullish on CER and have said numerous times that...

I remain very bullish on CER and have said numerous times that it will be a rewarding stock long term. I do however think that it's important you realise what may appear in the half year results and that the CER books are likely to get worse before they get better.

To say that hedging has zero impact to cashflow isn't right. In the real world, where most companies don't have big brother CNP on the other side of the trade, swaps are cash settled at regular intervals, usually monthly or quarterly. Cash settled. Now, it depends on the relationship and rating of the counterparties as to the terms of the contract and whether collateral is required to be put up. Either way though, swaps are netted out between counterparties and cash changes hands.

I said in a post a while back that the hedging is a black box and it still is. We know that most of the CER hedges are way out of the money. We suspect (although don't know for sure) that CNP hasn't made a call on the CER cash settlement yet, which the annual report (from memory) suggests it could do quarterly. You'll understand why when you see the amounts involved.

I'd caution against assuming the hedges are just accounting jargon about which nobody cares. At this stage, the hedge book is a millstone for CER and something which may end up costly to unwind.

With CNP being stabilised, the counterparty risk to CER has all but gone - this means that CNP will be able to honour any in-the-money hedges but it also means that no administrator will be appointed who calls the out-of-the-money hedges either. In a way though, if the market still thinks 15/1 is not a done-deal, the counterparty risk may be a factor in the decision to hold CER until this is cleared up once and for all.

In your NTA calculation, which was probably the best estimate any of us have seen so far, there are a couple of points I'd add:

Firstly, intuitively I just can't see the CER NTA going up this half and I've gone through my rationale using your number system below. In essence, I don't think the fx advantages will be greater than (asset revals - hedge writedowns). I also think we need to take a hit on the Oz properties. So:

1. The SuperLLC impairment charge will probably end up being written back, but it may not be this half. For our long term NTA calc, we have included the write-back because we believe that SuperLLC will recover from the CNP negative equity as the cycle turns upwards, although this may not be for some time.

It depends on the view of the auditors, but for this half we have depreciated the CNP assets in SuperLLC by 10% and assumed CER will have to take an impairment for this too. This is about US$220m or ($0.10) per share.

We also marked the current A$317m impairment to current fx rates and this gives an increase of ~A$178m or ($0.08) per share.

Note, if the entire CER holding in SuperLLC was written off, it would now amount to A$1.05bn or about ($0.48) per share.

The CER portion of the SuperLLC holding is dealt with in point 4 below.

2. The value of the derivative contracts are either an asset or a liability (or profit / loss depending on the accounting). If they go out of the money, they don't just get written off, they become a liability or cost. If you look at the sensitivity analysis in the annual report, it gives a guide of what the impact could be. Our calculations indicate that a rate of 0.69 would move the hedges from a $340m asset to over $800m liability or a change of ~$1.1bn or ($0.50) per share.

3. Difficult to say.

4. I think a 5% decrease is optimistic but we live in hope. It will all depend on the cap rates used and the independent / directors valuations. Just because interest rates have dropped, it doesn't mean cap rates will follow as there is simply very little capital around leading to few transactions and (usually) distressed sellers. WDC will always command a higher book value on their assets as they are higher quality, especially in the US. Having said this though, they will undoubtedly take a write down this half too.

You might want to go with a 10% decrease in the hope of being pleasantly surprised rather than 5% and get a shock. Re-doing the numbers gives about $0.27 per share.

I also think you need to write down the Australian assets by about 5% of $2bn or $100m. This gives about ($0.05) per share. There hasn't been a great deal of transactional evidence in Australia but I suspect that the independent valuations will come in lower just given the overall economic environment.

So, starting at $1.28 NTA we have 3 scenarios, which (like everything Centro) are dependent on SuperLLC:

1. SuperLLC full write off

$1.28 - $0.48 - $0.50 + $0.27 - $0.05 = ~$0.52 NTA


2. SuperLLC write back

The impairment is written back.

$1.28 + $0.154 - $0.50 + $0.27 - $0.05 = ~$1.15 NTA


3. SuperLLC no write back, but further impairment for CNP exposure:

$1.28 - $0.18 - $0.50 + 0.27 - $0.05 = ~$1 NTA


These are really rough numbers. I haven't used the same methodology around income or dividends that you did. This also assumes that there are no one-off charges for extension fees, etc.

Long term NTA would see the impairment charge written back and an eventual upswing in the value of the properties again. A two year NTA target might be around about where it is today at $1.30 odd, maybe as high as $1.50. If the upswing happens in conjunction with a fall in the US dollar, then even better.

What I would highlight is that whichever methodology you adopt, the NTA is still way above the SP which is what value investors are looking for. At 55c NTA, which has to be a worst-case scenario, it's still 10 TIMES the current SP.

The leverage killed on the way down but when the inevitable upswing comes, it will accelerate recovery on the way back up.