@Jausty,
To properly frame any discussion about the appropriateness of carrying values of its asset base, I think it is important to define the financial pedigree of the company in question.
In this case, while people might talk in qualitative terms about CDP being a "good-quality" business (citing long-term tenancy arrangements, granular nature of customer base, large and growing demographic catchment area, stable and predictable earnings stream, and the like), in terms of the quantitative measures that drive shareholder value creation, it is actually a mediocre business.
In the absence of major development capital being spent periodically (every decade or so) to significantly refresh the offering, it's really a low-, to ex-, growth business.
The need to - once every 10 or 15 years - undertake major refurbishments means shopping centers are actually quite capital-intensive businesses (this lumpy capex needed to kickstart earnings is in a way akin to airlines, which have to incur significant capital outlays periodically to upgrade their fleets, or steel plants which have to re-line their furnaces every 8 or 10 years).
As case in point, over the past 2 decades (which is as far back as I have checked), CDP has generated total Operating Cash Flows of ~$450m, of which $240m needed to be re-invested in the business, so more than half half of the capital that was generated organically, was retained.
The result is quite ordinary financial return metrics - lower than the company's cost of capital (Refer chart below):
(Note: Based on operating earnings, so excluding property revaluations).
While Operating Profit-to-Assets has been experiencing long-term decline, ROE has held up but that is overwhelmingly due to the significantly higher use of financial leverage in recent years (in 2010, Net Debt-to-Equity was around 10%; today it is almost 65%):
As an aside, the reason for the gearing increase in the earlier part of the past decade was for the $300m refurbishment (50% being CDP's share) of the centre during 2012 and 2013, depicted by the yellow shaded area in the chart below. (Fair enough, too; the major upgrade was needed at the time because Revenues were flat-lining and the refurbishment program was successful, resulting in a step function lift in subsequent Revenue and Profits):
But over the past 5 years, capex has been merely of a maintenance nature, yet the company has still needed to access an additional ~$80m of borrowings in order to pay the dividends that have been declared:
While FY2020 was clearly an unrepresentative year, the trend of a rising proportion of dividends requiring subsidisation from increased borrowings, was already well-entrenched in preceding periods.
This might sound like I'm getting side-tracked but the analysis above I believe goes a long way, at least in my mind, to informing the discussion around asset carrying values for CDP.
And the key takeaway for me is that it is a business which is facing more fundamental challenges that most people seem to think: Over time, to generate the same level of profitability requires proportionally larger amounts of capital: case in point, despite the 2012/13 major upgrade being hailed as highly successful, the company in FY2019 generated some 45% more EBIT than FY2011 (the year prior to the commencement of the upgrade), but on a 75% bigger asset base.
Capital inputs rising faster than earnings is not the kind of fiscal backdrop that leads to upwards revaluations of company assets, in my book. The opposite, more like it.
(Related to that, having visited the center in early December (it was crazy busy, but we all know that) it strikes me that at some stage in the next 5 to 7 years, it might be due for another face lift - albeit not as major as the 2012 project. The difference is that, in 2012 that large call on capital was made from the starting point of a balance sheet that had negligible debt; the next major capital commitment will take place off a leveraged balance sheet. The pre-emptive question is does the board issue fresh equity to re-capitalise the balance sheet well before then. If I was a CDP director, I would certainly consider it prudent tabling it for discussion now. As a shareholder, I feel it is something to think about.)
But another way to view the propensity, or otherwise, of asset writedowns is to study CPD's history of asset revaluations:
FY2010: $0.2m
FY2011: $0
FY2012: $69.7m
FY2013: $5.1m
FY2014: $49.1m
FY2015: $31.0m
FY2016: $24.9m
FY2017: $12.1m
FY2018: -$0.7m
FY2019: $1.7m
FY2020: -$124.4m
As can be seen, the largest annual upwards reval. in recent times was $70m, and that was booked in FY2012 after the company's successful refurb. of the centre, which saw a $45m uplift in operating earnings in that year, followed by a further $55m upwards reval. over FY2013 and FY2014.
Because interest rates were still elevated at that stage (well, far more elevated than they are currently), I think it is not unfair to link those upward revals. overwhelmingly to the continued profit momentum in the wake of the the big 2012/2013 refurb.
And it was in 2014 that the decline in the risk-free rate started to commence is precipitous fall, from around 400bp (on the Australian 10-Year), to less than 100bp at the end of 2019, so a full 300bp nominal decline.
By comparison, the cap rate used by the company fell by only 75bp over that period, from 5.5% in 2014, to 4.75% in 2019
So that 300bp reduction in the proxy for the risk-free rate between FY2015 and FY2019 was accompanied by a mere 75bp of cap rate compression, which in turn induced a further mere $70m of cumulative upward reval.
So changes in cap rates, and hence in asset valuations, are really quite elastic to changes in bond rates.
Which is why, when it comes to the value of CDP, I don't get overly animated by interest rate movements in the tens of basis points.
When I first acquired shares in CDP - viewing it at the time as an unambiguously deep-value investment (even compared to conceivable worst-case scenarios) - it was because it was cheaper than with even a worst-case scenario in mind, that being the possibility of the value of the company's assets being written down.
As it happened, the write-down was larger than I had expected and it came earlier than I had expected. I thought the directors and auditors might have waited for some better clarity in terms of how Covid would ultimately impact the business.
At the time that the company's financial managers, directors and auditors were signing off on the FY2020 accounts, it would have already have been clear that the momentum in the performance metrics of the business was on the up and that the sky wasn't about to fall onto collective heads. So the need for the downwards reval - both in timing and in extent - surprised me at the time.
Without any hard evidence to back it up, it "smells"to me like the valuation reductions to some degree had already been pending, and Covid provided the excuse to formalise them.
Besides, I think it will be a decidedly curious look, to reverse something that you just signed off on a year earlier; would smack like they don't know what they are doing.
To conclude, based on the above, I'm not anticipating anything major in the way of changes to CDP's asset values.
For certain, I don't let it form part of my investment thinking.
.
(20min delay)
