Prime retail commercial property assets are thriving, not diving

Vince Pezzullo, Perpetual Investments

Unibail Rodamco Westfield (ASX:URW) is a very large cap that trades at a steep discount to recent valuations, but is such a selloff justified? 

Remember the context; investors are so desperate for yield they are piling into government bonds with negative yields and even pouring cash into risky “junk bonds” with thin compensation. 

Yet here is a huge, high-quality global property stock trading on a yield of 8.3% staring them in the face... and investors are turning up their nose at it.

URW is partly a victim of the pervasive fear around retail. There are some legitimate concerns about declining demand at shopping malls in the future as online shopping continues to rise. This is especially true of smaller, lower quality malls in suburban areas.

But our recent tour of URW’s assets in Europe found something very interesting: Prime retail “trophy” assets are thriving.

Indeed, a strange phenomenon is occurring. Erstwhile online-only businesses, like Amazon and Apple, are opening bricks and mortar stores in these trophy malls. There is a symbiotic relationship here; not only is it advantageous for Amazon and Apple to expand their retail “ecosystem” into these malls, but these stores help bring additional foot traffic to the properties, further enhancing their overall value. Combined with the continued rise of food retailing these high end “cathedral” malls continue to increase their dominance, even as the suburban “chapel” malls lose their allure.

URW has a vast and diverse property portfolio. Gearing is not excessive. It has numerous capital management choices to sustain its exceptional 8.3% yield and trades at a P/E of 10.8x.

For an equity that is cheap. But for a REIT of its size and quality, that is an exceptional bargain.

A value stock with growth metrics

Alex Shevelev, Forager Funds

Profit up 80%. Revenue up 55%. A strong growth outlook...

These aren’t common traits for a value stock. Yet the share price of mining services business Macmahon (ASX:MAH) is down 20% over the past year as a series of missteps have dented confidence in the company.

• The first issue arose at the half-year result in February. An employee bonus scheme meant most of the earnings above the low end of management’s previously guided range was to go to staff.

• The second came when two directors unexpectedly resigned.

• The third when the company entered a formal dispute with a client over a large contract.

None of these issues are individually significant and they are being addressed.

• Profits for last year were in the middle of the forecast earnings range, after the payment of $3m for the employee bonus scheme. A smaller bonus pool, with more stringent conditions, is in place for this year.

• Resigning directors have been replaced with board members who will bring plenty of experience and independence to their roles. The first is Vyril Vella, a former Macmahon director who, despite being a CIMIC (CIM) appointee to the board, joined with the rest of the board in resisting a lowball bid from the construction giant 2017.

• Two other experienced industry participants, both formerly employed by CIMIC subsidiaries, have also joined the board. CEO Mick Finnegan will also step up to the board table. With seven members and four independent non-executives the board will be able to keep AMNT, Macmahon’s largest shareholder and a major client, in check.

The dispute over Newcrest’s Telfer mine also looks to have been put behind the company, though a formal agreement is still to be signed off. It has been problematic and loss-making for years. Macmahon management now expects the project to be cash flow positive after negotiating for increased contract rates. If management didn’t push hard to achieve fair rates the company could have been facing a loss of $25m to $35m over four years.

Mostly forgotten as these corporate issues gripped investor attention is the company’s strong operational performance.

One of the cheapest banks in the world

James Miller, Firetrail Investments

Before we discuss one of the cheapest banks in the world, as a recap, one of our top picks for 2019 was Nufarm (ASX:NUF), an Australian company that specialises in chemical crop protection globally. Our investment thesis for Nufarm was covered in detail in a December 2018 Livewire article titled, ‘One of the most compelling opportunities today.’

Since writing the article less than 12-months ago, the share price performance of Nufarm has been volatile. The company has dealt with a numerous headwinds including multiple droughts in Australia and flooding in the US. 

However, the investment thesis remains intact and we continue to remain patient investors in Nufarm for the long-term. Nufarm is now trading at similar levels to when we first wrote the article, however the chart below highlights that investing in value stocks requires conviction and a longer-term mind-set. It is not for the faint-hearted.

Source: Factset

With that in mind, we move on to our pick for today’s most compelling value stock, Clydesdale Bank (ASX:CYB).

Clydesdale is materially undervalued, trading on less than 0.5x book value. When we look across the developed market, Clydesdale stacks up as one of the cheapest banks globally. To put the valuation into context, Australian banks trade anywhere between 1.4x to 2.0x book value. So, why is Clydesdale so cheap?

One key reason is Brexit.

All UK banks are trading at historically low multiples because of Brexit uncertainty. Importantly, we do not know what the outcome of Brexit will be. However, the UK is the world’s 5th largest economy and banking is an integral part of that economy. The UK mortgage market is continuing to grow despite the uncertainty caused by Brexit and Clydesdale is a UK focused business with no European passport issues like some if its major UK banking peers. As long-term investors, the share price reaction to Brexit has created an opportunity to be greedy when others are fearful and buy a good business at a material discount to its historical multiple and peer valuations.

The second reason Clydesdale is undervalued today is the company has disappointed on earnings expectations, post the acquisition of Virgin Money in 2018. Short-term earnings downgrades by the company have been disappointing. However, we believe the longer-term prospects from the Virgin acquisition are compelling. In particular, acquiring Virgin provides Clydesdale with:

• A compelling brand (Virgin) which resonates in key growth areas for the business. Particularly in metro areas such as London where Clydesdale did not have a strong brand or presence.

• Strategic synergies and cost-out opportunities – delivered by a management team with a solid track record delivering on cost-out targets.

Putting the revenue and cost opportunities together, we believe Clydesdale can grow earnings over the next few years, despite the challenges that Brexit and acquiring a new business represent. At current prices, the market believes that things will not get better for Clydesdale from here. However, experience has taught us that some of the most compelling value opportunities are in unloved companies in an unloved sector. At 0.5x book value, Clydesdale is a compelling value opportunity for the patient, long-term investor.

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In part one of this trilogy, The trend if your friend (until the bend at the end), we asked our partners what their observations had been in regards to the rotation. Then in part two, Is the wax melting? we asked what the drivers were behind the shift.