Centro's US dream run over?

WHEN Centro launched into the United States it was hailed as great strategy. However, analysts no longer share that view, downgrading the group from Buy to Neutral.

Investment bank Merrill Lynch is downgrading Centro from Neutral from Buy citing the weakening US economy.

ML said unfortunately for Centro, its timing has been questionable given the weakening macro outlook, not to mention US REITs selling off 17% since New Plan Excel transactions was announced.

“The US consumer has been hit hard by the housing downturn and related problems in the sub-prime market and the employment data is starting to show real signs of strain in the economy, materially increasing the chances of a recession. Merrill Lynch’s chief US economist David Rosenberg sees the chances of a recession at 70%, although he is still calling for 1.4% real GDP growth in 2008.

“Given the increasingly negative data points coming out of the US, we believe the risk/reward outlook for CNP has deteriorated. While we still believe CNP will achieve 18% DPS growth in FY08, it’ll be harder for CNP to maintain its growth trajectory going forward given the slowing consumer, rising cap rates and the increasing likelihood of a US recession,” ML added.

ML said Centro trades on an ability to expand its funds management model through acquisitions and if it is unable to do so, it says the group’s shares will suffer.

In addition, ML noted Centro’s balance sheet at 72% look through gearing (excluding the $5.5 billion value of the services business) and 55% debt to enterprise value makes future acquisitions less likely near to medium term unless accompanied by equity.

“We would not be positive on Centro making an acquisition near term without having proven it can sell down its current US inventory,” the investment bank said in a report.

ML quoted its US team, who recently said increasing unemployment is deterring sales growth, which will most likely result in negative sales growth before the end of the year.

The US team said whilst retail REITs may not feel the negative effects immediately, it is only a matter of time before negative sales trends and high inventories lead to store closing and bankruptcies.

ML also warned if the proposed Centro Shopping America Trust/Centro Retail Trust merger fails, it could be detrimental to Centro in many ways.

First, Centro’s reputation as a fund manager could suffer and its ability to sell down assets to CER may be limited if CER’s placed in the penalty box.

In addition, Centro may more trouble trying to offload US assets to third parties given potential buyers gain leverage from the fact CNP was unable to sell NXL assets at a 7% cap rate to its own subsidiaries.

“The more time passes and the US economy deteriorates, CNP’s at risk of not finding buyers at attractive prices for its assets relative to acquisition valuations,”

ML has since reduced its 12 month valuation of Centro by 16% to $8.20 based on our NAV of $8.10, DCF of $10.20 and Implied IRR of 9.6%.

“Longer term as demonstrated by our DCF, Centro does appear attractive, but we feel given the increasing risks facing the model that the NAV is a more appropriate valuation methodology to focus on for the time being,” ML concluded.

Australian Property Journal