Intu Properties Plc Winning destinations delivered resilient income streams in a challenging market

Intu Properties Plc (LON:INTU), today released audited results for year ended 31 December 2018.

John Strachan, intu Chairman, commented:
“intu has had a challenging year with a difficult retail and uncertain economic environment, together with responding to two abortive corporate offers for the company. However, our management team has produced a robust operational performance with increased like-for-like net rental income for the fourth consecutive year, 97 per cent occupancy and signed 248 new long-term leases.

This outcome is testimony to our long-term strategy of investing in our centres and the intu brand, making them different, attractive and exciting so retailers look to our centres as key trading locations.

Our three core objectives for the year ahead are to continue to deliver strong underlying individual centre performance, continue our strategy of adapting to the changing retail environment and to make smart use of capital.

We propose to reduce our debt to assets ratio over time back below 50 per cent by further disposals and part-disposals and retaining the cash generated by our activities rather than distributing it as dividend, to enable us to invest in our winning destinations.

I would like to thank our strong management team for their dedication and commitment in a difficult economic environment as we focus on making intu centres winning destinations for brands and shoppers.”

David Fischel, intu Chief Executive, commented:
“intu has again delivered a resilient operational performance which demonstrates how our centres differentiate themselves as winning destinations for retailers with their variety and excitement. We own and manage many of the best shopping centres, in some of the strongest locations, in the UK and Spain.

In a difficult year for the whole UK retail real estate sector and with very limited comparable transactional evidence, property valuations declined as sentiment weakened significantly. We reported a further 3 per cent fall in valuations in the final quarter of 2018, additional to the 9 per cent fall over the first nine months of the year. As a result, EPRA NNNAV at the end of year was 271p per share, down from 349p the year before.

Although sentiment in the retail sector is at an all-time low, the reality is that around
400 million shoppers visit our centres each year and occupancy is at 97 per cent. As some 85 per cent of all retail transactions still touch a physical store, demand from major retailers continues to be positive for our centres.

New tenants to our centres include Abercrombie & Fitch, Uniqlo, Bershka, and Monki, with established retailers such as Next, Primark, Zara and River Island all upsizing.
Our tenants invested a record £144 million in their stores over the year, a clear indication that these retailers see great physical space as a key part of a successful multichannel strategy.”

Highlights of 2018

1 Including Group’s share of joint ventures. See other information section for reconciliations between presented figures and IFRS figures.

2 31 December 2017 including intu Chapelfield which was classified as an asset held for sale.

3 See notes 8 and 9 for reconciliations between presented figures and IFRS figures.

4 31 December 2017 figure pro forma for the net initial consideration of £148 million on 50 per cent disposal of intu Chapelfield which completed on 31 January 2018.

Our results for the year show a resilient operating performance with a continued like-for-like net rental income growth. The uncertainty around the UK economy and the challenging retail background are leading to weakening sentiment in the retail property investment market, impacting property valuations:

– property values reduced in the year by 13.3 per cent with a total revaluation deficit of £1,405.0 million (see below)

– like-for-like net rental income growth of 0.6 per cent (£2.3 million) driven by increased rents from new lettings (+6 per cent ahead of previous rent) and rent reviews (+7 per cent ahead of previous rent) partially offsets £11.8 million impact from disposals and developments

– underlying earnings of £193.1 million, impacted by disposals and development activity in 2018

– loss for the year of £1,173.7 million, an increase of £1,377.0 million, primarily from the property revaluation deficit

– underlying earnings per share of 14.4 pence, 0.6 pence lower than 2017 reflecting the impact of disposals and developments

– NAV per share (diluted, adjusted) of 312 pence, down 99 pence, the decrease due to the property revaluation deficit. NNNAV per share is 271 pence, reducing by 78 pence

– debt to assets ratio is 53.1 per cent. Net external debt largely unchanged at £4,867 million, with cash and available facilities of £548 million

Property valuations
In a challenging year for the whole retail real estate sector, intu reported a 6.2 per cent valuation fall in the period to 30 June 2018 and a further 3.0 per cent in the quarter to 30 September 2018 with the full year reduction in our assets amounting to 13.3 per cent (£1,405.0 million).

This is driven by weakening sentiment in the UK retail property investment market as illustrated by the low levels of transactions (see market trends). The valuers’ assumption is that investors will focus on and seek higher net initial yields. In the year, intu’s average net initial yield (topped-up) has increased by 62 basis points to 4.98 per cent.

Additionally, given the current challenges for certain department stores, the valuers have taken a more conservative view on ERVs for larger space units. On a like-for-like basis, ERVs decreased by 3.9 per cent.

Operating highlights

Growing like-for-like net rental income

– like-for-like net rental income increased by 0.6 per cent in the year, driven by increased rents from new lettings and rent reviews and impacted by some 1.9 per cent from tenant failures

– anticipate 2019 full year change in like-for-like net rental income, including the impact of House of Fraser, to be down by 1 to 2 per cent (subject to no new material tenant failures)

– signed 248 long-term leases (187 in the UK and 61 in Spain) delivering £39 million of annual rent at an average of 6 per cent above previous passing rent (like-for-like units) and in line with valuers’ assumptions (2017: 217 leases; £38 million of annual rent; 7 per cent above previous passing rent)

– rent reviews settled in the year on average 7 per cent above previous passing rent (2017: 9 per cent)

– sustained high occupancy of 96.7 per cent (December 2017: 97.0 per cent)

Delivering operational excellence

– footfall decreased by 1.6 per cent (2017: up 0.1 per cent) outperforming the national ShopperTrak retail average which fell by 3.5 per cent in the year

– net promoter score, our measure of customer service, improved in the year averaging 75 (2017: 70)

– brand awareness increased to 28 per cent on an unprompted basis (December 2017: 26 per cent) and to 76 per cent on a prompted basis (December 2017: 71 per cent)

Optimising our winning destinations

– capital investment by intu of £201 million in the year including £67 million on the 380,000 sq ft extension of intu Watford which opened in September 2018 and £40 million on the leisure extension at intu Lakeside, anchored by Nickelodeon, Puttshack and Hollywood Bowl

– record tenant investment of £144 million on new shopfits in 2018, with 262 stores opened in the year (2017: £89 million; 259 stores)

– commenced the £75 million extension and enclosure of Barton Square at intu Trafford Centre which will be anchored by Primark and is due to open in early 2020

– appointed the main contractor on the £89 million mixed-use regeneration of intu Broadmarsh which will be anchored by The Light cinema and Hollywood Bowl

– near-term committed and pipeline of projects through to the end of 2021 of £428 million

– actively pursuing non-retail development opportunities, particularly around super-regional centres, including residential with, for example, the potential for over 1,000 private-rented-sector residential units at intu Lakeside

Making smart use of capital

– completed the disposal of 50 per cent of intu Chapelfield for net initial consideration of £148 million, in line with the December 2016 market value. Other disposals of sundry assets amounted to £23 million, 6 per cent ahead of December 2017 valuations

– we have refinanced or entered new facilities of over £500 million, including development finance loans on intu Trafford Centre’s Barton Square and intu Broadmarsh

– cash and available facilities of £548 million (31 December 2017: £833 million). Weighted average debt maturity of 5.8 years, with minimal debt maturities until 2021

– substantial headroom on our loan to value debt covenants. By way of example, a further 10 per cent fall in capital values would create a covenant shortfall of only £1 million which could be cured from available facilities

Chief Executive’s review

Introduction – a challenging year
2018 has been an eventful and challenging year for intu.

The UK economy has struggled through a third year of pre-Brexit political uncertainty. Specific to intu, we had to overcome the disruption from two public company offers, neither of which, for reasons outside our control, ultimately concluded.

I would like to thank the executive team and all intu staff for their outstandingly resolute and determined performance through these events which coincided with significant industry challenges.

In terms of UK economic data most relevant to intu, non-food retail sales were essentially static year-on-year, but online sales continued to grow so physical sales shrank. In fact, in-store non-food retail sales in the UK have shown a year-on-year reduction every month for the last two years. Retailer costs, by contrast have not declined, not least as a result of the significant burden of the UK’s property tax known as business rates.

Retailer failures therefore picked up substantially, impacting our net rental income by an estimated 1.9 per cent. Increasingly negative investor sentiment towards retail property fed through to a 13.3 per cent fall in the valuations of our UK assets.

In the face of this adversity, shareholders have seen the share price decline to a level representing for intu a virtually unprecedented discount to NAV per share (diluted, adjusted) of over 60 per cent.

Plans to reduce debt to assets ratio
Our debt to assets ratio at 31 December 2018 was 53 per cent, exceeding the Board’s target maximum of 50 per cent.

We propose to take the following steps to lower the Group’s debt to assets ratio over time to back below 50 per cent and lower the share price discount:

– retaining for the time being the cash generated by our activities rather than distributing it as dividend, commencing with no final dividend for 2018 (2017 final dividend: 9.4 pence). In 2018 we paid dividends of £188 million based on an annual dividend per share of 14.0 pence. Retaining the dividend will enable us to continue to invest in our winning destinations

– through further disposals and part-disposals in due course in both the UK and Spain. Following £171 million of disposals in 2018, we will continue to recycle capital from individual assets. We consider substantial sales in the UK as challenging until a political resolution on the Brexit issue is achieved and not in shareholders’ interest while market sentiment towards UK retail property is so negative. In Spain we have received a number of unsolicited offers which we are evaluating

Resilient 2018 operating performance
Despite negative external factors, intu demonstrated considerable resilience in its operating performance through a challenging period, evidence of the underlying quality of the intu business. This includes ownership of eight of the UK’s top-20 centres, which amount to 69 per cent of our property assets by value, and three of the top-10 centres in Spain.

intu has reported a 0.6 per cent increase in like-for-like net rental income despite the retailer failures referred to above, stable occupancy around 97 per cent, and 248 new leases signed (2017: 217) at 6 per cent above previous rents. Lettings included an attractive mix of new and established names, significantly refreshing the centres, among them Abercrombie & Fitch, Uniqlo, Bershka and Monki, with the likes of Next, Primark, Zara and River Island all upsizing.

As we operate in many of the top UK retail destinations where retailers want to maintain their best stores, like-for-like net rental income performance was robust despite recent administrations and CVAs. The administrations and CVAs in the year relate to around 6 per cent of our passing rent, but the majority of these (72 per cent) have had minimal impact with the retailer keeping their stores open on the existing rent or with a small reduction.

Underlying earnings per share reduced from 15.0p to 14.4p mainly as a result of the income impact from disposals.

Fall in property valuations
After two years of essentially unchanged valuations for our UK centres, 2018 saw investor sentiment turn against retail property.

We reported a 6.2 per cent fall in property values in the six months to 30 June 2018 and a further 3.0 per cent in the quarter to 30 September 2018, with the full year reduction in our assets amounting to 13.3 per cent. Net initial yield (topped-up) climbed over the year from 4.36 per cent to 4.98 per cent and was the primary factor driving NAV per share (diluted, adjusted) down in the year from 411 pence to 312 pence.

By way of illustration of the impact on intu, a further 10 per cent fall in valuations, amounting to approximately a further £920 million reduction and 22 per cent overall since the beginning of 2018, would reduce NAV per share (diluted, adjusted) to around 243 pence from 312 pence and EPRA NNNAV per share to around 202 pence from 271 pence.

Focus on winning destinations
With the structural changes going on in our industry, we regard it as increasingly important that intu focuses on centres which rank as winning destinations where customers love to come and retailers want to be.

Alongside best retail, food, beverage and leisure, we intend to add further mixed-use attractions to these centres in the form of improved public space with more frequent experiences, residential space, hotels and other uses such as state-of-the-art office and co-working space.

Our retailers regularly confirm to us the importance of flagship physical stores in centres such as ours for their overall offer to consumers, with around 85 per cent of all transactions estimated to still touch a store. Our target is that every store in our centres should rank in the retailer’s top quintile of UK stores – ideally as many as possible in their top-20 stores.

Continuing investment programme
We and our tenants have continued to invest in our centres in 2018. We invested £201 million which included completing the transformational extension of intu Watford that promotes Watford to a top-20 UK retail destination and handing over units to be fitted out at our exciting leisure extension at intu Lakeside which is 93 per cent pre-let and due to open in spring 2019. Our tenants invested around a further £161 million – £144 million introducing their latest shopfits and £17 million on maintenance expenditure.

Our pipeline over the next three years of £428 million includes £82 million on the regeneration of intu Broadmarsh which will be anchored by The Light cinema, the transformation and expansion of Barton Square at intu Trafford Centre, introducing Primark to the centre, and the creation of the new generation 255,000 sq m shopping resort intu Costa del Sol, near Málaga in Spain.

2019 objectives
We have set three strategic objectives for 2019:

– delivering strong underlying individual centre performance

– adapting fast to a changing retail environment

– making smart use of capital

The first two objectives are to be measured by a number of key performance indicators, similar to those currently reported.

In terms of the third objective, making smart use of capital, the events of 2018 have impacted our views on capital allocation, especially as a result of the discount to NAV per share (diluted, adjusted) widening to an unprecedented 64 per cent between the reported NAV per share (diluted, adjusted) of 312 pence and the share price of 113 pence as at 31 December 2018.

Expressed another way, the year-end share price reflects a 29 per cent discount to gross assets of £9.2 billion. The implied initial yield on our assets to a shareholder at this share price is currently 7.03 per cent rather than the published net initial yield
(topped-up) according to the year-end property valuations of 4.98 per cent.

Financial strength
We have cash and available facilities of £548 million. Net external debt was largely unchanged at £4,867 million and we have refinanced or entered new facilities of over £500 million in 2018 illustrating that debt markets continue to be supportive of our highest quality retail property. We consider the structure of our borrowings, predominantly using flexible asset specific
non-recourse arrangements, to be appropriate for our concentrated portfolio.

These facilities have significant covenant headroom. For example, a further fall of 10 per cent in capital values would create a covenant shortfall of only £1 million.

The table below shows the covenant shortfalls on our non-recourse debt that could be remedied from our available facilities for further falls in capital values:

David Fischel
Chief Executive

2019 Strategy

Winning destinations strategy

Our strategy is to focus on winning destinations delivering resilient income streams, investing where there is the greatest potential, and reducing our debt to assets ratio to below 50 per cent through disposals, part-disposals and introducing partners to assets. In recent years we have successfully recycled capital through this approach, disposing of over £1 billion of assets.

The retail environment remains challenging. Our response is to adapt our strategy, protecting shareholder value in the short term and maximising growth in the medium term as we progress the repositioning process.

Our strategy will ensure that we focus on the centres with the greatest potential, with a capital structure that enables us to make the required investment.

Optimal positioning in a fast-moving environment
We operate in a fast-moving retail and leisure environment and to ensure we are optimally positioned we will:

– refine the portfolio to concentrate on regional destinations, making high-impact investments to ensure they remain winning locations where customers love to come often and are great locations for retailers where it is easy for them to do business

– leverage the brand, aided by the delivery of world class service, compelling experiences and innovative digital initiatives

– deliver a compelling value proposition for our tenants, ensuring their locations in our centres are among their top quintile
in the UK

– actively pursuing complementary non-retail development alternatives to maximise the potential from our significant land holdings around our centres which offer many opportunities for alternative uses, including residential and hotels

A capital structure to meet our needs
To deliver this transformation, we will create a capital structure to meet our needs, refinancing debt both as required and where attractive for the Group to do so, targeting a reduction in our debt to assets ratio to below 50 per cent over time. This will be delivered by:

– significantly reducing the dividend paid and disposing of sundry assets

– the disposal and part-disposal of centres which do not meet our winning destination criteria over the medium term. We have
the flexibility to introduce partners into some of our flagship centres, with around two-thirds, by value, of our total assets
100 per cent owned

Strategic objectives for 2019
Our three strategic objectives for 2019 are:

1. Delivering strong underlying individual centre performance

2. Adapting fast to a changing retail environment

3. Making smart use of capital