Fitch Ratings: Larger Retail Exposure Weighs on Scentre; Offices Support Mirvac

(The following statement was released by the rating agency) Fitch Ratings-Sydney-30 August 2020: The weak performance across the retail sector, which is among the worst affected by curbs to contain the coronavirus pandemic, has impacted Australian retail REITs. Consequently, REITS with greater exposure to retail properties fared worse than peers in 1H20 and we do not expect a meaningful improvement in the second half, Fitch Ratings says. Poor performance in retail property portfolios was driven by the impact of rental relief provided to tenants in the three months to 30 June 2020, as well as a decline in valuations due to expectation that structural changes in the sector, including the shift to online retailing, have accelerated. We expect some recovery in the second half as social distancing measures are relaxed and visitations improve, although this remains vulnerable to stricter social distancing curbs that may be implemented to combat localised outbreaks. Further, we believe that strain will continue to be felt across the sector, particularly as retailers navigate prolonged spending weakness as government support moderates in the second phase of relief measures coming into effect at the end of September. Some retailers say they will shut more stores to reflect any continued changes in consumer spending. However, office and industrial properties benefited from these assets' resilience, with office properties protected by the longer weighted average lease expiries and industrial properties benefiting from increased online shopping and the resilient logistics industry. The pandemic is highlighting divergence in performance across the REITs with those with a portfolio skewed towards office and industrial showing more resilient underlying performance, and we believe this divergence will continue for at least 12 months. Mirvac Limited's (A-/Stable) results for FY20 benefitted from its diversification into office and industrial properties, as well as residential development, which offset weakness in its retail portfolio. This was reflected in Fitch's affirmation of its rating and maintaining the rating Outlook at Stable earlier this week. Mirvac reported that the pandemic had a total AUD118 million net impact on its earnings, with AUD86 million attributable to its investment portfolio and AUD32 million to its development business. Specifically, Mirvac provided AUD48 million for rental receivables and waivers, of which AUD40 million was for retail. The impact of the pandemic on Scentre Group Limited (A/Negative), whose portfolio comprises retail assets only, was larger. Its high exposure to structural changes in the retail sector is reflected in the Negative Outlook. Scentre reported expected credit charges relating to the pandemic of AUD232 million. During the lockdowns in April and May 2020, it collected only 28% and 35% of billings, respectively, compared with 94% in January and February, prior to the outbreak. Collections have since recovered to around 80% in June and July, as social distancing measures were relaxed - this measure is before taking into account relief to tenants. For the six months to 30 June 2020 (1H20), Scentre's collections were 70% of gross rental billings. Nevertheless, Scentre was able to generate positive funds from operations of around AUD360 million in 1H20, underscoring the strength of its properties. However, this was around 45% less than a year earlier. Both REITs' portfolios faced market value declines of 10%, similar to peers Vicinity Centres (not rated) and Stockland Corporation Limited (not rated). This amounted to AUD315 million for Mirvac and around AUD4 billion for Scentre, which led to it reporting a statutory loss of AUD3.6 billion for 1H20. However, Mirvac's retail revaluation charge was offset by increased office and industrial valuations. Both REITs' retail portfolios are recovering as Australian states relax social distancing requirements. Scentre reported that more than 93% of retail stores in its portfolio, excluding those in Victoria which implemented a second lockdown, are now open, while around 92% of Mirvac's gross lettable area was open and trading at end-June 2020. We believe that this recovery will support Mirvac's and Scentre's strong retail occupancy rates, which remained above 98% at 30 June 2020. The more capital-intensive residential development business performed well for Mirvac and Lendlease Corporation Limited (BBB-/Stable), despite the challenging conditions in the quarter ended 30 June 2020. However, we expect the economic weakness will dampen demand for residential properties, although it will be buoyed to an extent by government stimulus. We expect that the companies will continue to be disciplined in this capital-intensive business and manage launches and construction commencements to match demand. Scentre, Mirvac and Lendlease were all able to secure additional liquidity and extend financing facilities to provide headroom against a potential worsening in the pandemic. This highlights their strong access to credit markets and ongoing financial strength and flexibility. Scentre reported available liquidity of AUD4.4 billion (after repaying a EUR600 million bond which matured in July), which is sufficient to cover all debt maturities to January 2023. Mirvac had cash and undrawn facilities of AUD1.4 billion, with only AUD200 million of debt due for repayment before February 2022. Lendlease reported total liquidity of AUD5.8 billion (including AUD451 million in assets held for sale), with only AUD134 million in drawn debt due in FY21. Contact: Kelly Amato, CFA Director +61 2 8256 0348 Fitch Australia Pty Ltd Suite 15.01, Level 15, 135 King Street, Sydney 2000 Australia Media Relations: Peter Hoflich, Singapore, Tel: +65 6796 7229, Email: peter.hoflich@thefitchgroup.com Additional information is available on www.fitchratings.com ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTPS://WWW.FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. PUBLISHED RATINGS, CRITERIA, AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE, AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE CODE OF CONDUCT SECTION OF THIS SITE. 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