Chief executive's review
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.
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.
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:
Chief executive of intu