Letter to the Shareholders of the Chairman and the CEO
2019 was the first year of the three- year Business Plan 2019-2021. Aware of the challenging path we have undertaken in a weak global environment and an increasingly complex scenario for retail, in this first year we completed a significant number of investment projects and finalized a series of debt optimization transactions which have put us in a position to benefit as quickly as possible from the growth in FFO that these initiatives should trigger.
After a decade of intense growth fueled by new openings and acquisitions which resulted in buoyant growth rates in rental income and FFO, today we are working on consolidation which will lead to solid and sustainable growth, albeit at different rates than in the past.
In 2019 our operating performance, specifically FFO, was in line with our guidance, while property values fell slightly due to the market conditions
The main performance indicators in the 2019 Annual Report confirm IGD’s ability to achieve positive results even in the face of modest economic growth in Italy. ISTAT estimates GDP growth of +0.2% YoY. Funds from Operations, in fact, grew 4.5%, to €83.3 million. This figure is in line with the guidance disclosed last August when we forecast an increase in FFO of between 4% and 5% YoY.
Core business EBITDA rose 10.1% in 2019 to €125.2 million (net the effects of IFRS16¹ the figure comes to €114.9 million, +1.0%), driven by rental income which rose 2.3%. The EBITDA Margin was 56 basis points higher than in 2018, coming in at 77.5%, with the margin for the freehold portfolio reaching almost 80%.
At year-end 2019 the Fair Value of IGD SIIQ’s real estate portfolio came to €2,381 million, a drop of 1.27% compared to year-end 2018 based on the independent appraisals. In Italy the hypermarkets were 0.34% lower, while malls dropped by 1.16%.
The Loan-to-Value, which came to 47.6%, remains steady, as does the Interest Cover Ratio (interest expense as a percentage of earnings) which reached 3.8x², while financial charges amounted to €36.8 million in 2019. This figure, net of the accounting impact of the last bond issue and restated in accordance with IFRS16 (€31.4 million), was 3.4% lower than in 2018. The negative carry linked to the refinancing of future maturities also had an impact of around €0.3 million. The Business Plan calls for a Loan-to-Value of below 45% by year-end 2021.
The €31.5 million decrease in adjusted net profit posted in 2019 is, therefore, largely linked to the year-end property valuations: write-downs and fair value adjustments showed a negative balance of €60.9 million1 in 2019 versus €30.3 million in 2018. If you consider that the IGD Group’s real estate portfolio is valued at more than €2.4 billion, the impact of the fair value adjustment is, in reality, quite modest.
The new rules of the game: invest in order to have quality occupancy
Overall IGD’s real estate portfolio has proven to be solid even in light of the slight, but generalized, increase in the cap rates used by the four independent appraisers and despite a series of investments made in order to maintain the high quality and appeal of the assets which do not translate immediately into higher rents.
In a challenging business environment, IGD benefits from the fact that in the past the company invested consistently in the quality and appeal of its assets and will continue to do so going forward. While in the short term the valuations may be lower, in the long term IGD will reap the benefits of a portfolio with sustainable revenue which, thanks to the innovations introduced and the continuous quest for operating excellence, will maintain a highly competitive position in the reference catchment areas and deep roots in the local community.
Given the focus on quality occupancy, IGD believes that it is imperative to continue to have shopping centers which meet the highest environmental and safety standards, which are also welcoming and innovative, capable of providing shoppers with an appealing commercial offering, even though it may not always translate into higher rental income.
Part of the flexibility in asset management and commercial policies called for today stems from the changing needs and lack of interest in large spaces. What we have seen today, consistent with sector trends, is that retailers need less space than in the past, while the experience that a shopping center provides is extremely important. E-commerce also impacts the business dynamics resulting in shorter life cycles for retail spaces and rapidly changing needs.
While not all retailers have resolved the issue of how to integrate physical and online presences, everyone agrees that the store still has an indispensable role: this has caused the brands with strong contractual power to put pressure on the average rents per square meter, an erosion in reversionary potential and an increase in the investments shopping center owners must make in new fit-outs.
In IGD we are well aware that the layout of the mall spaces must be revisited, that the merchandise mix must be renewed, with targeted investments in entertainment and restaurants. In 2019 we worked to shift our focus to food courts, services and entertainment, while we reduced the size of our hypermarkets and midsize stores.
The investments made resulted in remodeled spaces and a profound transformation in several shopping centers
In 2019 investments totaled €28.6 million.
In fall 2019 we inaugurated two restyled shopping centers, Casilino in Rome and Fonti del Corallo in Livorno. The changes made on both the interior and exterior structures radically changed the two centers’ ability to meet the visitors’ new shopping and entertainment needs. The restyling of the interior and the exterior of the Gran Rondò Shopping Center (Crema) was also completed and in 2020 is planned an extension of the mall.
In accordance with the framework agreement signed with Coop Alleanza 3.0 in November 2018, we worked on reducing the size of three other hypermarkets (Le Maioliche, Conè and Porto Grande) whose work has been completed in 2019. In 2020 in Porto Grande is also planned a restyling.
As for the Porta a Mare project in Livorno, work continued on the Officine Storiche section, and in September the sale of the historic Palazzo Orlando, an office building, for €12.8 million was finalized.
The proceeds covered most of the €13.9 million paid for the remaining 50% of the Darsena City mall in Ferrara (IGD was already joint owner) which was purchased in order to increase the portfolio’s focus on the retail segment, the Group’s core business.
In September the requalification of the multiplex cinema in Milan’s CentroSarca was also completed which paved the way for the inauguration of the multiplex “Notorious Cinemas – The experience”: a new entertainment format which covers more than 5,500 square meters with 10 cinemas and different lounge areas, advanced audiovisual systems, maximum comfort and fully automated ticketing.
The new institutional communication campaign, conceived to change the perception of the shopping center, helps to increase footfalls
Sales of retailers in Italian malls grew 0.5% year-on-year, despite the decrease in footfalls stemming from unfavorable weather conditions, specifically in February and May, and the negative performance of a few hypermarkets, particularly those where remodeling was underway.
The institutional communication campaign “I’m possible. The place where everything is possible”, launched in IGD’s 7 core shopping centers beginning last fall slowed the drop in footfalls beginning already in December and made it possible to reverse the trend in January 2020. The new positioning of the image of these seven centers, which represent the quintessential IGD shopping center, therefore, proved to be effective.
The repositioning focuses on strong emotional engagement through the use of a dreamlike and evocative graphic design as part of a campaign designed to improve footfalls, but which strategically has broader ambitions: make people aware of the transformation of the shopping center into a place where you can find shopping experiences and entertainment. The campaign centers around the concept of the shopping center as a place where your dreams can come true, that takes you out of your daily routine, where people can dedicate special time to themselves, their families and friends, in a shopping center that becomes a true “space to be lived in”. A message which was well received and has already triggered the first initial changes in perception.
Consistent with changing trends, in 2019 more space was dedicated to services, resulting in a new dental office being added to the 20 which were already up and running, the inclusion of new brands and the introduction of retailers which provide merchandise that may no longer be available in the hypermarkets. At the same time, vegan and organic formulas were added to the food courts.
The operating indicators point to a healthy situation
Looking again at the operating indicators, the average Financial Occupancy of the Italian portfolio reached 96.9% in 2019: a high level which was basically unchanged with respect to the 97.2% recorded in 2018. Rental income in Italy rose 2.3% in 2019, while net rental income was up 10.1% (+1.8% adj. ex IFRS16). These increases were driven by the inclusion of the portfolio acquired from ECP in April 2018 in the group’s perimeter for the entire year and the expanded Gran Rondò center in Crema inaugurated in May 2018. Like-for-like revenue was also reassuring, rising 0.3% YoY in Italy despite the temporary vacancies of a few midsize stores which were rapidly leased again at higher rates, which will be fully expressed in 2020. The average upside on the new leases in Italian malls was 1.1%.
The positive performances recorded in Romania reflect, on the one hand, economic growth driven by family spending, and, on the other, the positive effects of the work done by IGD over the years to upgrade its assets and rethink the merchandising mix. Occupancy for the subsidiary Winmarkt reached 97.6%, higher than the 97.1% reported in 2018. Rental income rose 3.2% in 2019, thanks also to the average upside of 4% on the new leases.
A new digital strategy to transform interaction and build connected experiences
With a view to improving the customer journey as much as possible, we developed a new digital strategy, based on key touchpoints which will allow for more effective and complete interaction with the mall retailers. The data collected through the new CRM system will also allow us to develop a series of dedicated proposals for each IGD shopping center visitor, including promotions, events and special offers.
At the same time, we decided to revisit IGD’s entire social media strategy, paying more attention to the unique regional characteristics. All of IGD’s centers in Italy will, therefore, be on Instagram and Facebook in 2020, while the relative websites will be updated in order to strengthen the identity of the IGD brand.
Great steps taken toward implementing the financial strategy included in the three-year plan
Our financial management in the Plan focuses on three areas: reducing the financial leverage with a LTV of below 45% by 2021, lowering the cost of debt to 2.4-2.7% and increasing the Interest Cover Ratio to around 4x. In short, we will strive to maintain rigorous financial discipline, consistent with our investment grade rating.
Even in a low interest rate environment, we are very clear that FFO growth will be limited if the LTV is high. We are, therefore, aware that we need to optimize our capital structure if we want to support revenue growth, above all by limiting refinancing risk. In addition, we are firmly committed to improving the liquidity of our debt, maintaining a significant percentage of long-term debt, and to maintaining the utmost flexibility in financing, well balanced between bank debt and corporate issues.
Thanks to the liability management transactions carried out in 2019 we were able to deliver a large part of the relative targets included in the Plan: the average cost of debt fell below 2.35%, while the hedging of interest rate risk on long term debt and bonds reached 94.8%.
As we can count on the €200 million unsecured senior facility entered into year-end 2018 at a cost of 2.1%, in January 2019 we repaid the €125 million bond (coupon 3.875%). The investment grade rating, BBB-, received from two agencies – S&P Global Ratings in April and Fitch Ratings in October – made it possible for us to place a new fixed rate 5-year €400 million bond (coupon 2.125%) in November. The new issue was well received by the market, with the participation of high profile domestic and international investors, and oversubscribed three times. The proceeds were used to repurchase part of two outstanding issues, expiring in 2021 and 2022, and lengthen existing financial maturities.
The bond market, moreover, is confident in the stability of our cash flow as demonstrated by the success of the transactions we completed in 2019.
Sustainability fully integrated, which speaks to our leadership and will sustain it over time
The idea of sustainability drives the choices that IGD, a top tier player in retail real estate, makes and the way the company does things. The commitment to “becoming G.R.E.A.T.”, namely Green, Responsible, Ethical, Attractive, Together, is an integral part of the strategy and daily operations, which, while already clear today, will become even clearer going forward and will make a difference in the long term.
We are following a path which over time will lead us to have a carbon neutral real estate portfolio. Already today we have a portfolio that is 95% ISO 14001 certified; five of our shopping centers also have BREEAM in USE certification of at least “Very Good”. That’s not all: we invested €5 million in improving the energy efficiency of our buildings, in addition to the €6 million we had already invested in measures that included new LED lighting systems and which contributed to lowering the consumption of electricity by 3.2% in 2019.
Today we already use energy generated 100% by renewable sources, including marine geothermal energy. This was not enough for us: in 2019 we also installed photovoltaic systems in Crema and Catania, bringing the total centers with solar panels to seven.
The attention we pay to the environmental sustainability of our properties also resulted in concrete support of sustainable mobility. Thanks to the agreements with Enerhub and Tesla we installed charging stations for electric cars in 18 shopping centers, while in Clodì we installed the first charging station for 24 e-bikes powered by solar energy. As our properties are, on average, 4.5 km from the city centers, we want to encourage the use of bicycles.
We are also continuing with initiatives designed to promote the development of a circular economy, like the project Waste2Value, which is now operative, along with greater focus on waste management and recycling.
As the population becomes increasingly sensitive to environmental issues and the most important retailers view compliance with environmental standards as a prerequisite to leasing space, IGD will be even better positioned as a real leader in sustainability in its reference market, capable of making “wellbeing” a key feature of its shopping centers.
In honor of the 10-year anniversary of our first Corporate Sustainability Report, on 22 April we will host an event in which we will look back at what we have done and what we intend to do over the next few years. This will mark the launch of a communication campaign involving our shopping centers designed to increase visitors’ awareness of the philosophy underlying each of our initiatives.
Increasingly stronger governance shaped by specific business needs
Significant progress was also made in terms of Governance.
Great attention was paid to developing a Succession Plan for the two top tiers of the organization’s management, as per the Board Review completed in February 2019 by a premiere consulting firm, whose work is still underway.
A key change was also made to the Compensation Policy. Part of the variable compensation was shifted from short to long-term, as it was deemed more consistent with the ability to achieve the targets found in the Business Plan.
A careful remapping of IGD’s main risks was also carried out as part of the Enterprise Risk Management model that the Company has been using for some time. In 2019 greater weight was given to strategic risks, linked to consumer trends and the impact of market sentiment on real estate finance; greater attention was also paid to the risks stemming from the large and midsize stores. The most opportune operational, asset management and financial strategies were developed for each risk.
In 2019 the process was completed which should lead to the ISO 37001 anticorruption certification of IGD’s Italian portfolio in the first part of 2020.
IGD continues to provide its shareholders with compelling returns
In our 2019-2021 Plan we committed to providing a compelling and sustainable dividend to our shareholders over time. We will work to maintain our promise: the Board of Directors will propose the payment of a dividend of 50 euro cents for 2019, unchanged with respect to 2018.
At current prices, around 6 euros, the dividend yield comes to around 8%. A level which, when compared to the negative interest rates seen in this period, enhances the appeal of our stock, including with respect to other sector companies. The high dividend yield and the 2019 dividend of 50 euro cents confirm that the dividend continues to be a cornerstone of our equity story.
In 2019 IGD’s stock price rose 15.2%. Anyone who bought the stock at the end of 2018 (at €5.38) realized a Total Shareholder Return of 24.5% in 2019.
Despite the price increase recorded in 2019 and the strategy presented clearly in the Plan – in which we stated that we have no M&A in the pipeline financed by capital increases and that we can reasonably achieve further increases in FFO – IGD’s stock continues to trade a very low multiple. Part of this gap reflects the extremely negative view that the pan-European brokers have of the retail real estate sector going forward; another part is attributable to latent political risk and the danger of economic stagnation that could affect Italy, in particular, which puts pressure on our business returns. The market seems, therefore, to have failed to acknowledge the benefits that this period, in which the cost of funding is so low, may provide to far sighted operators with a clear investment plan.
The sector in which we operate is certainly going through a phase of great change globally, with new expectations and priorities. As ESG (Environment, Social and Governance) criteria become increasingly prevalent IGD will have a concrete opportunity to highlight see some of its key strongpoints.
In the near term we also hope that the changes made to the taxation of the PIR, Piani Individuali di Risparmio, will result in new capital – including from pension funds – being invested in domestic funds, which would also benefit our stock.
The room for potential upside in the stock price appears clear, not only because of the discount against the EPRA NAREIT NNNAV of €10.92, but also because of the net difference with respect to the brokers’ consensus target price which at the end of January 2020 was €7.83 euro. Two analysts had a target price for IGD of more than €9.
We look ahead to 2020 with confidence, as we have a clear path in front of us
In 2020 the Italian GDP should recover gradually, while lower levels of unemployment, more stable consumer confidence and cuts in the tax rates for many types of employees should fuel moderate growth in consumption even if the signs of weakness, along with political instability and the impact of unforeseeable events like the coronavirus that has affected some regions of Northern Italy, should not be underestimated. We will, however, continue with the execution of our Business Plan, calmly and steadfastly. In 2020 Officine Storiche in Livorno will also be inaugurated. This is the heart of our most important development project which, by the end of the year, will provide the city with a new area full of restaurants, entertainment, along with areas dedicated to fitness and wellbeing, while we will have a new source of revenue which will sustain the growth in FFO called for in our Plan.
After having consistently achieved the Business Plan targets of the past decade – a decade focused largely on growth – today we are committed to strengthening the leadership position of our shopping centers in the respective catchment areas. The progress made in 2019 allows us to confirm the validity of the 2021 targets found in the three-year Business Plan and to look ahead to the ‘20s with confidence as we are ready to address the market transformations underway and the consumers’ new priorities.