British commercial property
As I’ve been saying for some time now the British retail property market is in considerable trouble. The irruption of the internet has led to High Street shops being worth very much less than they were. Rents on the open market are falling considerably. This means that companies like Intu Properties (OTCPK:CCRGF) are in near terminal trouble.
The process is that the retailers occupying the properties find that they can’t afford the rents. They agitate for a rent reduction, possibly go bankrupt – something that reduces rents nicely – or go through that intermediate stage of a company voluntary arrangement and gain rent reductions that way.
Of course, this doesn’t really work for a company that’s doing just fine. Which is where Primark is. Thus the surprise at this:
Retail stalwart Primark has refused to pay its rent bill as it seeks more support from its landlords in a sign of the chaos sweeping the high street.
The firm is scrambling to save cash after being forced to shut all of its stores at a cost of £650m a month in lost sales.
A host of firms are thought to have refused to pay rent on Wednesday, the day when quarterly bills are due for a huge number of retail players. That Primark is among them despite being one of the most resilient names in the industry shows the huge pressure firms are under.
Associated British Foods (OTCPK:ASBFY)
The parent company is Associated British Foods and we really don’t expect to see this when there’s such a statement of financial distress as withholding the rent bill:
(Associated British Foods share price from Seeking Alpha)
It’s that jump at the end that we’re not expecting. So, what’s happening?
One of America’s most popular restaurants, The Cheesecake Factory, reportedly cannot afford April’s rent at any of its nearly 300 locations due to the financial strain caused by the coronavirus pandemic.
Primark could pay those rents, it just chooses not to. That’s my reading of the situation anyway.
One thing to know about British commercial property is that rent is payable every three months. In advance. The last rent day was Lady Day, March 25th. Rents are not being paid:
Intu has revealed that it received 29% of the rent that was due yesterday on rent quarter day, down from 77% at the same point last year.
Those commercial landlords are in a lot of pain. Perversely, I think Intu will do better there than many others. Simply because they’re so close to the edge that the offers of cheap loans from the government to get through Covid-19 are of more importance to them than the falling rent rolls are. But that’s an aside.
So that’s the background
UK retail property rents are falling. That causes problems for the landlords, of course it does. However, given the structure of the market it’s very difficult to insist upon a lower rent for an extant lease. The only way of forcing it is through that CVA route, which has obvious implications for shareholders. And a company which is doing just fine but would like lower – closer to new market lets – rents can’t really use that route for that reason alone.
So, if you’re one of the dominant retailers, as Primark is, what can you do?
The obvious plan is to use this current nastiness, coronavirus, to play hardball with the landlords. Every £1 offer the rent bill is another £1 added to the pure profit line after all. And you’re really pretty sure that no one, in the current situation, is going to either bankrupt you or call you out on the tactic.
Which is why the stock price rose. Playing hardball when you can is a good tactic after all. And no, it’s not a signal that Primark is about to go under. Quite the opposite.
When this is all over Primark is going to be there, still one of the country’s major clothes retailers. And by playing these cards as they have done at a lower rent bill and thus a higher profit margin.
Of course, we can say this is all a bit tough here. Slightly underhand tactics even. And yet we want the people managing our money to be exactly that when dealing with our money. We want them on our side, being beastly to the rest of the world to the profit of our pockets.
This tactic thus just increases my admiration for the management team.
The investor view
Associated British Foods rests on two legs, the food business and Primark. Sure, retailers are having a very hard time of it given that near all non-food shops in Europe are now closed. Primark recently declared force majeure on all income clothing orders for example.
This is going to cause a shakeout, no doubt about it, the whole situation. At least some of the landlord companies will go under, so too will some retailers. But I expect Primark to be one of those that comes out of it in better condition than they went in. Competition reduced, rent bills lower, profits I think will be higher.
Thus ABF is a buy. Not because their not paying the rent bill, refusing goods already ordered, indicates they are in distress. But precisely because they’re vicious enough managers that they’re willing to use the circumstances to act that way. They’re acting like right – well, this is a family place so I won’t say – but that’s what we want, the right -d’s on our side, managing our money.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.