When Paying Tax Beats Paying a Dividend

(Bloomberg Opinion) -- You know things are dire in the U.K. property industry when a real estate investment trust scraps its dividend entirely.

In the U.K., REITs are exempt from corporation tax on their domestic rental income providing they pay out at least 90 percent of that profit to their owners.

But on Wednesday Intu Properties Plc, a publicly traded owner of several U.K. and Spanish shopping malls, announced that it won’t pay a final dividend for 2018 and indicated it might not pay much of one for 2019.

This radical move is understandable in such a tough environment for retailers as Brexit Britain. A 13 percent year-on-year slump in valuations has caused leverage to balloon. Intu’s debt has swelled to 53 percent of assets, an uncomfortably high level.  

The company says it wants to remain a REIT and will resume regular distributions in the long term. Still, its decision to cancel the dividend sets a bad precedent for an already beaten-down sector. Intu’s shares fell another 8 percent on Wednesday, bringing their decline over the past year to almost 50 percent.

Intu isn’t the master of its own fate here. If property valuations continue to fall, leverage will worsen and further unsettle equity and debt holders. Thus its decision to prioritize debt reduction – it says it wants to get its loan-to-value ratio back below 50 percent – is the right one, even if it leaves equity investors feeling sore.  

The group’s dividend departure means it could be hit with a tax bill of about 20 million pounds ($26 million), or about 10 percent of last year’s underlying earnings. Right now, though, that looks a better outcome than having to fork out roughly 190 million pounds a year in shareholder payouts. That amount is almost twice the operating cash flow Intu generated in 2018, according to Bloomberg Intelligence.

The other plank of its deleveraging plan is asset sales. Finding a buyer for its Spanish sites might be more straightforward than in the U.K., where transactions have all but ground to a halt amid uncertainty about Brexit and worries about the financial health of retail tenants. But these disposals are no panacea: divestments bring in cash but cut future earnings, which might further harm the equity story.

Intu doesn’t face any big refinancing pressures for the next couple of years and its covenants look manageable. Considering that in the past year the CEO has resigned, the company missed out on two takeover attempts and tenants like House of Fraser started to shutter stores, operationally the group isn’t in such a bad state: occupancy levels and rental income look pretty good. 

The shares trade at a near two-thirds discount to adjusted net asset value, a level management says is “virtually unprecedented.” That discount may prove hard to close. As both Brexit and Intu’s decision to forgo the dividend show, we are living in treacherous times.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Chris Bryant is a Bloomberg Opinion columnist covering industrial companies. He previously worked for the Financial Times.

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