Australia | Jul 18 2011
– Retail slowdown having limited earnings impact on retail A-REITs
– Leasing spreads achieved by retail managers still solid
– Quality assets preferred, some value on offer in sector
By Chris Shaw
With David Jones ((DJS)) cutting earnings guidance and brokers lowering estimates for rivals such as Myer ((MYR)) as well, Citi has taken the time to examine the potential earnings implications of a soft retail environment on retail landlords.
One key point Citi notes is while the likes of David Jones and Myer occupy a significant portion of retail floor space for the likes of Westfield Retail ((WRT)), they both pay relatively little rent. As an example, Citi estimates David Jones occupies 6.3% of Westfield Retail floor space but only contributes around 2% to group rent.
The stockbroker points out this means the direct effect of currently soft retail sales is negligible for the major retail landlords. The other point made by Citi is any ongoing softness in the retail sector takes some time to impact on landlords.
This is due to long-term leases, which mean landlords have far greater surety of income than do their retail tenants. This is especially the case given only a small proportion of total leases expire in any one year.
Given the current soft Australian retail environment, Citi sees scope for specialty leasing spreads to act as a swing factor in retail EBIT earnings. Assuming a fall of 10% in leasing spreads for two years running, Citi estimates the earnings decline for Westfield Retail, the most affected stock, would only be in the order of 1.5% in FY12 and 4% in FY13.
Actual outcomes may not prove to have as much an impact, Citi noting retail landlords have generally continued to report positive leasing spreads and solid operational guidance. As an example, GPT ((GPT)) achieved leasing spreads of around 4.5% on renewals in the March quarter, while Stockland ((SGP)) indicated 2H11 net operating income should see similar growth to the 4.3% achieved in 1H11.
Post Citi's review of the retail A-REITs, the broker continues to rate CFS Retail ((CFX)), Stockland, Westfield Group ((WDC)) and Westfield Retail as Buy. BWP Trust ((BWP)), Charter Hall Retail ((CQR)), GPT and Mirvac ((MGR)) are rated as Hold.
UBS has undertaken a similar analysis, attempting to assess the impact on retail A-REITs of a bear case scenario with respect to rental growth. The review was to ascertain potential earnings impacts if specialty rents fell by more than the 4% currently assumed.
The review required a breakdown of mall income, UBS noting major tenants deliver around 17% of income, this due to 5% for each department store, discount store and supermarket and others at 2%. Specialty stores account for the other 83% of mall rental income.
The base case model of UBS assumes standard 5-year leases with fixed reviews of 4.5% annually, but with expiring specialty stores securing a 4% drop in new starting rent. This implies net operating income growth of 2.5%.
A bear case scenario would factor in no rental growth across the majors and an 18.5% decline in new specialty leases, the result being no net operating income growth. UBS suggests such an outcome is very unlikely, as fixed specialty reviews and strong supermarket growth continue to boost overall growth.
The sensitivity analysis conduction by UBS shows a relatively modest earnings growth impact across the major retail REITs in Australia, an outcome helped by other exposures. As examples, Westfield Retail has some non-domestic assets and GPT some exposure to the office sector as well.
Post its analysis, UBS suggests Westfield Group offers the best value among Australian retail REITs, while portfolio quality for Westfield Retail is also quite good. UBS continues to rate Westfield Group and Westfield Retail as Buy and GPT, Charter Hall Retail and CFS Retail as Neutral.
Credit Suisse also retains a preference for high quality retail A-REIT names despite the currently challenging conditions, seeing value as the sector is trading on an implied cap rate of 6.7%. This is 30-basis points above book value.
The analysis by Credit Suisse shows rents on new specialty leasing deals in regional centres continued to increase in the June quarter. While the pace of increases are moderating, gains of 0.5% were recorded, which equates to a year-on-year increase of 2.2%.
In general, Credit Suisse notes tenant demand remains relatively subdued, especially from fashion based retailers. Demand from supermarket based retailers remains strong in most markets.
Among the retail plays it covers, Credit Suisse rates Westfield Group and Westfield Retail as Outperform, CFS Retail is rated as Neutral and GPT and Charter Hall Retail are rated as Underperform.
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