Retail A-REITs And The New World

This story features SCENTRE GROUP, and other companies. For more info SHARE ANALYSIS: SCG

-Retail digital income increasing
-Higher bond yields a negative
-Mall quality equates to sales
-Conditions ripe for consolidation
 

By Eva Brocklehurst

Macquarie has taken a look at non-traditional sources of income for retail Australian Real Estate Investment Trusts (A-REITs), triggered by the announcement that Scentre Group ((SCG)) has taken its shopping centre signage provision in-house. The broker observes the retail A-REITs are increasingly intent on driving a digital strategy via screen advertising in malls, free WiFi – used to track shopper foot traffic – as well as improved websites and smart phone applications. While it remains difficult to quantify, these sources of income are expected to increase as a proportion of gross revenue.

Digital advertising allows for more and varied content compared to a traditional display but with this increased revenue comes increased capital expenditure. Macquarie does not believe the revenue opportunity will outweigh the other opportunities that come from the structural changes affecting retail landlords, such as elevated supply, downside risk to tenant margins when factoring in a lower Australian dollar, and a subdued performance from key categories such as apparel. Hence in the segment, the broker prefers Westfield Corp ((WFD)), Goodman Group ((GMG)) and GPT ((GPT)).

What would the impact of higher bond yields be on the retail A-REITs? The correlation is negative and Macquarie continues to expect modest like-for-like growth for the retail landlords in the foreseeable future, with compressed dividend yields and the relativity to bond yields likely to narrow. Changes to exchange rates are also expected to be a key feature of the sector. This suggests to Macquarie that many of the basic rent-collecting A-REITs will fall short of delivering an adequate total return for investors.

In this scenario, Scentre Group remains a key Underperform recommendation as the pay-out ratio is likely to ease over time, in Macquarie's view. In contrast, the lower Australian dollar is expected to benefit Westfield and the broker retains an Outperform rating on this stock, underpinned by potential for a further value-affirming restructure, M&A and a strong US retail outlook relative to Australia.

JP Morgan suspects a strong relationship between shopping centre quality and sales growth as landlords race to redevelop their centres. When cap rates fall – the ratio of asset value to producing income – hurdle rents also fall and the feasibility of any given development improves. The role of the anchor tenant in these redeveloping shopping centres is diminishing, the broker maintains, with the focus now on international "mini majors" up-market casual dining, retail services and technology. With this in mind, JP Morgan considers Scentre Group is the best placed, as it has the highest quality portfolio and best development track record.

The broker has also found that Stockland's ((SGP)) portfolio is under rented in this segment and undervalued relative to its productivity. Therefore, that company should be well placed to deliver strong net operating income and capital growth relative to peers.

JP Morgan has also reviewed the Investa Property Group portfolio and management platform, given Morgan Stanley's recent announcement it will commence a sale process. The broker estimates the portfolio has 75% Sydney CBD exposure and over the next three years there will be 35% of total space expiring. Investa Office Fund ((IOF)) has last right of refusal to acquire the rights to the management platform. Other than Investa Office, JP Morgan considers Charter Hall ((CHC)) to be well placed to accommodate the platform.

Analysis shows a joint venture acquisition of the portfolio at current security prices would be accretive to net tangible assets and free funds from operations, but the low yield would be potentially dilutive to cash flow forecasts. The degree to which an acquisition would require a material increase in gearing is critical, in JP Morgan's analysis.

Conditions are good for consolidation in retail property globally, Morgan Stanley observes. This comes with structural change in retailing, unprecedented access to capital and, for most, reduced development activity. Portfolios appear to the broker to have moved to a smaller footprint around major gateway cities, providing greater growth potential as retailers look to exit smaller markets.

Although conditions look conducive to cross border mergers and acquisitions, the broker observes there are obstacles, including family ownership and the complexities of scrip-based consideration. Moreover, cost synergies may be limited. Overall, the broker considers the segment is fully valued. If Westfield can execute on non-core asset sales and its development pipeline then Morgan Stanley considers its portfolio is likely to be the most geographically attractive over the next five years.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms