The Changing Nature Of Shopping Centres

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-Strong mobiles, weak apparel
-Location and experience paramount
-Discretionary retail to outperform
 

By Eva Brocklehurst

JP Morgan asks the question: are department stores obsolete as the anchors of a shopping centre? The broker highlights recent quarterly sales updates which reveal substantial strength in specialty store sales, suggesting landlords are usually better off replacing unprofitable anchors.

GPT Group ((GPT)) and Scentre Group ((SCG)) are expected to benefit from a more favourable retail sales environment compared with the likes of Novion ((NVN)), because of their hefty exposure to NSW, where sales growth is running at 8.0% year on year. Still, JP Morgan does not believe Novion, which has more than 40% of its exposure to the Victorian market, will miss out in a low inflation environment. Novion is expected to deliver stronger net operating income growth because of its 5.0% fixed reviews on specialty leases.

Retail sales growth may have improved but landlords have not yet seen a major benefit, in Citi's view. This broker suggests the importance of food and entertainment in the mix of offerings is growing, along with an ongoing impact from international retailers, making centre upgrades more necessary. The broker maintains that most upside in retail property will come from exposure to rising shopping centre values.

NSW is the most important market for the majority of listed retail landlords and retail sales growth has outpaced the national average, potentially because of stronger residential prices. Citi observes rents have lagged, nonetheless, because of the growth in the amount of space in the market. Victoria is similar as retail sales have grown in line with the national average and, while rent growth was relatively strong over the last five years, recently it has stalled. That said, Citi envisages the main drivers for shopping centres will be their specific catchment, rather than the actual city or state. For example, whether a centre is in Sydney, Melbourne or Brisbane is less relevant than whether it faces increased competition from a newly expanded centre nearby.

Specialty sales growth may be accelerating but Credit Suisse finds system growth unimpressive. What this broker considers is most import in the Australian retail environment is market share. Meanwhile, segments continue to diverge: strong mobile phone sales contrast with weak apparel and department stores. Credit Suisse retains a view that the high quality malls – which have good locations and offer a better experience – will increasingly dominate the landscape. In this sense, Scentre Group and GPT stand out for the broker.

UBS expects discretionary retail will outperform over 2015, driven by higher house prices & equity markets, and lower Australian dollar, oil price and interest rates. All these factors boost discretionary income. Meanwhile, supermarket sales growth is likely to weaken, partly because of rising competitive pressure amongst the grocers. UBS, too, notes a key driver in specialty sales in the March quarter was mobile phones, with the launch of the iPhone 5 late last year continuing to have an impact.

UBS prefers Westfield Corp ((WFD)) and Scentre Group in this segment. Westfield has exposure to the US dollar and is in the execution phase of its development pipeline while Scentre Group is exposed to NSW with 50% of its asset value in that state, amid improving sales trends. UBS' least preferred retail exposure is Charter Hall Retail ((CQR)) as income is under pressure in the short term and the company carries acquisition risk.

Having visited development sites in Sydney and Melbourne Citi considers there remains more upside to be had from residential markets, with Sydney continue to make gains in price and volumes. Melbourne is less impressive in terms of price but volume is still significant. Queensland is improving as affordability issue in the former two capitals start to drive interstate migration.The broker likes the residential developers and retains a Buy rating for Stockland ((SGP))) and Charter Hall Group ((CHC)) with a preference also for Mirvac Group ((MGR)), Federation Centres ((FDC)) and Scentre Group amongst the other Australian Real Estate Investment Trusts (A-REITs).

Overall, A-REITs are facing a sharp correction to relative performance. This sector suffers when yield curves steepen, Credit Suisse observes. Since the Reserve Bank of Australia's latest cut to the cash rate bond yields are now 80 basis points higher than cash rates, compared with a flat curve back in January. The central bank's language in its statement was more upbeat than previously, noting improving trends in demand and stronger growth in employment. This signals to the broker there is limited upside in A-REITs as the market starts to price in the removal of an easing bias from the RBA. A-REITs enjoyed an extended period of outperformance over recent years in the context of a flattening yield curve.
 

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