Stark choices when shopping for Westfield

Call it simplistic, but it’s always wise to follow the smart money.

One of the great adages of modern Australian investment was: “Never buy anything from the Packers.”  From an investment strategy standpoint, that translated into “Sell when they are selling, and get on board when they are buying.”

The same goes with the Lowy family.

While best known for their property development nous, particularly in retail malls, they have been equally adept in reading the state of global capital markets and adapting the structure of their business for maximum growth.

Long before the “Macquarie Model” became famous, Westfield had separate development, international and management arms. And quite some time before Macquarie’s version blew up, the family amalgamated the separate entities. Always ahead of the trend.

And don’t forget that it sold a large swag of secondary American malls to Centro shortly before the great American real estate bubble burst, an event that sparked the global financial crisis.

Now, once again, the company is in a state of metamorphosis. During the past two years, Westfield has been in a state of gradual, but nevertheless quite radical, transformation.

Individually, the changes – corporate spin-offs, asset sales and family ownership restructuring – have been incremental.  Put them all together and a distinct message is there for the discerning reader.

For the Lowy family, the investment pendulum is swinging back towards shopping mall development and management and away from ownership.

This all comes at a time when retail is facing structural and cyclical challenges; as shoppers embrace online purchasing and as sales globally remain sluggish at best.

Evolution

It began in late 2010 with the spin-off of a 50% share of 47 Australian and New Zealand shopping centres into the Westfield Retail Trust (WRT), a vehicle designed to appeal to domestic investors desiring a solid yield.

It was a move that saw the company revert to its old structure: a vehicle for growth in Westfield Group and a yield play in Westfield Retail Trust.

But it also was an attempt to ignite some capital gain into the Westfield juggernaut which, while it cruised through the financial crisis virtually unscathed, had seen its share price languishing.

From $18.45 in 2008, Westfield’s share price had halved by 2009 and then spent most of 2010 hovering between $12 and $13 – a performance patriarch Frank Lowy found distressing.

The late 2010 split has met with modest success, with the combined share price of the parent and spin-off now totalling around $14.50, although that is against the backdrop of a solid rally on the Australian market since midway last year.

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Since March this year, however, the Lowy family has embarked on a serious change in course. The family sold its entire 7.1% stake in Westfield Retail Trust early that month, raising $664 million.

The sale emphasised the strategic investment shift by the family. There were better growth opportunities internationally, and specifically in development and management.

It also reinforced the strategy enunciated 18 months earlier that the parent company would be selling down its ownership of malls by forming joint ventures. In March it sold a half share in six Florida properties – raising almost $700 million – to private equity group O’Conner Capital Partners.

That followed similar global joint ventures with the Canada Pension Plan Investment Board, Starwood Capital Group, Hammerson and the previously mentioned Westfield Retail Trust.

Due to watertight agreements, however, Westfield retains management rights within the joint venture arrangements. In fact, the parent company could sell down to a minimum 25% ownership of most of its malls but still operate them.

Further asset sales are expected, possibly even within Australia with the likelihood of Westfield Group offloading further interests to Westfield Retail Trust.

This has the effect of lightening the capital burden on Westfield Group – the Lowy family’s personal choice of investment – while retaining management income. And any dilution in earnings will be offset by the 10% buyback announced in March.

Performance

Westfield Retail Trust turned in a less-than-spectacular earnings performance in 2012, dropping to $830.8 million from $849 million the previous year.

The parent company, on the other hand, turned in an 18% improvement during the same period, rising to $1.7 billion.

In terms of future growth, the median expectation is that WRT earnings will grow 2.2% in 2014 while the parent company’s earnings will rise 3.2%.

On the yield front though, it is another story. Where the parent company is offering 4.5%, Westfield Retail Trust is dangling a 6.3% return.

That alone has been enough to maintain momentum in the stock, although its payout ratio is high; by some calculations even higher than earnings.

UBS last week applauded WRT’s decision to upgrade its Garden City Queensland operation, arguing that mall owners are under pressure to upgrade in order to maintain market share.

Despite its quality portfolio and its dominant position – or perhaps because of it – Westfield Retail Trust has experienced greater pressure on leasing renewals and new leasing margins than any of its competitors.

Incentives to attract new tenants and to maintain existing tenants has resulted in a drag on earnings.

Battle of the Westfields

Decision

When it comes to investment in Westfield, it is a stark choice: Growth versus yield.

In general the broking analysts like both options, mostly with hold recommendations on both companies, although Citigroup and Deutsche Bank rate Westfield Group as a buy. Deutsche and Credit Suisse rate Westfield Retail as a buy.

The Lowy family, however, have made it clear where its focus lies. It has opted for growth and the parent company, Westfield Group.