Weighing up Westfield's and Westpac's yield plays

The yield boom in Australia continues to dominate so many market actions, and last night’s interest rate reductions in Europe will increase the intensity.

Last month I talked about Transurban in Tapping Transurban’s toll stream. This week I want to talk about Westpac term deposits and the yield strategies behind the Westfield Retail Trust skirmish.

A word of revision – there is almost no chance of Australian interest rates rising in the remainder of this year, and I suspect there is little chance of them increasing for a good portion of 2015. The latest boost to the quarterly GDP was a once-off and, as 2014 extends into 2015, we are going to see a substantial fall in mining investment which, at this stage, does not look like being picked up in other parts of the economy.

At the same time our export revenues, which were buoyant in the March quarter, will be increasingly affected by the fall in the iron ore price and tougher mineral times.

Westfield’s separation anxiety

All attention this week has been on Westfield and the terrible mess the company got itself into as it tried to separate its overseas and local operations. Westfield Group is Australia’s pre-eminent owner, manager and developer of shopping centres. Westfield Retail Trust was spun out of Westfield Group in 2010 and currently owns $13.6 billion of property across 46 malls. Locations of flagship centres include Bondi, Sydney CBD, Doncaster, Chermside, Carindale and Marion. At the moment those shopping centres are owned half by Westfield Group and half by Westfield Retail Trust, with Westfield Group the manager and developer of new centres. Westfield Group wants to merge its Australian ownership, management and development operations with Westfield Retail Trust.

There are still a lot of legal and other boxing matches to be played out but it is now clear that Westfield Retail Trust stockholders now have two choices, and at least one of those choices is clearly about a yield play.

At last week’s meeting a great deal of the pressure put on the Lowy family was designed to have them sweeten the offer to Westfield Retail Trust. That is not going to happen, hence the two clear choices for Westfield Retail Trust holders.

Westfield Retail proposal 1

The first is that being proposed by the Lowy family, whereby Westfield Retail Trust acquires the 50% stake in their shopping centres currently held by Westfield Group at book value and also acquires Westfield Group’s management rights over the Westfield centres, which effectively means 1% of revenue plus outgoings.

The management price that has been set is based on similar deals but the valuation implies a level of property development management fees in perpetuity, which big Westfield Retail stockholder UniSuper says is unfair. Partly as a result of that valuation, Westfield Retail Trust is contributing 69% of the shopping centre assets but receiving 51.4% of the equity.

If Westfield Retail does the deal, the yield to investors will rise, but part of the higher distribution comes from increased borrowing which, according to UniSuper, takes gearing from 22% to 37% – although Westfield say it will sell assets to lower gearing to 30%.

Westfield Retail proposal 2

The second proposal is that Westfield Retail stays exactly as it is. A new listed company will be set up that acquires Westfield Group’s 50% of the Australian Westfield shopping centres and manages those centres. The new company would also have a small development role. So investors wanting a stake in the Westfield Australian shopping centres would choose between the existing Westfield Retail Trust or the new company, which would also have 50% of the centres but in addition would hold the management rights and a small development role.

That new company would have a higher gearing than Westfield Retail Trust at 22%. Even with higher gearing, the likelihood is that over time market support would tend to go to the company that owns the management rights compared to the Westfield Retail Trust that does not have those management rights.

A question of yield

So why would UniSuper and other institutions reject the deal and want to stay with Westfield Retail Trust as it is? The first reason in the question of fairness, The second is yield. They want a simple yield play with low borrowing – which is what they have now. And if they lose the vote, and the new company becomes the major investment vehicle, they can still win in the yield game.

UniSuper and many other institutions have large sums that they want to invest into high-yielding direct property. If the new company went to a premium and attracted support that would otherwise have gone to Westfield Retail Trust, then UniSuper would have the opportunity to increase its stake. (UniSuper already has 8.5% of Westfield retail).

It would see the problem of a small fall in Westfield Retail stock as greatly overshadowed by the opportunity to buy top shopping centres at a discount asset backing, which would deliver good yields. It may even make a bid in due course.

Every shareholder in Westfield Retail will now need to relook at how they want to vote – take one united company or the pure long-term yield play .

The great danger of a yield boom is that when interest rates eventually rise the high premiums paid for yield in the boom will be greatly affected, and so we will see a fall in bond prices and all those stocks that have been bid up as people chased yields. As I mentioned earlier, unless there are dramatic events overseas the local Australian economy is not going to trigger an end to the yield boom for some time.

Westpac lifts five-year rate

But this week we saw a bank recognise that down the track there is a future change in direction, and so Westpac lifted its five-year term deposit rate from the big bank level of about 4.25-4.3%, to 4.55%. That makes Westpac’s five-year rate higher than any other significant bank and begins to knock on the door of Rabo Bank’s 4.6%, which has been one of the leaders of long-term deposit rates.

The great problem with five-year deposit rates are that when interest rates rise you don’t get that benefit. You also need liquidity around those deposits, because it can become expensive to break term deposits. Nevertheless, Westpac is now putting out a carrot.

Of course, just under five years ago Westpac was offering 8% for five years and attracted enormous sums. Those five-year returns offered in 2009 deposits will start to mature during the second-half of 2014, and Westpac might be trying to look at keeping those people in the fold at a more attractive rate.

But, more importantly, Westpac is setting its five-year rate at 1.25% above its one-year rate, which is a significant premium and a taste of what is ahead longer term.

Around the world interest rates have fallen to unsustainable positions and those investing in longer-term securities, particularly debt securities, are taking a great risk. The Westpac long-term interest rate is one of the first recognitions of this.