Westfield value

In 2004, 44 years after it first ventured on to the sharemarket, Westfield Holdings merged with Westfield Trust and Westfield America Trust to create the Westfield Group.

As it operates today, Westfield Group (WDC) is an internally managed, vertically integrated shopping centre group employing about 4000 people. The entire operation is run under the stewardship of the Lowy family. Frank Lowy founded the business, and in the process turned himself into Australia’s second-richest private investor. Today Frank’s sons Peter, David and Steven are also at the helm, bringing together extensive management experience and a solid track record of completing projects on time and within budget.

The group has investment interests in 123 shopping centres in four countries: 50 properties in Australia and New Zealand, 66 in the United States and seven in the United Kingdom.

Their combined value is more than $60 billion, making Westfield Group the largest Australian property group listed on the ASX and the world’s largest retail property group by market capitalisation. The portfolio contains about 22,750 retail outlets and benefits from extensive geographic diversity.

Source: Westfield Group

The Westfield Group trades as a stapled security on the ASX. A single Westfield Group stapled security comprises:

• One Westfield Trust unit.
• One Westfield America Trust unit.
• One Westfield Holding Company share.

The two trusts hold the portfolio of assets, while the related company carries out the funds management and/or development opportunities. The group’s three core business activities can be summarised below:

1: Maximising returns on invested capital through the development, design and construction of new shopping centres.
2: The day-to-day leasing, management and marketing of those centres in order to ensure retailers have a dynamic platform from which they have an opportunity to capitalise on the consumer’s shopping experience.
3: Asset management services for institutional and retail investors.

The Lowys still have the majority of their personal wealth tied up in Westfield Group. They are certainly betting on above-average performance.

This above-average performance is shown in the column chart above. Since the merger in 2004, Westfield Group has averaged a 27.9% return on equity. Only a great business with compelling business economics can continue to generate these sorts of returns on shareholders’ funds.

The latest annual report, for 2006, shows that management are sticking to their guns. Reported net profit after tax, which included property revaluations and mark-to-market adjustments (capital growth), was a whopping $5.58 billion, up from the $4.25 billion after-tax profit reported in 2005. Shareholders received a distribution of $1,919.9 million (unfranked), which equates to a 5.2% yield at current market prices, and a 28.4% normalised return on shareholders equity for the year.

Future prospects

As LPTs struggled against changed currency conditions and a cooling of enthusiasm among commentators this year, it is interesting to note that Westfield Group shares are down about 10% from levels seen a short time ago.

What the “market” and financial commentators seem to have forgotten is the fact that this business has created higher rates of return on equity than most other listed investment assets. With ongoing developments globally, this quality is unlikely to change over the course of a few weeks or months.

Investors will continue to receive income returns from rents charged to shopping mall tenants. Current occupancy rates in Australia, New Zealand and the UK are close to 100% and an industry-leading 94% in the US. The Lowys have created regional centres with monopolistic characteristics, giving management the leverage to charge higher rents and adopt an aggressive stance in regards to what tenants can and cannot do. If tenants don’t like management’s style (or the rents), someone else will take their place.

The strong pipeline of current development projects will also keep management and the businesses assets mobilised into the foreseeable future. There are about 15 projects under way, with a forecast group investment of $4.6 billion. These projects will continue to create wealth for shareholders through capital growth.

As long as management can keep ahead of ever-changing consumer demand trends, which they have been doing since 1959, it is hard to see another player crossing Westfield's economic moat. The fact that about 70% of Australians live within 30 minutes’ drive of a Westfield centre is also a major advantage. Large numbers of consumers will continue to shop at Westfield, and of course always expect more from their shopping experience, which will eventually lead to more development and refurbishment projects to create bigger and better shopping malls.

One only needs to look at the rejuvenated Bondi Junction centre in Sydney’s Eastern suburbs to see what can be accomplished by the Westfield team. It was the Lowys who invented to rooftop car park, the food court and an entire generation of shoppers who no longer say “I am going to the mall”, but rather “I am going to Westfield”. It is difficult for rivals to compete with that.

Business Valuation

Potential movements in the value of the Australian dollar need to be taken into account with any valuation of Westfield Group. The dollar’s recent appreciation to over US83¢ has highlighted this fact. With the level of foreign investment currently around 64%, overseas rental income and property asset values are converted from overseas currencies into Australian dollars, it currently takes more overseas currency to buy the same amount of Australian dollars (the opposite occurs if the dollar depreciates). Even with the current hedging policies in place, investors need to account for this risk by adopting a higher required return.

The current share price is $20.74. I value the business at $22.26 – indicated by the circle on the share price graph. This valuation is based on equity per share of $13.28, a conservative sustainable return on equity of 18.5% on shareholders’ funds and an increased investor’s pre-tax required return of 13.5%. Think about it like this; if the Lowys have $13.28 of equity and are able to generate 18.5% annually, and if you are happy with a 13.5% required return, you can pay nearly 1.6 times for that $13.28 equity. At the current market price of $20.74, investors are either expecting much lower sustainable rates of return on equity or are seeking a return higher than 13.5% for a business which has not reported a loss from its property activities in over 40 years.

* Russell Muldoon is a senior analyst at the Clime Asset Management group: website www.stockval.com.au .