Westfield's bold split ends well

It says something about the astuteness of the Lowy family that the twin vehicle structure they created nearly two years ago is starting to deliver the benefits they envisaged.

While it took some time for the market to warm to the hiving off of half Westfield's Australian shopping centres into a new Westfield Group-managed entity, this year both entities have significantly outperformed their A-REIT peers in terms of sharemarket performance, with Westfield Group up 30 per cent and Westfield Retail up 26 per cent against an index that is up 16 per cent.

The philosophy of the Lowys' restructuring was to put some distance, but not too much, between their development and property-owning interests while releasing capital from the spin-off of Westfield Retail and lowering its own future capital intensity to improve its returns on equity. It also gave investors purer choices of the types of Westfield exposure they were most interested in.

Earlier this year they effectively extended the concept to their US portfolio by selling a 45 per cent interest in a portfolio of 12 centres in the US to Canada Pension Plan Investment Board and separately selling 12 non-core centres for $1.4 billion.

The $US2.1 billion US deal released about $US1.8 billion of net cash and again leveraged the returns Westfield Group will receive from its development, leasing and management fees. In gross terms, asset sales in the half raised about $4.8 billion.

Today's Westfield Group result for the June half showed earnings up 31 per cent and a return on capital of 11.4 per cent. As a consequence of the US deal and the start of a $2 billion buy-back (Westfield has spent about $440 million so far) that return on capital should continue to rise.

The strategic plan, and Westfield's willingness to continue to pursue it aggressively, has given it a lot of firepower. The joint chief executives, Peter and Steven Lowy, said today the group now had about $10 billion of capital it could redeploy into higher-returning opportunities.

There are quite a few of them already underway or in the pipeline. At present Westfield has $1.5 billion of projects under construction (its share is $1.2 billion), it expects to start new projects costing between about $1.25 billion and $1.5 billion in each of the next two years and says the identified pipeline of future developments is about $11 billion.

There is demonstrated potential to recycle some of the capital deployed into those projects, or tied up in existing property assets, by selling interests in them into the existing joint ventures or creating new ones.

Westfield's centres tend to be high-end and have proven themselves through the crisis to be quite resilient despite the continuing difficulties being experienced by retailers here and offshore.

In Australia, for instance, Westfield was able to extract increases in its average specialty store rents of 3.2 per cent in the half and had comparable net operating income growth of 3.3 per cent even though overall retail sales rose a meagre 0.9 per cent and specialty retailers experienced only a 0.8 per cent increase.

As noted previously, the divergence between the experience of the landlords and their tenants – rents continually rising at rates out of kilter with the tenants' experience – raises a question mark over the sustainability of the traditional business model for property centre owners at a time when retail is experiencing structural as well as cyclical change.

The Lowys, of course, by stripping capital out of the property assets by selling interests in them to third parties have materially reduced their exposure to the prospect that in the longer term that risk becomes a reality.