Westfield's lucrative risk defence

After reporting a handsome net profit, it's clear the retail property giant has found a pragmatic and lucrative approach to managing the risks of a changing sector.

The Lowy family is remarkably pragmatic, prepared to make major changes to the structure of their sprawling property empire to suit the market circumstances and their own ambitions.

In 2010, the family partially reversed the consolidation strategy they had put in place six years earlier in pursuit of more scale to pursue a global ambition by spinning off half of their core Australian portfolio of shopping centres into a new vehicle, Westfield Retail Trust. That was done in response to a flat-lining securities price and the lingering impact of the financial crisis on the cost and access to funding for property developments.

The aim was to improve Westfield’s return on equity by maintaining development and management fees, but with a far smaller capital commitment to the portfolio, while releasing a big lump of capital to fund further developments. That strategy is working, with Westfield announcing a 37 per cent increase in profit for the year to December, to $1.53 billion.

Now it plans to take the concept of a "capital lighter" Westfield a step further.

Today, it also announced the sale of a 45 per cent interest in a portfolio of 12 centres in the US with Canada Pension Plan Investment Board. The transaction will release about $US1.8 billion of net cash to Westfield, which will continue to collect development, leasing and management fees from the $US4.7 billion partnership.

Once that deal has been settled, about half Westfield’s US centres by value will be within joint venture structures, replicating its new Australian structure.

Westfield also announced the sale of three non-core centres in the UK for $240 million.

By joint venturing its core portfolio and becoming more aggressive in cashing out non-core properties – it says there will be more divestments and perhaps joint ventures this year – Westfield is releasing cash and capital, which gives it options in terms of how it funds its $11 billion development pipeline and any acquisitions it might make as well as the ability to return capital to security holders.

It has exercised that latter option, planning to undertake an on-market buy-back of up to 10 per cent of its capital – around $2 billion – which will again leverage its performance statistics and generate higher returns on capital.

Underneath the strategic shifts, Westfields’ portfolio is performing solidly, with growth in income and average rents in Australia, the US and the UK despite quite difficult conditions for its retail tenants.

The Australian story is interesting, with Westfield generating 4.3 per cent growth in net operating income despite the 2.2 per cent decline in major retailers’ sales and the modest 1.4 per cent and 1.5 per cent sales gains by "mini majors" and speciality stores respectively. Department store sales were down 7.5 per cent last year and discount department stores 2.7 per cent, but that hasn’t stopped Westfield from collecting higher rents.

Consumer conservatism, the strong dollar and the surging growth in online retailing are definitely impacting the big retailers and there is logic to the view that eventually that will flow through to rents and the value of retail property, although whether it will materially impact the kind of giant "destination" centres a Westfield controls is unclear.

What’s particularly interesting about the Westfield strategy is that the group is effectively hedging its bets by selling down its ownership of the properties to third parties. It is both reducing and sharing the risk of a structural change in retailing that flows through to the value of its centres while continuing to collect layers of fees for managing them.

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