Why I don't like Westfield Retail Trust

Over the Christmas break two related retail related investment events caught my eye – one in the UK and the other in Australia.

In the UK, like Australia, Christmas shopping is the time when retailers make their large profits. But 2013 in the UK saw trading trends developing that were in sharp contrast to anything we have seen before. Those trading in upmarket retail sectors including food, that had a strong online presence, did very well. Those trading at the cheaper end, including supermarkets like Aldi, also did well.

But those in the middle had a tough time over Christmas. And the key reason is that inequality in the UK is rising, and the middle class is being hammered.

Following the money

The second retail event to catch my eye was Westfield, where the Lowy family is clearly seeing its future growth outside of Australia. I’d like to talk first about what is taking place in Westfield, and then return to the population changes.

Many decades ago I was told by an old stockbroker that when you are investing in family entrepreneurial companies, where there are several ways to invest, always make sure your money is on the same stock where most of the family money is. In other words, “follow the money”.

Just over two years ago the Lowy family separated the Australian property holdings of Westfield into a separate vehicle, the Westfield Retail Trust. The trust attracted a lot of conservative investors who simply wanted the inflation hedge that investment in top retail property normally produces. The base Westfield Corporation company continued its management and development role, and also owned centres in the UK and the US. Last year the Lowy family raised $665 million by selling its stake in Westfield Retail Trust. The old brokers rule of “follow the money” sent a signal to Westfield Retail, although it was a specialised shopping centre owner.

The rule of “following the family money”, of course, can prove to be very wrong if the family itself has difficulty managing the business where it has invested. But the Lowy family are superb operators, although they face many challenges in the years ahead.

I think this a clear case of where you follow the money, although I do emphasise that in the asset split the Lowy family will end up with a $600 million investment in the Westfield Retail Trust, which is to be called Scentre.

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The online phenomenon

You will remember last year, in Lighten the retail property load, I linked the accelerating growth in Australian online retailing to the looming rise in our shift allowances and penalty rates in retail stores, which kick in this July. I believe it will boost online retailing in Australia and I advocated people lighten their retail property exposure.

And then, during the Australian Open, Woolworths has advertised its online service extremely heavily. Woolworths is clearly making a major push in the online area and no doubt it will be matched by Coles. I am not suggesting that the Woolworths promotion was a direct response to the looming rise in shift allowances and penalty rates, but it certainly confirms the trend. All this means that there is going to be a lot more Australian retail space around than we need. Many centres, including many Westfield centres, will still do very well but others will not and the excess of space will affect everybody.

The Lowy’s want to sell their development and management arm in Australia to Westfield Retail and concentrate their efforts on the overseas operations. That sale will give the effect of substantially increasing the gearing of Westfield Retail (Scentre) and lowering its asset backing because there is a capital return involved and, under the proposal, Westfield Retail Trust is buying intangible assets.

Many institutions are vigorously opposing the proposal because they believe Westfield Retail is paying far too much for the management and development rights, particularly in the current environment. In addition, if the Federal Government honours its promise and makes retail shopping centre rents with small retailers the subject of consumer protection style laws, it may affect the profitability of centres ( the Shopping Centre Council is trying to have shopping centres exempted).

The Lowy family has incredible influence, particularly in Sydney, and I would be surprised if it was knocked back. But I would suggest that this is a case where you should follow the money and reduce or eliminate your holding in Westfield Retail as part of a reduction in retail exposure.

The rise of income inequality

The second item which really caught my attention was the fact that in the UK we are seeing a real hollowing out of the retail market, because inequality is increasing and lessening the spending power of the middle class.

Similarly, in the US, inequality is rising and I think we will see exactly the same trends develop here. Could it happen in Australia? In the Human Development Indices survey undertaken by the United Nations, which measures not just income but education and other issues, Australia is shown up as one of the best ranking in terms of income equality. But our increase in inequality was in the top quartile, so we are going in the same direction as the US and the UK at a rapid rate.

What is taking place is that we have experienced globalised blue collar labour, and we are now globalising white collar labour. This will affect many areas, and it puts great pressure on the middle class.

Middle class unemployment

In addition, in Australia there are three very big pods of middle class unemployment set to become apparent in the next two or three years.

The first will be the decline in mining investment, which will put a large number of middle class people into unemployment. Similarly, the retail revolution will cause a lot of people to lose their jobs. And, if Tony Abbott plunges his knife into the automotive sector, the same thing will take place.

To that we must add the loss of public servants and the loss of jobs as part of normal globalisation of labour. I therefore think we will see not only a rise in unemployment in 2015 and 2016, but a rise in inequality and a decline in the middle class.

I emphasise that this is not a development that I welcome, and rising income inequality is not a good thing for any country. But in terms of strategy, retailers operating in the middle area will need to watch out. That obviously includes Myer and perhaps David Jones.

In the UK, supermarkets operating in the middle area are being affected. In Australia, Woolworths has allowed its margins to get too high and Coles’ margins have also crept up. I suspect the pressure from Costco and Aldi, and the increased attraction of buying low-priced goods, will put pressure on the margins of both Coles and Woolworths.

Lighten the load

I am not suggesting that you need to sell either stock, but keep an eye on that trend. They will need to be reviewed if we start to see too big a swing to cheaper retailing, to the point where it affects margins. Meanwhile, the retail space has moved from its traditional place as being a relatively safe and secure area to invest – either through retailers or through retail property. It now carries a higher degree of risk, particularly in the property sector, and I do emphasise that while people should not completely exit the retail property area, lightening the load is a good idea. The Westfield shenanigans represents a very good way to achieve that end.

* This article is part of the “It's Time” series in Eureka Report focussing on new opportunities for investors in 2014. Click here to see the entire series.