Scentre and Westfield: Spot the difference

If only I had a dollar for every time I've heard a just-returned Australian tourist say something along the lines of ‘wow, they have Westfield there too'. I'd probably be able to afford valet parking at one of their centres.

We're used to seeing Aussie brands locally, even taking them for granted. However, it's still rare for an Australian company to expand internationally and it's even rarer for them to succeed — particularly in a market like America — so the shock is understandable.

Following a restructure in 2014 that created Scentre Group and Westfield Corporation, investors can now choose which Westfield to be a part of — the familiar local malls or the fancier international ones. Both have been successful for investors, with their share prices up 46% and 32% respectively.

The Lowys made their choice, reducing their stake in Scentre Group. But which one is right for you? You might be surprised at how different these two companies actually are.

A world of difference

We'll start with their geography.

Scentre Group owns 40 properties with more than half located in New South Wales and 96% in Australia by asset value. Westfield Corporation has 35 properties, with 72% of its asset value in the USA and 28% in London.

The difference in geography means each business is affected by different economic forces, with Westfield — which reports and pays dividends in US dollars — also exposing investors to foreign exchange risk.

Unlike Australia, where Scentre dominates the super/major regional mall category, Westfield has to compete with other American giants. Add in higher online shopping penetration in the US and UK and the international shopping centre market is a lot more competitive. It's also a reason why Westfield has lower levels of occupancy than Scentre (see Table 1) and its tenants have lower occupancy costs (see Shoptalk).

Anchoring

There are also some major differences in how each company operates. Although the UK is very similar to Australia, a quirk of the American shopping centre industry is that anchor tenants typically own their stores rather than lease them and contribute to the malls' operating costs rather than pay rent.

No company takes up more space inside a Westfield Corporation mall than Macy's (19% of lettable area as at 31 December 2015) — which has recently announced an intention to close up to 100 stores across the USA.

Although the quality and location of Westfield Corporation's properties — being flagship properties in major tourism and trading districts — mean the company is less likely to be a victim of store closures by the major retailers, it does limit flexibility as Westfield may be required to purchase the store before trying to find a new tenant.

Business of fashion

The lack of rent from American anchor tenants also means the success of specialty retailers becomes a lot more important.

Specialty retailers for both companies sign up to leases with terms of typically 5–10 years and rental increases at rates higher than inflation (inflation plus 2% in the case of most of Scentre's portfolio).

Specialty retailers generate higher income growth for landlords but are also on shorter leases. These can be more volatile as terms are renegotiated more frequently and they could be at lower rents than previously (known as negative leasing spreads) or lead to higher vacancies.

Around 95% of Westfield's rental income comes from specialties even though they only take up half of total floor space. That's a lot higher than Scentre Group, where specialty stores contribute 83% of rental income and 46% of the space to rent.

A look at the top specialty tenants for each company shows that Westfield Corporation has some of the world's top fashion brands taking up most of its specialty space (see Table 2). Although popular, customer spending habits in this market can change quickly.

Scentre, on the other hand, is dominated by local Australian retailers, including less-discretionary retailers, such as pharmacies and those selling discount clothing, which are less likely to see customers move online and are less likely to leave when the lease is up.

Development

With the world at its fingertips, Westfield Corporation has the most room to grow.

Indeed, as at 30 September 2016, Westfield Corporation had a development pipeline of more than US$9bn, including a second building at the site of the World Trade Centre in New York and a new property in London as well as beginning pre-development work on a property in Milan.

In fact, as at 30 June 2016, Westfield Corporation's development pipeline made up around half of the company's total assets. The company is also exploring residential opportunities in London and growing the amount of revenue coming from other non-retail activities such as events and digital advertising. Westfield Corporation's developments are expected to yield between 7% and 8%.

On the other hand, Scentre's development pipeline was around $3b (12% of assets) and is more focused on expanding and improving its existing portfolio rather than buying or building new centres. Scentre's development pipeline also has a slightly lower anticipated yield of between 7% and 7.5%.

Similar size, different fit

With different geographic markets, different lease terms, different tenants and different development opportunities, Scentre and Westfield are two very different companies with different levels of risk.

Scentre Group has less money tied up in future development and gets more of its rent from anchor tenants on long-term leases. That makes it less risky, but also means it has lower growth potential. Westfield, on the other hand, promises less income but more growth as well as some international diversification into America and the United Kingdom.

We'll provide updates on both companies' results for the 2016 financial year next month (they both have financial years that end on 31 December). In the meantime, Scentre has guided towards a distributable profit of around 23 cents per share of which it will pay out 92%, equating to about 21 cents per share and putting the stock on an unfranked distribution yield of around 4.7%.

Westfield has guided towards a distributable profit of about 34 US cents per share and will pay out about 74%, equating to around 25 US cents per share. Converting to Australian dollars, that puts Westfield on an unfranked distribution yield of 3.6%.

Factoring in our estimations of long-term growth of around 4–5% for Scentre and 4–6% for Westfield, we don't see enough value to warrant buying either stock at the moment, but recommend existing shareholders continue to HOLD both.