Scentre Group: Interim result 2016

The collapse of Dick Smith left a number of victims in its wake. However, unlike the shareholders or bankers who are desperately fighting to get some of their money back, it barely left a dent in Scentre Group — who leased 40 sites to the former electronics retailer. Although it took a few months, all 40 sites have now been successfully re-leased to other retailers at higher rents than before. Dick who?

It's a testament to the quality of Scentre's properties that the collapse of a company that leased 1% of its total lettable area was so easily overcome.

In the first half of 2016 — Scentre's financial year ends on 31 December — Scentre's occupancy was still above 99.5% leased, and total specialty sales hit a record high with shoppers now spending around $11,000 annually per square metre.

It is not just the shopping activity that has been getting bigger, many of the actual properties are as well. The company completed $855m of development activity in the six months to June (Scentre's share was $170m) and commenced another $855m (Scentre's share $480m). The second half of the year will see the completion of two more projects, including the new wing to Sydney's Westfield Warringah Mall which will include Myer's first department store opened under its new concept.

Development continues to be a key source of growth for Scentre and the company expects its development pipeline of over $3bn to generate a yield of between 7% and 7.5%.  

It isn't just developments, however, that will help boost future performance for Scentre. The company won the auction for the 78-year-old David Jones building on Sydney's market street (currently connected to the existing Westfield Sydney on Pitt Street). David Jones will continue to lease this building until 2019, but will eventually make way for 10,000sqm of new luxury retail space.

Best yet to come?

Scentre remains one of the best listed property companies on the ASX with well-located properties in many of Australia's busiest trading regions. Its great locations and the highest sales per square metre in the industry mean it should have no problem maintaining its high occupancy and continue to attract the most popular names in retail.

With specialty leases mandating rental increases of either 2% or 3% above inflation (5% fixed in Victoria) over at least five years and strong development pipeline, we expect the company to be able to grow distributable profit over the long term between 3–5% per year. Combined with an unfranked distribution yield of 4.4%, that would imply total long-term returns of 7.4–9.4% before tax.

Note, however, that you'll only get that return if our assumptions are right and you hold forever. If you sell before then, then the sooner that is the more your total return will be determined by changes in the price the market puts on Scentre's returns. If long-term interest rates start to rise, the market will doubtless put a lower value on the stock.

The current returns on offer aren't sufficient for us to recommend Scentre as a Buy for most members, but it may make sense for people who particularly value a high quality source of income, particularly if you take a long-term view and expect interest rates to remain low. We're moving our Buy price up to $4.00 and our Sell price up to $7.00. The wide range is despite a relatively narrow range of expected returns, but reflects the fact that the desirability of those returns will be highly dependent on personal circumstances and attitudes to risk. HOLD.