Westfield: Interim result 2013

Following criticism from investors after the GFC, Westfield Group embarked on a strategy to significantly increase its return on equity. For a mature, large and highly capital-intensive business like Westfield, slower economic growth, cautious consumers and more money being spent online means that’s going to take time.

Westfield’s interim result (the company has a 31 December year end) showed a 6% decrease in revenue to $1.3bn, compared to the same period last year, after $4.5bn in asset sales. Underlying profit, measured by the company’s preferred measure of Funds From Operations (FFO), increased 9% to $729m, and increased 13% on a per share basis to 33.1 cents after the company spent over a billion dollars buying back 141m shares at an average price of $10.23. An interim unfranked distribution of 25.5 cents was declared (ex date already passed), and the final distribution should also be 25.5 cents, putting the company on a forecast yield of 4.6%. 

With the US economy supported by ankle-high interest rates, the key statistics for the US portfolio are heading in the right direction. Underlying income increased 4.3%, occupancy increased slightly to 93.8% and new leases are being struck at rents 10% higher than expiring leases.

In contrast, while Westfield’s shopping centres remain full in Australia, underlying income only increased 1.8% despite a 4.4% increase in rents from existing specialty leases. The problem is that new leases are being signed at a 10% discount to expiring leases and renewed leases require a 2% discount. If this trend continues it will have a much larger impact on Westfield’s profits as more and more leases come up for renewal, but it’s a testament to the quality of Westfield’s centres that rents for new specialty leases are generally falling by 10-20% across the industry.

Despite this, our key concern in Australia is that specialty rents as a percentage of sales for Westfield’s tenants have increased on average to 16%, compared to 13% and 10% in the US and UK respectively. Sales for Westfield’s specialty stores only increased by less than one percent, though rents for existing leases increased 4.4%. This can’t go on forever. Either sales need to pick up or rents will need to fall, which is why Westfield is selling poor performing centres in favour of landmark developments that force retailers from all around the globe to compete for space.

Evolution

Unlike a typical A-REIT, which doesn’t develop many new properties and pays out virtually all of its earnings as distributions, 22% of Westfield’s FFO came from property management and project fees. Westfield has built a competitive advantage from its scores of designs and developments over the past five decades. By designing and building shopping centres for other investors, such as AMP, selling poor performing shopping centres, investing less of its own money and buying back shares, return on equity should increase from 11.6% currently.    

It’s a sensible strategy but partnerships can disintegrate quickly. Westfield recently dissolved its joint venture with Brazilian partner Almedia Junior, for example. Westfield currently has a $12bn pipeline of developments globally including flagship projects, such as Westfield Milan and Westfield World Trade Centre, and is aiming to produce returns of 12-15%. This would likely be impossible if Westfield was the sole investor in every project and wasn’t able to charge partners for project and management fees given completed developments are expected to yield 7-8%.   

While Westfield’s iconic shopping centres are changing to offer more entertainment, such as the Aspers Casino at Westfield Stratford in the UK, and dining options, Westfield’s profitability remains hitched to its ability to charge sky-high rents to discretionary retailers, which is becoming more difficult, particularly in Australia. Despite Westfield's track record, should the share price increase by around 15% we would consider selling. Westfield currently trades on a forecast price-to-earnings ratio (based on FFO) of 17, and with the share price falling 6% since 29 May 13 (Hold – $11.85) we’re sticking with HOLD.

Note: The model Growth and Income Portfolios owns shares in Westfield Group.