Four in five retailers expect improved trading conditions this Christmas and believe Amazon will have little effect on their sales, the Deloitte Retailers’ Christmas Survey 2018 survey found.
The results look optimistic and do not match what listed retailers are reporting or the trend of private retailers, such as menswear chain Roger David, going bust. Or retailers discounting earlier and more aggressively through Black Friday and other new sales.
This week’s lower-than-expected economic growth figures, showing 2.8% annual growth to September, showed households are doing it tougher. Household spending growth was just 0.3% over the quarter and 2.5% over the year.
Escalating property price falls in Sydney and Melbourne this year, a share market correction and sluggish wages growth are hardly conducive to a strong Christmas trading season. I hope I’m wrong, but Christmas trading will disappoint when figures are tallied in the New Year.
More concerning is the outlook for Australian Real Estate Investment Trusts (AREITs) in the retail sub-sector. The market, at least, has priced in challenged trading conditions in retail stock valuations. That’s not as apparent in retail AREITs.
To recap, I took a contrarian positive view on the large retail AREITs, principally the then Westfield Corporation, and Vicinity Centres (VCX), in November 2017. I felt the retail bloodbath at the time, amid hype of an Amazon-led sector Armageddon in the sector, was overdone.
Westfield Corp was taken over by French shopping centre giant Unibail-Rodamco and Vicinity is up about 3% over 12 months (including distributions). Another of my favoured retail AREITs, Shopping Centres Australasia Property Group (SCP), has returned 18% over one year.
Chart 1: SCA Property Group
Source: ASX
I liked the so-called “fortress” mall owners (Westfield, Vicinity and Scentre Group) and avoided retail AREITs with mid-ranking assets. The fortress malls have hard-to-replicate assets and are morphing into de facto CBDs and multi-property developments in some areas.
Shopping Centres Australasia Property Group, a sub-regional and neighbourhood shopping centre owner, was favoured because of its leverage to Australia’s strong population growth. More people means higher patronage of regional shopping centres that have an anchor supermarket and a dozen or so surrounding shops.
However, I’ve become bearish on retail REITs this quarter for five reasons, except for Unibail-Rodamco, which is in value territory after recent price falls (more on Unibail shortly).
The first reason is Myer Holding’s horrific full-year results and 4.8% sales drop in the first quarter of FY19 – a fall that emphasises the challenges facing discount and department stores. These anchor tenants consume plenty of shopping-centre space and Myer’s quickening demise creates new doubts about the timetable for store closures or cutbacks on department-store space in shopping centres.
Second, recent shopping-centre transactions are occurring at discounts to book value, noted Macquarie Equities Research this week. Charter Hall Retail REIT (CQR), Vicinity and Shopping Centres Australasia Property Group have each sold sub-regional or neighbourhood assets at slight discounts to book value since October 2018. This suggests Net Asset Values for retail AREITs are starting to unwind and that retail ARIETs trading at a significant premium to NTA could be re-rated lower in the next 12 months.
Granted, these transactions were for non-core assets and in smaller sub-regional or neighbourhood shopping centres rather than premium fortress malls. But cyclical and structural pressures in retail are starting to affect shopping-centre valuations.
Third, Amazon is quickly building its retail profile in Australia, judging by its current advertising campaign and research showing it is increasing awareness among consumers here. Those who write off Amazon’s prospects in this market do so at their peril; Australian industry has never encountered a competitor as formidable as the US giant.
There was too much hype about Amazon in Australia at the start, when it announced local-distribution plans. And, equally too much complacency now. Amazon has a pattern of starting slow in new markets as it beds down distribution centres and logistics, before ramping up. Sharply higher online sales from Amazon and other e-commerce platforms mean weaker demand for shopping-centre space.
Fourth, recent reports about slowing sales of luxury goods should concern shopping centres. In the US, luxury-goods icon Tiffany’s & Co recently missed sales estimates because of lower-than-expected spending by Chinese tourists. The news hurt share prices of other luxury retailers that depend on a growing stream of cashed-up Chinese shoppers.
Some of Australia’s largest shopping centres have changed their store mix to appeal to wealthy Chinese consumers; witness the growth of the global fashion brands, such as Chanel and Gucci, at Melbourne’s Chadstone shopping centre and other fortress malls. Strong growth in luxury-goods sales was a rare bright spot on the retail landscape, but the tourism boom’s effect on retail, at the luxury end, might have peaked for now.
Fifth, Australia’s softening property market is taking a bigger toll on household consumption that most economists expected, judging by this week’s GDP figures. I don’t expect a full-blown property crash, but commentators predicting a mild ‘soft landing’ in housing, before a fast recovery, are misguided. The slowdown will be sharp enough to limit household consumption, retail sales growth, and leasing demand and rates in shopping centres.
Taken together, these trends suggest more retailers doing it tough over the next 12 months and looking to close stores or reduce space. Fortress malls will weather the downturn better than AREITs with lower-quality assets, but it’s hard to justify buying retail AREITs that are trading at a substantial premium to NTA, such as Shopping Centres Australasia Property Group, in this market.
Unibail-Rodamco-Westfield (URW)
URW, one of the world’s largest global REITs, has 87% of its assets in shopping centres in Europe and US and the rest in offices and convention centres. The REIT has a bias towards premium malls, a reason why it acquired Westfield, and the deal made sense.
Like Westfield, URW believes premium malls will thrive, even as more retail sales occur online. The fortress malls are attracting new shoppers as they increase their focus on food, entertainment and other services, and benefit from property-development opportunities. Office towers, hotels and premium residential apartments at big centres are part of a global trend.
URW has a valuable first-mover advantage in its key catchment areas. Fortress malls are hard to build in crowded capital cities. Try constructing another Chadstone in Melbourne in that catchment area or Westfield Bondi Junction in Sydney. These assets are quasi-monopolies.
URW has fallen from just above $15 in early July to $11.22. The REIT’s first-half profit, reported in late August, was slightly ahead of analyst forecasts and synergy targets were upgraded. Limited guidance on Westfield’s earnings outlook disappointed but it did not warrant a big price selloff.
In its third-quarter update, the REIT noted tougher retail leasing conditions but reiterated previous full-year FY18 earnings-per-share guidance.
Source: ASX
URW’s 24% fall from its price peak in July is more about the broader sharemarket sell-off and index machinations. The market expects URW to have a slightly lower weighting in the S&P/ASX 200 index when S&P next rebalances it. That would lead to index investors selling URW stock to reweight their index exposure and price pressure on the shares.
On Macquarie’s numbers, URW is trading on a forecast Price Earnings (PE) of less than 12 times FY19 earnings. Morningstar’s forecasts imply a forward PE of 11 times. That looks too low for a leading global REIT with iconic malls that have barriers to entry in their market.
Macquarie’s price target of $16.29 suggests URW is materially undervalued at the current price. Macquarie’s valuation, if correct, implies a total return of more than 40% for URW (including distributions) over 12 months from the current price.
Morningstar’s valuation of $14.30 also suggests value in URW. An expected yield of 8.3% is an attraction for income seekers.
Unlike its Australia-focussed peers, URW provides exposure to the booming US economy and to Europe. Diversified global retail REIT exposure looks a better bet that concentrated Australian exposure in shopping centres given growing headwinds for our economy.
Also, I’d rather buy URW on a forward PE of 11 times than Scentre Group on 16.2 times or Vicinity on 15 times, using consensus analyst estimates. The latter are well-run, quality property owners, but their prices are yet to adjust sufficiently to retail conditions and expectations of contracting retail property values.
Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. The article has been prepared without considering your objectives, financial situation or needs. All prices and analysis at 5 December 2018.
