Back into the fold

Westfield Group has been a member in the Fat Prophets portfolio before; in fact, we only sold out of the position back in November 2010 after initially buying in May 2009. Most of the initial attributes that attracted us to the stock remain today, along with other additional catalysts that could add value and an attractive entry price for a long-term investor. Therefore, we believe the stock currently merits another look from members and are recommending it as a buy around $8.85.

We will cover some background on the broader sector following the GFC and then move onto Westfield itself, before moving onto the specific investment case.

After completing a basing formation as highlighted by the purple arc, prices have swung firmly higher. The sustained break above the technically important 200 day moving average has confirmed broader term momentum to have rotated to the upside.

A stronger, cheaper sector than before

The Australian REIT sector has changed markedly for the better since the dark days when the debt bubble burst in the U.S., which toppled some and brought many to their knees after gorging themselves on debt. During this period, the valuation of the sector collapsed. From peak to trough the sector lost around 70% of its value and in the process impaired its reputation with investors. A sector thought of as relatively defensive by many was bleeding out. It was triage time.

Gearing had skyrocketed; prices to Net Tangible Assets (NTA) were at huge premiums and many had strayed from their core competencies or acquired assets that were not a good fit in their portfolio.

Times have changed and some lessons have been learned, however that certainly doesn’t mean we can relax. Mistakes have a tendency to be made repetitively throughout business cycles so we will be keeping an eye on any straying back into excessive debt territory or price exuberance. 

Nevertheless, gearing within the sector has come down dramatically to levels not seen since for almost a decade ago for the broader sector, around 30%. In addition, while by 2008 property trusts could be trading at double the NAV per share and approximately 85% across the sector, it is more like a 10% discount currently.

Westfield I am

Westfield likely does not need an extensive introduction for most members, as the name is synonymous with a day at the mall and the retail shopping experience in Australia. However, we shall give a brief outline of the business background.  

Westfield’s previous success and pedigree have turned it into one of the largest retail property groups in the world with 118 shopping centres across Australia (43), the United States (55), the United Kingdom (5), New Zealand (12) and Brazil (3).

They house over 24,000 retail outlets, with a gross lettable area of a whopping 10.6 million square metres and an asset value based on pro forma numbers attributable to Westfield Group of approximately $32.4 billion.

Westfield is an old hand in the industry, having been in the shopping centre business for over a half century, under the direction of Chairman and founder Frank Lowy, one of Australia’s most successful businesspersons and a leading philanthropist. 

Despite being a major international operation, Westfield remains at its core very much a family business with the Lowy family owning a significant part of the business and extended family playing major roles in its management. The Lowy’s owner/manager status aligns their interests with unit holders generally, which we consider a positive as well as their depth of experience in the industry.

Westfield Group is involved in most aspects of the property cycle including management, marketing and leasing activities related to its shopping centres. It is a stapled security and since the establishment of the Westfield Retail Trust (WRT) in December 2010, its property development business has become a much larger part of the overall pie. This is a strength for the company and is more profitable generally than acquiring existing centres.

Management has considerable expertise in negotiating bureaucracy, often facilitating success in obtaining development rights where their competitors may fail to do so.

Westfield’s developments certainly have a history of generating strong returns. This is in part due to management’s strategy of keeping the development functions in house, with their own designers, architects, contractors and builders. In addition to reducing costs, this internalisation enhances efficiency and facilitates a greater depth of knowledge throughout the organisation.

To recap, the Group distributed a 50% interest in a in a number of its Australia and New Zealand controlled entities to WRT, covered in detail in the FAT-AUS-498 report.

Sales spree

Westfield Group (ASX:WDC) is on a sales spree at present, after having earlier stated it will sell some of its midscale malls to raise capital for new projects, redevelopment at promising properties and a 10% share buyback.

We can think of this strategy as raising money by way of selling an interest of what it considers its non-core assets into a JV with the aim of recycling the cash into channels that management believe will enhance value for shareholders. In recent years the Group has been developing or has on the drawing board plans to develop flagship world-class projects. These include shopping centres in Sydney, Melbourne, London, Los Angeles and San Francisco.

Major developments in the pipeline include a proposed venture to develop the retail component of the new World Trade Centre in New York and a new retail project in Milan, which the company believes will rival its project in London.

In February, Westfield announced that it had entered into two strategic transactions including a US$4.8 billion joint venture over 12 assets in the United States with Canada Pension Plan Investment Board (CPPIB) and the sale of its interest in 3 non-core shopping centres in the United Kingdom for £159m (A$240m).

In the US deal, CPPIB will become a 45% JV partner in a portfolio of 12 assets in the U.S. with a gross asset value of US$4.8 billion, representing a 3% premium over prior book value and should close imminently. The transaction will result in approximately US$1.85 billion in net proceeds to the group.

Management believes that these two deals proceeds combined with current dry powder for the company give them approximately $9 billion in firepower for deployment into higher return opportunities. A couple of specific projects highlighted were the World Trade Centre and Milan projects mentioned above.

Also in the works according to an article in The Wall Street Journal reported last Friday (27 March) it seems Westfield are close to a sale of majority stakes in seven U.S. shopping malls, for approximately $1 billion to Starwood Capital Group headed by veteran investor Barry Sternlicht.

With reference to the weekly chart, we would expect prices to continue to coil north, targeting the technically important 200 week moving average at $9.70.

A number of positives to drive solid returns over the next few years

Management announced at the time of the FY11 results that they would be instituting a buyback of up to 10% of shares outstanding. This will tighten the share base and act as a fillip to earnings growth and support sentiment towards the stock.

As Westfield refinances its US properties over the next couple of years, they will benefit from ultra-low financing rates, also a boost to earnings.

We believe that the company’s repositioning of its portfolio into higher quality assets better suits the contemporary retail environment, where malls face considerable competition from online shopping and the growing entertainment alternatives at home. I.e. many consumers in the developed world have premium Audio Visual equipment at home to enjoy movies, reducing the need to head down to the cinema in the mall to catch the blockbusters on the big screen.

By being involved with flagship projects, they maintain an ambience for the modern consumer that is worthwhile for them to jump in the car and get down for some retail therapy. The upcoming London Olympics will drive considerable foot traffic through the flagship Westfield Stratford City shopping centre in London and generate some additional profile for the company.

In addition, we expect positive news flow regarding new development projects, which is a key strength for the company. The recent move into the Brazilian market, although small at present offers the potential for significantly higher returns than in developed markets.

The move to an ‘asset-light’ model will pay off with increased return on equity through the next few years, while gearing remains modest at approximately 38% (versus >80% pre-GFC).

Meanwhile, on the valuation front, Westfield looks reasonable, trading at around 0.9x Net Asset Value when ascribing only a modest value to new projects. It trades at 13.4x the December 2012 consensus price earnings multiple and a 5.6% distribution yield. We expect growth in earnings through share tightening, cheaper financing and organic earnings growth along with the distribution to give shareholders a solid total shareholder return (TSR) over the next few years.

Therefore, we are adding Westfield Group back into the Fat Prophets portfolio and recommending it as a buy around $8.85.