There are two competing theories on retail property trusts. The bears say shopping centres are vulnerable to growth in online sales and could face an exodus of struggling tenants. Store vacancies will rise and rental growth will moderate as e-commerce expands.
The bulls say the so-called “fortress” malls – the giant shopping malls that are destination experiences – have outstanding long-term prospects. These hard-to-replicate assets are benefiting from growth in services and have valuable redevelopment potential.
This debate goes to the heart of whether retail Real Estate Investment Trusts (REITs) are undervalued after unit-price falls and if the likes of Vicinity Centres, Australia’s second-largest retail landlord, will attract a takeover bid from foreign predators.
Unibail-Rodamco’s $32-billion acquisition this year of Westfield Corporation put a takeover target on other retail REITs. Unibail obviously sees a bright future for fortress malls; cynics counter that Westfield founder, the Lowy family, is selling at the right time.
But there is more to takeover speculation on retail REITs than the Westfield play.
So far, the bears are winning the debate on the outlook for shopping-centre owners. Vicinity has fallen from a 52-week high of $2.92 to $2.62, having slumped lower. Scentre Group, owner of Trans-Tasman centres, also tumbled earlier this year, before rallying in the second quarter.
Chart 1: Vicinity Centres
Chart 2: Scentre Group
The outlook is worse overseas. Retail REITs were among the worst-performing stocks in the United States in 2017, amid waves of stores closing as online retailing crushed more bricks-and-mortar outlets. Investors smacked US REITs with lower-quality shopping malls.
In Australia, tepid retail sales growth, fears about high household debt, patchy consumer sentiment and record-low wages growth are weighing on retail stocks and property owners. Several discretionary fashion providers have shut up shop and others will follow.
Worse, the big department and discount chains are likely to close more stores and reduce their mall space. The struggling Myer Holdings is reducing its national shopping-centre footprint and Toys R Us is closing. Macquarie Bank research earlier this year suggested landlords face up to 344,000 square metres in vacancy, based on announced closures.
Rising interest rates are another headwind for the REIT sector. Right or wrong, REITs are considered a bond proxy because they are typically bought for yield, and are mostly stable entities with annuity-like cashflows (that wasn’t the case after the Global Financial Crisis).
Expectations of rising US rates are also weighing on REIT valuations. Rising global interest rates are a poor backdrop for interest-rate-sensitive companies with high debt and shareholder base that find their yield relatively less attractive. Higher rates explain why the global REIT sector is trading at a discount to net asset value when it usually trades at a small premium.
The counter view
I don’t discount the bear argument on retail property trusts. But the question is whether the market has already priced in the gloom in retail valuations and, locally, at least, overreacted to the online retail threat.
I see merit in the bull argument about fortress malls. That said, smaller shopping centres that rely heavily on discretionary retail and a few big anchor tenants are best avoided. They will come under increasing pressure in this challenged retail environment and as online sales grow.
Fortress malls are a different proposition. Australia’s biggest, such as Chadstone in Melbourne or the Myer Centre in Brisbane, are transforming before our eyes. Their tenant mix is changing to include more services and upmarket retailers aimed at wealthy Asian shoppers.
I have visited Chadstone Shopping Centre, the Southern Hemisphere’s largest, many times. The centre, half owned by Vicinity, has undergone several major redevelopments this decade and more are on the way as a $130-million hotel is built.
The best fortress malls have latent long-term strategic value. They are not immune to the e-commerce threat, but their market position is so strong that retailers must rent space there given the malls are becoming the area’s de facto CBD.
Unibail-Rodamco no doubt sees this potential in Westfield Corporation’s portfolio of high-quality malls. A future where more people work in office towers at shopping malls, live there in ritzy residential developments, or where tourists visit and stay at fancy hotels. The fortress mall of the future is a different beast to the shopping-centre experience of the past.
Vicinity well positioned
Which brings me to Vicinity, owner of several of Australia’s leading fortress malls. Vicinity has investments in Chadstone in Melbourne, Chatswood Chase and the Queen Victoria building and surrounding arcade in Sydney, and the Myer Centre in Brisbane, among other assets. It had 76 retail properties in its portfolio at March 2018.
Vicinity has a powerful retail position in Australia’s three largest CBDs and plenty of scope for redevelopment at other key malls, such as The Glen in Melbourne’s south-east, which is undergoing a $430-million redevelopment (Vicinity has a 50% interest in The Glen).
A third-party developer paid $60 million for residential air rights at The Glen and is building 500 apartments on-site at a centre popular with Melbourne’s Chinese community. It’s a good example of the development opportunities that exist at fortress malls.
Vicinity’s portfolio is hard to replicate. A rival operator could never build another Chadstone because its surrounding area is built out. Offshore predators with deep pockets and a long-term outlook will surely have looked at Vicinity.
The REIT’s recent decision to sell up to a $1 billion of its sub-regional and neighbourhood shopping centres is smart. It positions the Vicinity portfolio more towards market-leading shopping, dining and entertainment malls, and away from lower-quality centres.
The planned divestment, in my view, adds to Vicinity’s takeover appeal by improving portfolio quality and recycling capital to develop its higher-quality malls. Vicinity’s divestment strategy would appeal to a foreign predator seeking purer exposure to Australian fortress malls.
To be clear, I do not see screaming value in Vicinity at the current price, or an imminent catalyst to spark a large price rally (excluding a takeover), given the retail outlook and lingering concerns about online-retailing threats. Vicinity’s full-year result in August might provide price support, but there are many challenges.
Vicinity’s current price of $2.62 compares to its latest stated net tangible asset (NTA) per security of $2.93, announced in the interim result in February. That equates to an 11% discount to NTA, but the gap could persist for some time in this retail environment.
An average share-price target of $2.85, based on the consensus of 10 broking firms, suggests Vicinity is a touch undervalued at the current price. Believers in the fortress-mall outlook must be prepared for ongoing weakness in retail REITs, including Vicinity. This is a long-term story (3-5 years).
Still, there’s value in Vicinity for those who can see past the current sluggish retail conditions and who know online retailing is not the end of shopping centres as we know them. If Australian investors take too long to see the value, a foreign predator will.
In the meantime, Vicinity fits the main criteria of the Switzer Takeover portfolio: finding undervalued companies that are sound long-term investments, with or without takeover.
Vicinity Centres is added to the portfolio this month. Media-monitoring group iSentia, a portfolio disappointment over the past few years, is removed.
- All prices and analysis at July 10, 2018.
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