Toes Up or Toes Down for Westfield?

We all know a story about a European immigrant who worked hard, bought property, and ended up rich, right? Well let me tell you about a couple of guys who became billionaires.

In the 1950s two Hungarians opened a delicatessen in Sydney’s Blacktown to cater to the growing numbers of migrants. Business was so good they had enough profits to start developing land on the side.

Soon they were making more out of property than they were out of cold cuts. That’s when they noticed that the Americans had begun building these things called ‘shopping malls’. They decided to build one in Sydney.

The site they chose was in Sydney’s West and it was located on farming fields, so they called it ‘Westfield’.

Frank Lowy was 26 years old and his business partner, John Saunders, was 32. Over the next fifty years they went on to create one of the most successful companies in Australia – if not the world. Anyone lucky enough to be an early investor would now be a millionaire many times over.

Every month or so I like to take a look at what I call a ‘Barefoot Bluechip’, a company that we all know, use and own – through our superannuation investments. So let’s see if Westfield is a stock you should have on your shopping list.

There are two securities that comprise Westfield: the Westfield Retail Trust (WRT), which has a 50 per cent share in the Australian and New Zealand shopping centres (including the mega-profitable Bondi Junction), and the Westfield Group (WDC), which has the balance of the Australian malls, the international assets and the property development business. Both stocks have forecasted healthy dividend yields of over 5.5 per cent.

With Westfield’s share price (WDC) trading near its lowest point in three years, let’s go shopping to see if there’s a bargain to be had.

How do they make their dough?

Remember earlier this year when Gerry Harvey got crucified for campaigning against GST-free online sales? There was a name missing from the coalition of big retailers – Westfield.

Why did they stay quiet?

Well, they didn’t want to draw attention to the fact that one of the major reasons retailers can’t compete with online sales is Westfield slugs its 24,000 tenants with some of the highest rents in the world. These costs are passed on to consumers, who are increasingly preferring to buy online.

Here’s how the business model works.

If you go into your local Westfield you’ll notice the big retailers – Coles, Woolies, Myer, DJs – take up most of the space. They’re the shops that suck people in, and that’s why Westfield signs these big guys up to long, relatively cheap leases.

They then lease out the rest of the shopping centre to smaller, specialty retailers like Smiggle and Supré – who feed off the foot traffic from the big boys – and sting them roughly six times the rent (per square metre) they charge the big boys. The smaller retailers make up over 80 per cent of the underlying profits of the group.

“Tell me the good stuff”

It generally always pays to back a self-made billionaire (or his sons, who now run the business) who has their own skin in the game, and for years the Westfield Group has generated extremely high profit margins.

While it costs a lot to build a shopping centre, once it’s completed the running costs are basically fixed, while the rental leases lock in terms that rise with inflation. And Westfield is a notoriously hardnosed negotiator (sometimes a little too hard according to the ACCC, who once found it had abused their market and commercial power).

There’s also speculation that Forever21, Abercrombie & Fitch and H&M will open stores in Australia in the next few years, which (as we’ve seen with the recent opening of Zara) pulls shoppers away from cyberspace and may help Westfield draw foot traffic so they can slug more of those small specialty retailers.

“Tell me the bad stuff”

Two words: online shopping.

The specialty retailers who for years have been coughing up to 80 per cent of Westfield’s profits to reach consumers can now build their presence online − much cheaper than paying sky-high rents.

And being in a Westfield shopping centre doesn’t automatically mean you’re going to be profitable, as Borders, Angus & Robertson and the Colorado Group have found.

Many of Westfield’s tenants are having a tough time – even the big boys. DJs last week forecast that sales would be down 11 per cent (citing everything other than its star CEO getting the chop).

Westfield’s competitors are now Amazon and eBay Australia, who are looking to entice traditional retailers to sell from their site, and a host of cut-priced overseas stores who with a strong dollar are cheaper than local retailers, and don’t charge GST.

Westfield is reportedly spending millions of dollars building its own virtual shopping mall to combat the growth of online shopping, but many retailers are skeptical about letting them clip their online ticket.

Most industry experts reckon the Apple Store is a good window into what traditional retailing will look like in the future: rather than competing with online shopping it complements it – you can go into the store, touch the merchandise, ask questions at the Genius Bar, and then buy online. This is what’s happening to Westfield tenants today – except punters are not going home and buying on their sites.

Toes up, or toes down?

Westfield is one of Australia’s best businesses. People will continue to shop in the future, and odds-on it will be at a Westfield centre – with its bars, restaurants and premier locations making it an experience in itself.

Retail property development is a tough business, as the debt-plagued DFO and corporate carcass of Centro attest. And with the second phase of the GFC underway, this could ironically be good news for Westfield. That’s because sharp operators like Lowy can pick up ‘fire sale’ bargains, and the threat of increasing prices is offset against their revenue being all but guaranteed by long-term inflation-adjusted leases.

So – in the short term at least – it’s toes up. But its reliance on smaller retailers, and therefore its long-term eye-popping profitability, will be tested over the next decade and beyond.

Tread Your Own Path!