Australia's premium shopping centre portfolio, Scentre Group, owns great real estate in a sector that has huge barriers to entry (for their better retail assets), in strong locations, and with an extraordinary diversity of sources of income. This helps make the security of their earnings as attractive as any in the AREIT sector. Financially, the risks are minimal, and it has a balance sheet that allows you to sleep well at night.
They have a very sustainable debt to gross assets ratio of 31.9% and an average cost of debt of 4.4% that is expected to remain steady over 2018. They enjoy long-term debt facilities that average 4.9 years. 76% of their debt is hedged.
It is well managed at the property level, strategically, operationally and financially, and Peter Allen is an experienced and well-regarded CEO.
Key takeaways from the half-year report
Key takeaways from the Scentre Group half-year report related to the steady cash flows, good development returns and growing asset values.
Net income growth remained steady at around 2.5% over the first half of 2018. Importantly, management has guided to a strengthening of this growth over the full year. Supporting this income growth is occupancy levels which have remained steady at 99.5% of the floor space across the SCG portfolio; a level that has not varied in many years.
Development activity remains strong with a $3bn pipeline generating forecast total returns of around 15%. These returns have helped drive the increase in asset values. The net tangible asset value of the portfolio grew by 14% over the last 12 months.
What the market is missing here
The main thing the market is overlooking in SCG is the quality of the cash flows compared to lesser quality assets and portfolios in the AREIT sector.
The market remains fixated on downside risks posed by online retailing and the (cyclically) weak consumer cycle.
Many fail to understand the hierarchy that exists within the overall retail property market. The perspective that says: “online sales are increasing, therefore all retail property is doomed” is overly simplistic.
Retail assets that exist at the bottom of the hierarchy continue to suffer outsized impacts from structural changes that we are witnessing in retail property. Specifically, it is single shops on once thriving “High Street” locations in all cities across Australia that are suffering the greatest impact from online. We expect this will continue.
However the best shopping centres that offer experiences (major regional centres mainly), convenience, security, parking, cleanliness and easy access are a very different proposition to main street shops that offer none of this. The proof of this is evident in the consistently low vacancy and debtor levels of the best retail AREITs. Vacancy rates on the High Streets remain high.
The listed property market is ignoring the physical property market’s assessments of value. We have seen numerous sales over the last 12 months that have validated all the carrying values of assets in the SCG portfolio.
The other perceived downside lies with anchor tenants like Department Stores. Whilst some investors view the potential reduction in space by tenants like Myer as a downside, we see upside. These generally poorly performing tenants are often a drag on a shopping centre. They can be easily replaced with better tenants who sell more goods and attract more foot traffic. This results in higher rents and added value for the asset. There have been excellent examples of this remixing strategy in recent years.