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Morningstar | Larger Specialties Continue to Flatter Scentre’s Sales Metrics; FVE Unchanged at AUD 3.85

The sluggish tenant sales across Scentre Group’s portfolio have continued with no sign of a rebound during the September quarter. Guided 2018 earnings on a funds-from-operations basis were reaffirmed to increase by approximately 4% and distributions will be AUD 22.16 cents per security. Our 2018 forecasts align with guidance and our fair value estimate remains at AUD 3.85, marginally below narrow-moat-rated Scentre's current price of AUD 4.00.

Even though management has made inroads to replace out-of-favor tenancies with new contemporary tenants, fast changing consumer spending patterns continue to weigh heavily on sales within Scentre's malls. At a headline level the specialty sales growth of 2% is weak, but it has actually been flattered by the inclusion of very large specialties (stores over 400 square meters) whose sales growth of 3.2% offset the 1.6% sales growth for the more traditional specialties. The problem with this situation is the larger specialties have a comparatively strong negotiating position enabling them to negotiate rents per square meter far below that of smaller tenancies. The plight of the smaller tenancies is made worse as the larger tenants often command shopfronts in the more heavily trafficked locations within the mall. Unless something changes, continuation of this trend will weaken the rental growth prospects of the mall. We already account for this risk in our assumptions by forecasting long-term rent growth slows to an average of 2.4% over the coming decade. This is far below the typical specialty rental escalation of 4%, but we think is justified given our view on the weakening sales growth prospects of high-rent-paying specialty tenants.

Aside from remixing tenancies to better align with new consumer shopping patterns, Scentre’s other major focus is redevelopment. In the September quarter Scentre opened over AUD 1 billion of new development projects including expansions at Westfield Carousel, Westfield Kotara and Westfield Tea Tree Plaza. These redeveloped malls and the recently opened new mall at Westfield Coomera do not feature in the recent sales metrics as asset need to trade for two years before inclusion in sales metrics. We are undecided as to whether the new assets will have a positive impact on the overall sales growth trajectory as falling mortgage rates and solid wage growth buoyed consumer spending coming into the projects. Both of these microeconomic metrics have weakened over the past three years and we suspect this could result in the developments failing to hit their sales objectives.