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Morningstar | Transferring Coverage of Narrow-Moat Scentre Group; Our AUD 3.85 Fair Value Estimate Is Unchanged

We confirm our AUD 3.85 per share fair value estimate for Scentre Group as we transition coverage to a new analyst. Our narrow moat, medium fair value uncertainty, and Standard stewardship ratings are unchanged. At current prices, the stock is trading broadly in line with our intrinsic valuation. Our fair value estimate implies fiscal 2019 price/earnings of 15 and enterprise value/adjusted EBITDA of 17. Our valuation is derived using a discounted cash flow methodology, using a 7.5% cost of equity and a weighted average cost of capital of 7.2%. Scentre’s economic moat is sourced from efficient scale and network effect benefits.

We forecast the weak sales performances of traditional brick-and-mortar retailers to persist, reflecting ongoing evolution in consumer spending patterns. The recent quarterly operating update highlighted the structural challenges for retail landlords, with total portfolio sales up a mere 1.3% year on year.

The most profound headwind for Scentre is the increasing proportion of consumer spending occurring in digital channels. Online accounts for 9% of total Australian retailing sales and we forecast the channel to grow at an average rate of 12% over the next decade.

Scentre and its peers have responded to this threat by reducing floor space allocated to more exposed, smaller fashion retailers and increasing the space allocated to health services and dining. In the short term this is a credible strategy, but there are limits. For instance, each additional unit of space allocated to dining dilutes the sales of existing restaurateurs and hence their rent-paying capacity. Long-term success requires increases in foot traffic to Scentre’s malls. However, foot traffic is hardly growing, a major headache for retail landlords and a key factor in our forecasting low outer-year rental growth for Scentre. Over the next decade, we forecast Australian rent growth of 2.2%, and only a slightly higher rent growth rate for the New Zealand assets at 2.4%.