Update will be interesting tomorrow. Centro recapitalisation proposal in mid Dec will also be important should CBA decide to pull the plug thus having a detrimental effect on commercial property values. Below is an article from Robert Gottliebsen from about 3 weeks ago which I found interesting. Apologies if already posted but interesting read.
Can Westfield beat the sceptics?
By Robert Gottliebsen
October 24, 2008
PORTFOLIO POINT: Its big expansion in the UK could bring serious challenges, if the GPT template is used to stress test Westfield.
The sharemarket might have put behind it the likelihood of a global banking meltdown, but investors are now trawling the list for companies that might have bad news ahead. Those stocks are being trashed irrespective of long-term value. The cessation of redemptions by mortgage funds run by Perpetual, Axa and Australian Unity underline this search for potential bad news (to read more on the mortgage trust crisis, see today's feature by Scott Francis, Last rites for mortgage funds?).
The miners, led by BHP, have fallen because the market can see bad news coming out of China in the next few months, which will depress commodity prices. And some analysts are predicting that the China downturn will last longer than the market expects. But some of the nastiest falls have been focused on the listed property trusts in the wake of the GPT debacle.
In particular, the market has suddenly begun trawling over what has until now been the untouchable edifice: the Lowy family’s Westfield group. Westfield is a wonderful enterprise whose survival is not at stake, but investors are marking it down, fearing there might be nasties in the pipeline. In the year to September 30 the property trust index has fallen 40%, the broader ASX index is down 40% (Westfield was down 18.5%)
It’s ironic that a minor but important factor in the decisions that led to the GPT debacle – which saw the departure of chief executive Nic Lyons this week – was the pressure the Lowys put on GPT to sell to Westfield prime GPT shopping centre assets at attractive prices. The Lowys would say they were merely doing their job in making money for Westfield.
Westfield shares this week have fallen to $13.34, below the $14.06 asset backing of the company based on book values. That means that if the sharemarket is happy with Westfield’s book values then it is putting very little value on the massive shopping centre management business the Lowy family has built up. Yet clearly this management operation has a substantial value.
Westfield shares are falling because the market is suddenly focusing on two potential sources of bad news: the actual value of Westfield shopping centres and the rate of expansion being undertaken by the company at a time when shopping centre values around the world are under pressure. And of course there are concerns that the whole expansion exercise is being financed by borrowed money, albeit borrowings that have been carefully lined up. Westfield has been a brilliant manager of currency exposure but fears of an unexpected mistake are always in the background.
In order to survive this, GPT has announced an enormous $1.6 billion capital raising, offered at a discount of up to 50%. GPT’s presentation in its capital raising embraced a concept that I have never seen from a property trust: a stress test that showed what could happen to GPT if the value of shopping centres and other property assets fell. Let’s look at what GPT did and look at what Westfield would look like in a similar test,
A key element in determining the value of shopping centres is the so called Cap Rate. This is the key rate used by property trusts to determine the value of property assets; it reflects the potential of a building's income to indicate its price.
GPT, in valuing its own portfolio, has used a cap rate for Australian shopping centres of 5.9%. It uses different cap rates for other real estate assets and assumes that its ill-fated Babcock European joint venture is written to zero to come up with an asset backing of 1.56 after the share issue.
But if a further 1.5% is added to all the GPT cap rates, then the GPT asset backing falls to 1.07. So what appears as a small rise in cap rate can have enormous effects on the asset backing of the property trusts. And of course if your book value is too high it means big write downs.
In our Westfield stress test, let’s look first at the book value of the Westfield Shopping Centres. The fall in the Australian dollar has dramatically changed the asset and liability mix of Westfield. The group now has about $A24 billion in US shopping malls (compared to about $A17 billion at June 30 when the Australian currency was close to parity with the US dollar). The American malls are different to Australian malls because there is a greater concentration on upmarket retailing.
As in GPT, the value of Westfield’s property is partly determined by the cap rate and, given the squeeze on funds around the world, cap rates are rising. Westfield values its US centres on the basis of a cap rate of 6.1%. In reviewing cap rates, Deutsche Bank recently used a US cap rate of 6.5% for Westfield US centres. (Deutsche recommended Westfield stock because of the value of the shopping centre management contracts).
I am in no position to debate American cap rates, however the decline in retail spending in America looks likely to be of staggering proportions and the contraction of funds available for asset purchases has few precedents. There must be a possibility that the appropriate US cap rate will rise and in that case the shopping centres would face a writedown. In Australia, Westfield had about $20.9 billion in prime shopping centre malls as at June 30 and they are valued at a cap rate of 5.5%. Deutsche used 6.25% in its valuation sums and GPT uses 5.9%).
In the UK, Westfield uses a cap rate of 5.7%. Deutsche went the other way and used 5.5% but as of June 30 Westfield only had about $A2.2 billion invested in completed UK centres. The sharemarket, in marking back Westfield stock, is clearly flagging that it expects those cap rates will be under pressure and rises are possible, given that we face a recession in both the UK and the US and a severe downturn in Australia.
Most listed property trusts are selling below their asset backing because the market believes writedowns are ahead and Westfield has been a remarkable exception for a long time, reflecting the quality of the assets and the management. But there is a second danger in Westfield. The company in the middle of this global recession is embarking on a remarkable expansion program. In all, the group is involved in expenditures about $A17 billion, of which the Westfield share is about $A11 billion. About $3 billion of that expansion was actually in the balance sheet at June 30 and remaining expenditure will be spread over the next four years.
Given that it is being funded totally on borrowed money, it is interesting how it will affect the Westfield balance sheet. The Westfield accounts are complex so this exercise is oversimplified. As of June 30, Westfield had net assets of $A27.3 billion and interest bearing liabilities of $A15.2 billion. Since then, as explained above, both assets and liabilities will have moved with currencies but we will ignore that. So if at June 30 we undertake a simple sum and add the Westfield $27.3 billion net assets (shareholders’ funds) to the interest bearing liabilities, we can see that there is a rough gearing of about 35%, which is just a bit above the more accurate gearing that is quoted by Westfield.
Four years out, with the developments completed, long-term borrowings will increase by $8 billion (Westfield’s share of the expansion, less money already spent) to $23 billion and will represent a figure that approaches half the total of shareholders’ funds and borrowings ($50 billion).
Certainly, we must recognise that in the past when Westfield has commissioned a new centre it has almost always been valued higher than the building costs, so this has boosted Westfield’s net assets (shareholders’ funds), along with the regular rise in the value of older centres. Once the downturn is over, that is what will happen again, especially to those centres that will be commissioned in three or four years time.
But the biggest Westfield expansion is in the UK and the economy over there at present is horrible and the tough times may last three or four years. There can be no certainty of value rises at the end of the construction road.
The massive Westfield London complex is due to come on stream in the current half-year and its valuation on completion will be an important pointer to the future. What this stress test shows is that if the GPT hypothetical assumption of a 1.5% rise in cap rates was used in the stress test Westfield would be under pressure because it would face major write downs at a time of large expansion.
I emphasise that will probably never happen but stories coming out of the UK of further Westfield asset purchases ring alarm bells because, in my view, they should require equity funding because Westfield distributes all its earnings.
During this period when potential nasties have been the focus of the stockmarket, it is a horrible time to invest. Westfield has a wonderful set of assets. In the past property trusts have been magnificent retirement vehicles and if bank deposit rates are going to decline then those property trusts that are clean, simply own properties and don’t undertake massive developments, will again attract retirement support.
Westfield’s job will be to make sure that the market is confident about the value of its properties and projects and that it is in a position to pass any GPT stress test. It would be much better if Westfield publicised its own stress test.
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