Company Overview: Scentre Group Limited is the parent company of Scentre Group Trust 1 (SGT1), Scentre Group Trust 2 (SGT2) and Scentre Group Trust 3 (SGT3). The principal activities of the Company include the ownership, development, design, construction, asset management, leasing and marketing activities with respect to its Australian and New Zealand portfolio of retail properties. Its segments include Property investments segment, which includes net property income from shopping centers, and Property and project management segment, which includes external fee income from third parties, primarily property management and development fees, and associated business expenses. The Company manages, develops and has an ownership interest in Westfield branded shopping centers in Australia and New Zealand. It manages every aspect of its portfolio, including from design, construction and development to leasing, management and marketing.
 

SCG Details

While some level of softness is seen in sales lately, Scentre Group (ASX: SCG) seems to be one real estate stock that is banking on earnings drivers relating to organic growth across the portfolio supported by fixed annual rental escalators, low cost of debt and contributions from redevelopments.

Third quarter highlights: Scentre reported mixed sales for its third-quarter trading update due to the general weaker than expected consumer sentiment. In the third quarter, the total sales grew 1.7% to $23 billion. The department store tenants posted sales declines of 6.7% for the nine months ending September 30, 2017. On the other hand, the more popular, internet-proof food clients reported an increase of 0.9%.
 

Third Quarter Performance (Source: Company Reports)
 
Business Growth: The group in the third quarter of 2017 started the $160 million redevelopment at Westfield Kotara and the $50 million redevelopment at Tea Tree Plaza. Further, the $80 million (with SCG share of $40m) cinema and restaurants expansion work started at Westfield Whitford City in September. The group had successfully finished the $355 million development at Westfield Chermside, setting a new benchmark in creating extraordinary retail and lifestyle destinations. Further, redevelopment includes a new fashion galleria over two levels establishing Chermside as the only Brisbane shopping Centre with international mini-majors H&M, Zara, Uniqlo and Sephora under one roof, as well as an additional 60 fashion, health & beauty, homeware and services retailers. The redevelopment is forecasted to add more than $300 million in retail sales while surpassing expected returns and creating significant long-term value for shareholders. Further, all active developments are progressing well and the customer visitation since opening of Chermside in June 2017 has improved tremendously.
 

Active Developments (Source: Company Reports)
 
Strong occupancy of assets: The group built a diversified portfolio with a pre-eminent shopping Centre portfolio in Australia and New Zealand. SCG has 39 centers in Australia and New Zealand as at 30 June 2017, with a combined value of $33.6 billion. The group’s portfolio is more than 99.5% leased. Net property income for the half year of 2017 had also reached $881.3 million. The group’s comparable net operating income growth across the portfolio reached 2.6%, boosted by rising contractual rent. Comparable specialty retail sales enhanced 1.5% during the period and 2.0% for the twelve months ended at 30 June 2017. The group is making strategic asset plans to leverage the unique benefits of vertically integrated operating platform. SCG is focusing on the curation of retail at its centers, ensuring the integration of major retail categories like food, fashion, international brands and entertainment. The group expanded the smartscreen media business to the New Zealand portfolio. SCG is also enhancing its focus on customer experience for enabling smooth visits while offering a vibrant mix of products and services that customers look for. In this regard, SCG also launched a customer experience net promoter system.
 
Capital Management: SCG is optimizing the capital structure through disciplined management of capital, funding and liquidity. SCG has settled the Casey and West City asset sales with total proceeds of $367m. Moreover, the company has raised US$500m (A$650m) bond finance and has refinanced and extended $3.6bn bank loan facilities. The group intends to cut the distribution payout ratio to 89.4% (forecast) for 2017 as compared to 93.8% in 2014. Further, SCG would extend the current practice to grow distributions at a lower rate than earnings growth until it reaches a payout ratio at 85% of Funds from Operations (FFO) with the additional retained earnings invested in redevelopments at > 15% IRR’s. The distribution is targeted to grow at 2% per annum until the target payout ratio of 85% is achieved. Once this target is achieved the distribution is expected to grow in line with FFO growth. The group expects further earnings of $25 - $30 million to be retained in 2017, post the operating and leasing capital expenditure. This is expected to grow to more than $100 million per annum at the 85% payout level. The retained FFO of $100 million represents 20% - 25% of SCG’s average annual share of development expenditure. Overall, SCG has set a target payout ratio of 85% to retain earnings for investing in growing the business. Additionally, the new target payout ratio enables SCG to invest additional retained earnings into the business with a development pipeline in excess of $3 billion, with expected total returns of more than 15%. This change will increase the group’s growth in Funds from Operations over time, and help reduce future debt financing requirements.
 

FFO Forecasts (Source: Company Reports)
 
Long term track record: The group built a strong track record over the last ten years by delivering Specialty sales productivity and Specialty rent productivity. In the Retail space, SCG added more than 480,000 sqm to the portfolio via redevelopments, which represents an 18% rise. The Australian online sales have grown by more than $16 billion, from ~2% to over 7% of total retail sales, representing more than 15% CAGR, over the last ten years. In the last two years, the overall sales for the Scentre Group portfolio has grown more than $1.2 billion with Specialty sales rising more than $750 million or greater than 7%. The Mini major sales enhanced more than $300 million or more than 11% while Majors sales enhanced more than $150 million or 2%. SCG has been delivering a long-term sustainable growth by strategically investing and proactively managing each individual shopping Centre in the portfolio. As of first half of 2017, the asset valuations enhanced by 4.0% while the weighted average capitalization rate enhanced to 5.25% (8bps). The comparable net operating income growth of 2.6% in the first half of 2017 was reported while SCG expects a full year net operating income in the range of 2.75% – 3%.
 
Target market opportunity: The group continues to focus on enhancing the market share from retail platforms, as over 80% of the overall retail sales in Australia are in ‘other shopping centers’ and ‘other bricks & mortar retail’. SCG believes that the portfolio is well positioned with strong demographics and diverse retail product offerings which would drive the market share. The group’s centers are located in urbanized transportation nodes with the highest population density growth while greater than 65% of the population living within a 30-minute drive to a Westfield shopping Centre. More than 33% of Scentre Group’s invested capital is in shopping centers that generate over $1 billion in sales while over 80% of the group’s invested capital is in shopping centers that had generated over $500 million in annual sales. The group has been witnessing a stable rise in customer visits, which are now over 530 million per annum.
 

Potential market opportunity (Source: Company Reports)
 
Outlook: Overall, SCG expects full-year funds from operations growth to be in line with guidance of 4.25%, and has maintained the distribution per security of 21.73 cents per security, which is a growth of 2%. Moreover, the group is maintaining the forecasts for net operating income in the range of 2.75% - 3.0% growth for the full year.
 
Stock Performance: The shares of SCG have risen 6.6% in the last three months (as on November 24, 2017) and still trade at a reasonable level. SCG expects its Westfield Chermside to continue to generate more than $1.1 billion in total sales per annum given the solid early trading performance. It is key to note that the Mini major and specialty tenants represent over 80% of gross rent for the Westfield Chermside shopping centre. The group has also built a strong balance sheet and is the pre-eminent retail property group in Australia and New Zealand. With stock trading at a decent dividend yield and witnessing improved fundamentals, we give a “Buy” recommendation at the current price of $4.18


SCG Daily Chart (Source: Thomson Reuters)

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