Property

The other day, Andrew Robertson interviewed me for ABC’s Lateline Business Program about property trusts (you can find the transcript in the Media Room, On TV). I thought you might benefit from an expanded précis.

For a very long time, property trusts were described rather derisorily as the investments of widows and orphans – boring, uneventful and staid. Then with the advent of a name change to REITS (Real Estate Investment Trusts), cheap credit and a healthy dose of me-too-ism, property trust managers trotted down the path that took them to near extinction.

Managers of today’s REITS are falling over themselves to once again describe themselves as staid boring old property trusts. But don’t be fooled, while a decade of stable returns and the life savings of so many are gone, many of the managers responsible are not.

With some basic arithmetic, let me explain what has occurred. Company A has $10 of Equity per Share that is returning 7% to 11%  year-in and year-out.  Somewhere between 2005 and 2006, like a kid at a toy shop screaming “I want one too”, the managers of property trusts started expanding in a debt-fuelled binge to get bigger.

Arguably led by Westfield a year earlier in 2004, and as one might expect, the increased debt produced rising Returns on Equity. But it didn’t last.

The party’s last song may have been August 29, 2007. That’s when Westfield was leading again. It sold a half share of Doncaster Shoppingtown for $738 million to one of the world’s largest property managers, LaSalle, on a yield of 4.7% – a record low. Westfield also sold half of its Westfield Parramatta centre for $717 million at a time when Centro, for example, was still loading up on debt. It sold another $1.3 billion in property-linked notes, launched a UK wholesale fund into which it sold $1.3 billion of its inventory, and sold more than A$750 million of US assets. And while it was selling assets, it was raising $3 billion of capital through a rights issue ostensibly to acquire more assets.

Unfortunately for many investors, the managers of other property concerns thought they were smarter than the Lowys. Have a look at the debt to equity ratios in 2007 and compare them to the corresponding ratios in 2004. And the US was reported to be heading into recession.

While it would be some time before the revelers turned into pumpkins and mice, the band had packed up and gone home.

If you want to set your kids on the road to financial success, tell them this:  “If you can’t afford to buy it with cash, you don’t deserve to have it.” Its harsh, but I grew up on that advice. There were a few lay-buys for Christmas, but there wasn’t a single card in my Mother’s glomesh purse.

The lesson however was lost on the property trust managers, and it wasn’t their money anyway!

Eventually everything did turn to pumpkins and mice, and what happened next saved the entities and protected many of the executive jobs but arguably did far fewer favours for the unit holders.

In 2008 Company A writes down its properties, triggering loan covenants and LVR limits. Debt to equity ratio explodes. Bank tells Company A to sort it out.  Company A’s share price falls to meaningless price and far below even the written down NTA. Company A conducts a capital raising anyway and issues hundreds of millions of new shares at a discount to the price and in complete annihilation of the equity per share, as the following tables demonstrate.

The result of all this activity, quite apart from the corporate finance fees it generated, was a dilution of Equity per unit, Earnings per unit and Return on Equity.

GPT’s, ING’s and Goodman’s Returns on Equity are expected to average 5 per cent or less for the next two years – that’s less than a bank account. Stockland and Dexus are expected to average 7 or 8 per cent – a little better, but nothing to write home about.

And finally, you can’t dilute Equity per Share, Earnings per Share and Returns on Equity without a reduction in the intrinsic values of these entities, and that’s precisely what has happened.

Stockland’s intrinsic value has fallen from $4.00 in 2008 to $2.16 today. Westfield from $8.25 to $6.71, Dexus from $2.74 in 2007 to 15 cents today and GPT, from $4.10 in 2007 to 30 cents today. Those intrinsic values aren’t going anywhere in a hurry either, unless Returns on Equity can rise significantly, but with debt now substantially lower that appears less likely.

Posted by Roger Montgomery, 9 April 2010.

by Roger Montgomery Posted in Companies, Property.

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Since early December Paul, Squigly, Steven and Darren have requested I value Westfield. WDC is also a popular stock with viewers of Nina May’s Your Money Your Call on the Sky Business Channel (you can watch highlights at my YouTube channel, just type ‘Westfield’ into the search feature), and rightly so. It’s a company run by three of the most capable men in the world and one whose shares I have owned in the past.

Today its price, according to a number of analysts and strategists, does not appear to have responded to expectations for an improvement in economic conditions in the US. The biggest gap between inventories and orders since the mid 70’s, the decline in housing inventory, the strong turnaround in cyclical indicators and the steep yield curve all suggest an acceleration in US economic growth – by the way if this doesn’t sound like me, you are right. I am just repeating what I have been reading.

I don’t subscribe to the view that it’s the job of the investor to allow macro economic forecasts to influence micro-based investment decisions.

If however the economists are right, and the US economic recovery does gain traction, then all that remains is a recovery in consumer confidence to see Westfield benefit. Of course if the US economic strength is sustained, then one suspects the US dollar will also recover, making Westfield’s profits more valuable in Australian dollar terms.

Those things aside, lets have a quick look at the valuation and take a dispassionate view about the price irrespective of whether others believe the price has or hasn’t responded to US growth expectations. continue…

by Roger Montgomery Posted in Companies, Consumer discretionary, Property.

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