The Lowe’s are the best in the business, but would I buy Westfield?
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.
Westfield (WDC) has about $10.93 of equity per share and if we assume that the analysts are right and the group earns returns on equity of about 7.5 percent (not exciting and less than a reasonable investor’s required return), then the only reasonable valuation is a discount to the equity. If you use a 13% discount rate, the value comes out at about $6.00. At 11% the value rises to about $7.00. In either case, the value is not even close to suggesting the current price of $12 offers a margin of safety.
The strategists may be right – the US economy may recover strongly and drag up Westfield with it, but an even higher price than what we see today can only be justified by a significant (think doubling) increase of the present rate of return on equity.
Now don’t get me wrong, I truly believe that if you owned a property development business you’d want the Lowy’s running it, and I am not predicting the share price. All I can offer is a valuation based on the numbers mentioned above. If the shares were trading at half their current price, they would represent a great opportunity considering the caliber of the people in charge.
Posted by Roger Montgomery, 30 January 2010
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
rob merlo
:
Hello Roger as a pure income return I have been watching AJA
with a dividend return of over 25%….I know higher the return…greater the risk,but am I missing something here?
Roger Montgomery
:
Hi Rob,
Its on the list to be reviewed. Generally I try not to make decisions based on yields so its important to look at the business.
JohnC
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Sorry about revisiting this post but I have just recalled an explanation of how Westfield equity grows.
In brief, when Westfield builds something, the different between cost and valuation as at finish is one-off development profit – however, whole valuation of the development itself then sits on the books as equity thereafter, to be revalued regularly. So in other words, Westfield’s equity is not just money that other shareholders have put in the Westfield “piggy bank”. Much of the equity represents the assessed book value of its assets from the perspective of potential buyers. At least, that is how I understood the explanation.
I hope you appreciate how this gives rise to a circular logic. Were you able to separate out equity put in by shareholders or is this an irrelevant distinction? How would your model handle this sort of accounting approach? I would add more but my handle on accounting is on shakier ground thereafter.
Brad Kendrick
:
I am with Dean too its great to have you back roger with your thoughts, look forward to hearing you speak in brisbane on wednesday going to make the trip up from the goldy for it. Any idea on a release date for the book?
rogermontgomeryinsights
:
Thanks Brad,
I have the manuscript under my elbow as I type this reply and I’m going through the third edit. The name of the book has been chosen. The First Edition will be out at the end of March or early April at the latest. Only printing enough copies of the First Edition for those who have pre-registered. So there will be a bit of a wait for the second edition. Let me know if anyone wants additional copies or get your friends to pre-register too because you won’t be able to stroll down to the bookshop to get it.
Dean
:
As John already said I think you’ve got confused about the currency. Hopefully, that’s a sign that you totally chilled out on your holiday.
I can’t see how WDC would ever appear cheap based on ROE and thus wonder if that is the best valuation yard stick for it.
Imagine if commercial real estate tanked in the US, the Lowes would then write down their property assets, equity would fall and bingo suddenly the ROE comes up. But the company would actually be worth less. Thoughts on that?
It’s nice to have you back posting Roger, I’m sure there are a lot of people, like me, who have missed hearing your thoughts.
rogermontgomeryinsights
:
Hi Dean,
Thanks for friendly jibe. All fixed now. Regarding your thoughts about value – the valuation of a company is based on both Return on equity and equity. If one rises because the other falls, this is taken into account in the valuation model. What you really want is big equity and big return on equity. Thats first prize. Thanks also for the encouraging words Dean.
JohnC
:
Thanks for the feedback on Westfield! Although I am not sure how you went from $10.93 of equity per share to a valuation of $6 at a 13% discount rate, I presume that’s where your book comes in.
Also I don’t mean to nitpick but I’m not sure how a recovering US dollar can be said to make Westfield’s profits in the USA less valuable in Australian dollar terms. If $100 US currently buys about $111 AUD, then wouldn’t a recovering US dollar imply that $100 US will buy even more $AUD? I recall that this point was made by other analysts who view Westfield as an indirect way of “betting on a rising US dollar” – not that I would invest in Westfield on such a basis.
rogermontgomeryinsights
:
Hi John,
Obviously the pina coladas have affected the signals from the brain to the keyboard and undone all the experience from my days as a derivatives trader. Good pick up. Of course you are spot on. Thank you. With regards to the valuation, when the required return is higher than the return on equity being produced by the equity, the only sensible price to pay is a discount to that equity. For example $10 earning 5% is worth only $5 to someone with a required return of 10%. Its all explained of course in terrific detail in the book with Australian examples.