International shopping centre conglomerate Westfield Corp Ltd (ASX: WFD) is a favourite of Australian investors familiar with the brand name, not to mention one of the easiest ways to get exposure to foreign currencies without leaving the comfort of the ASX.
Yet how bright are the company's prospects going forwards? The company's biggest weakness in my mind is its valuation.
Westfield's Net Tangible Assets (NTA) were worth US$4.44 per share at the half-year report, equivalent to approximately A$6. Funds From Operations (FFO), the company's preferred measure of ongoing income, is expected to grow by around 3% to 4% this year.
Even if we factor in the extra $1.4 billion of developments with 7% to 8% yields coming to completion in the next year or so, Westfield is valued at something like 40% more than the value of its underlying assets. For many businesses with the quality of Westfield, this wouldn't be a concern. However, since Westfield's income is primarily in the form of 'yield' (rental income) on its shopping centres, paying a higher price for its shopping centres has a material impact on the returns investors can expect to earn.
By way of illustration, say you have a $1 billion ($1,000 million, for ease of calculations) shopping centre paying rent of $80 million a year – a yield of 8% on your $1 billion. If you bought that shopping centre for $1.4 billion ($1,400 million) instead, your $80 million is now a 5.7% yield instead of an 8% one.
With minimal growth in its rents and the properties under development, Westfield looks fairly valued at today's prices.
Over the long term (5 years or more), management should be able to leverage the prime locations of its 'Flagship' stores to drive sales higher for a long time. That's the beauty of the company's current approach – with its centres in prime locations the company is pretty much guaranteed high tenant and customer interest for the next 50 years or longer. This depends on a few factors, including not getting too aggressive with rents, continuing to help tenants grow the sales, and spending maintenance and redevelopment $$ as necessary, but Westfield management has a very long track record at this sort of thing.
So although I think there is no rush to go and buy Westfield, which appears fully priced today, I also think there's no need to sell the business. I'd consider Westfield a 'Hold'.
