Like other well-known dividend plays Sydney Airport Limited (ASX: SYD) and Transurban Group (ASX: TCL), Scentre Group Ltd (ASX: SCG) shares have been on a tear lately as investors seek to escape the tyranny of falling low interest rates.
It’s led to an unprecedented increase in the value of Scentre shares, which are up 60% since they separated from Westfield Corp Ltd (ASX: WFD) two years ago. At today’s lofty prices, should investors think about buying Scentre Group?
Just this morning, management announced that Scentre and partner Cbus had acquired the David Jones building in Sydney’s CBD (adjacent to the existing Westfield Sydney mall also owned by Scentre). David Jones will live out the rest of its tenancy agreement until 2019, (yielding 4.5% per annum to Scentre) when it will exit and the property will be redeveloped to significantly expand the Westfield Sydney centre.
While this is a coup for the company given how tightly those premier locations can be held by owners, it’s tough to argue that it materially changes the investment case for Scentre – which I think is a ‘Hold’ today.
The buy case
On one hand, Scentre is a well-run business with premier retail locations with higher demand from tenants, regular rental increases, and highly capable management. There’s a considerable development pipeline (which the David Jones centre was just added to) as well as the potential for growth by acquisition.
Over the long term, the company can steadily grow rents and there are a number of macro tailwinds including increasing urbanisation and redevelopment, which can support and even grow the value of Scentre’s properties and tenants’ businesses.
The bear case
On the downside, Scentre’s rental growth is in low-single digits per annum and likely to stay there. Although its premium locations in high-density locations offer some protection, the group is vulnerable to an economic downturn and will have some trouble passing on rental rises if tenant sales are slack.
More importantly, the group looks substantially overpriced today, given that it is trading at a 70% premium to its Net Tangible Assets, which were $3.32 per share as of 31 December 2015. A premium should be factored in to account for the quality of Scentre’s portfolio, its development pipeline, and its management, but 70% is too steep for my liking.
So…what should I do?
‘Hold’ Scentre Group today. As a landlord, the value of Scentre’s shares can’t grow out of proportion with the value of the underlying assets (and the size of their rental payments) forever. On one hand, it’s a great business with a long-term future. On the other, it’s tough to argue that there aren’t better, more fairly priced opportunities out there today.