Federation Centres chief executive Steven Sewell tells Business Spectator's Alan Kohler, Robert Gottliebsen & Stephen Bartholomeusz:
Alan Kohler: Steven, welcome to Business Spectator. It seems to me that the way the business started off as Jennings Properties and became Centro in 1991 and then twenty years later became Federation Centres, it was actually a symbol of its times. In the 2000s it was a high geared, complicated structure, high growth and now you’ve turned it into a lower geared, simple structure for yield which in both cases reflects the times and what people want. Is that how you see it too?
Steven Sewell: I think even more than that it really is a case of back to the future, where what was created out of Jennings Property Trust in 1986 was simple, Australian investment grade properties, income producing, high yielding and in fact what we’ve taken the company back to is exactly that, a big balance sheet owning investment vehicle where basically more than 90 per cent of our income is produced from income producing shopping centres in Australia.
AK: And what about you and Andrew Scott, the guy who built up Centro. At a personal level how do you think you differ from him?
SS: Well, as you say, I think Andrew managed the business for what was appropriate at the time. And I think there was a need or a push towards global diversification of the asset base through the mid 2000s. He went to North America, was looking to move into Europe and it was very much encouraged at the time by investors and the banks. Now, I think, at the time I was in another fund doing exactly the same type of strategy, but through the latter part of 2000 into the GFC I think investors are very much now focused on looking for best of breed operators within a particular local market.
AK: Are you saying that Andrew would have done what you’re doing if Andrew was running Federation Centres now?
SS: Well, I hope he would have because I think it’s proving to be very successful and certainly very much embraced by both domestic and offshore investors. And again what we are doing is not a complicated formula. You know, it is basically back to the first principles of shopping centre management for maximising income and capital growth.
Stephen Bartholomeusz: As part of this ‘back to the future’ strategy you’ve had to sell interest in some of your best properties.
SS: Yes.
SB: Is that something that you would have done by choice or has it simply been forced on you by the balance sheet?
SS: No. We took a decision that with the equity that we had invested in the properties and the balance sheet – the way it was structured – that the best way for us to materially improve the return on invested capital was to look at selling stakes in assets, non controlling but joint ownership stakes, but contracting back to our partners to provide the services. So therefore we retain a stake, we share in the upside, the income and capital growth, but importantly from a business point of view we get to leverage off our national platform and provide the services to our partners.
SB: So, you get management income on a smaller capital base.
SS: Management income plus also development fees as we use the capital that we’ve equitised from those stakes and invest it back into those investments. So, we get to enhance the asset value and our partner will pay us for that service for their 50 per cent interest in the assets.
AK: So, you should you do it for more of the properties.
SS: Well, we’re in the situation that our balance sheet leverage will be down around 25 per cent once we settle the ISPT transaction in July and we’ll have an undrawn debt facility at that point of probably just on $1 billion dollars. So, it’s a question of how much equity… And it really is a ‘sources and uses of equity’ equation for us.
RG: Now, your partners are superannuation funds?
SS: A combination of high net worth individuals, three private – Stan Perron from Perth, Sam Tarascio from the Salta group here in Melbourne and Bob Ell from Sydney who we own with Tuggeranong in the ACT. The ISPT deal is the industry super fund transaction that we’ve just announced and that will settle in July.
RG: And what will they do?
SS: Well, they’re jointly owning five properties with us. They’ve bought an interest in five properties right across the country in every state.
RG: And what’s the Challenger deal?
SS: Out of the Perron transaction that we settled last year, basically we had a number of parties come to the surface. Stan Perron, you might recall, transacted extremely quickly on that transaction and a lot of parties were left wondering what had happened, so we had a number of enduring discussions ongoing after the Perron transaction. ISPT was one and we’ve been able to conclude a deal with them. Challenger was another one. Challenger also just across Christmas purchased the Paradise Centre from us on the Gold Coast and have contracted back to us as a third party manager to provide all the services.
So, out of that transaction they’ve asked us, are there other assets that we’re buying out of the syndicate business that they could take a half ownership interest in. I believe they have mandates with funds from offshore looking to invest in shopping centres in Australia. So therefore they’re the asset manager; we’re the property manager.
RG: So, these centres will come out of the old syndicates – private investors and syndicates.
SS: That’s right. So, that was a part of the legacy Centro business. You’ll remember Julius Colman sold the business to Andrew many years ago and that business grew and grew – and in fact twelve months ago had $2.5 billion of assets in the syndication business across 25 syndicates.
We’ve since reduced that to about $1.5 billion of assets today by bringing most of them onto our balance sheet or some selling out the door, such as Paradise Centre on the Gold Coast. And we’ve got a strategy of taking $1.5 billion down to about three $300 million by a combination again of bringing the assets on our balance sheet using our undrawn debt facility and cash or selling them out to the open market.
AK: I mean obviously with these assets, what you’re finding is that these are great assets for long-term investors such as super funds, annuity style retirement and private individuals who just want to have stable investments.
SS: It’s a return situation, so you…
AK: And so, can you see a time when it’s not actually that rational for a structure like yours to own these properties, being a listed company, and that what you should be doing is managing them for the long-term owners of the assets?
SS: Well, not really. I mean we’re a real estate investment trust for public investors in the stock and, you know, with our current earnings yield of about 6.5 per cent, dividend yield at 5.5 per cent with growth, we think we offer a very attractive investment proposition both to domestic investors as the chase for yield, as the cash rate collapses and the chase for yield intensifies, and particularly for offshore investors.
Robert Gottliebsen: We had Bernie Brookes here a week ago and he said ‘I’m going to get my lease costs down, in some cases 50 per cent, other cases 10-15 per cent’. We have David Jones’ chief executive saying ‘I’ll pull out of a centre if the lease doesn’t come down’ and he’s going to get his down. Are we now into a new era where the retailers with their marketing ability and their databases now have leverage over shopping centres that they simply didn’t have before?
SS: I think you have to divide it between what we call discretionary and nondiscretionary retail. And in the case of department stores, which very much fall into the discretionary category – so with principal categories of cosmetics and fashion and high end fashion – very much what we’re seeing is the businesses are needing to sort out their product mix, their pricing point and their service offer. In the case of Myer, for example, we only have four Myer department stores in our business. Two of them in Sydney actually are way too big. The footprint is over 20,000 square metres. Now, I think if Bernie was here he would say our ideal size…
RG: Where are these centres?
SS: Bankstown and Roselands, the two regional malls in Western Sydney.
RG: OK.
SS: And I think you’re looking at a situation where the success of their business recently has been in a footprint of about 12,000 or 14,000 square metres. So, we agree with Bernie that we think we’d like to reduce the footprint of those stores and we’re in discussions on doing exactly that and that will pro rata bring down his rent bill for those stores. Because at the end of the day, whether it doesn’t work for him because of profitability or it doesn’t work for us because of sales per square metre traffic generation for the shopping centre, it very much is of mutual benefit for us to fix that location.
RG: But he may want you to not only have less space, but he’ll say to you ‘I’m going to pay less per square foot’.
SS: Sure. And I think at the end of the day, that’s the commercial negotiation and what works for us with the space that we’ve got available, what works for the retailer. We’ve actually had in our business, in our portfolio – and it was before my time – two department stores exit two of our shopping centres. We had David Jones move out of Toombul in Brisbane. We had Myer move out of Tuggeranong in the ACT. Now, we’ve been able to backfill both those large tenancies with discount department stores, mini major type retailers who have done enormously well. And the shopping centres have actually gone on to do enormously well since those department stores have left. So, that was a case where it wasn’t working for the department store and it really wasn’t working for the shopping centre.
RG: So, you’re going to say to Bernie, leave. If you’re not prepared to pay a fair price…
SS: No, no. I think it’s very much a case by case discussion. What is the catchment? What’s their plan and what’s their spread and their offer within that catchment? Does the demographic need or want a department store type tenancy and therefore can we make the deal work?
AK: You’ve actually been forcibly switching a few of your retailers, haven’t you?
SS: We have. And I think, you know, at the end of the day, we keep coming back to first principles – and this is my discussion about discretionary and nondiscretionary. For our portfolio, in particular, supermarkets and national brand supermarkets are the lifeblood of our portfolio. So Coles, Woolworths. Where we can introduce Aldi to great benefit, to great traffic generation, or a specialist grocer like Thomas Dux, the Woolworths brand, or another specialist grocer, anything that we see can generate traffic, increase sales productivity for our retailers we see will have a flow on benefit to the rest of the retailers within the shopping centre.
AK: Just give us some examples of where you’ve done that, what switches you’ve made that have worked for you.
SS: We’ve got an example very recently at The Glen, our major regional shopping centre here in Melbourne. We had a Best & Less tenancy that was generating less than $2 million dollars annual sales. We’ve replaced them with a JB Hi-Fi tenancy, a brand new JB Hi-Fi tenancy, that opened in December last year and has generated over $6 million dollars sales in its first month of trade. So, we’re very much pleased that they’ve been able to reinvigorate the space and just in the last couple of weeks Kathmandu, a brand new tenancy, has opened next door to JB Hi-Fi. We think we could get between $20 million and $30 million of sales out of the two tenancies side by side, but there’s enormous traffic and enormous appeal to the local market to come to the centre. And obviously that traffic generation has benefits for the rest of the retailers in the shopping centre.
SB: Steven, one of the remarkable things about your business is that despite all the turmoil and trauma at the corporate level, the portfolio itself has actually held up pretty well.
SS: Yes.
SB: What do you attribute that to? You’ve got nearly a 100 per cent occupancy – 99.5 per cent occupancy – and no net operating incomes rising. How is it that those businesses have performed so well and there’s been no capital spend on them?
SS: Quality of the location. I mean Centro at its peak in Australia owned or managed over a 130 shopping centres. We now have about 70 properties. So, effectively the portfolio has been distilled to the properties that we really like and we believe are in some of the best locations around the country. So infield suburban, mature demographics and in some areas with very high population growth, such as Cranbourne.
We own the property in the middle of Cranbourne, which we’ve just lodged a DA to spend over a $100 million dollars to expand because we’ve got 6 per cent population growth in the Cranbourne catchment area. Mandurah, south of Perth, is one of the highest growth corridors in Australia we happen to own the major regional shopping centre in the middle of Mandurah. So, it is more a case that the portfolio absolutely did maintain very high metrics, operating metrics, through a period of corporate distraction, but that gets to the quality and I think also the strength of the anchor tenants and the supermarkets that we do have.
SB: Given it’s been capital constrained for almost a half a decade, presumably there’s a lot of upside in the development potential of the portfolio.
SS: Well, we see that there is great opportunity to spend on developments, but we’re being very cautious about it. You know, with the retail environment as it is, particularly consumer confidence being fairly soft at the moment, we think now is not the time to be making grandiose statements or, you know, splashing money around. So we’re being very measured.
For most of the projects that we do across the country the genesis will be a discussion or a transaction with a supermarket where they either refurbish or expand or we can introduce something like an Aldi to a shopping centre and that will lead the development pipeline. But the fortunate place that we are in is because of the four or five years of administration or corporate distraction, the portfolio is very well positioned for the current retail environment.
RG: Woolworths and Coles, particularly Woolworths, have opened a lot of new stores.
SS: Yes.
RG: Have you had a share of that market or are you looking to get into that market?
SS: No. Because what we’ve understood is that the new stores that are being opened typically are in the residential growth corridors around Australia, so they’re where the population is expanding, whether it be to southwest Sydney, whether it be out to the north and west of Victoria, so they’re very much in new growth corridors and they tend to be small scale neighbourhood shopping centres that service those areas. To give you an example, in Cranbourne, while we’ve been on ice effectively for five years, population growth has been continuing at around 6 per cent, there have been 13 neighbourhood shopping centres, supermarket anchored shopping centres, open within the primary and secondary catchment of our shopping centre at Cranbourne. Now, the lettable area per head of population has not changed materially because the population growth has been so strong for that period.
RG: But that might affect your shopping centres?
SS: Well, it does at the margin but we believe that you know, there’s a place for everybody. Supermarkets are expert at working out where they can put supermarkets in order to capture the income and the spend. As long as you see positive movement in retail spend and demand, the retailers are the best ones to work out.
RG: It sounds like the old service station boom, all these little shopping centres being set up with supermarkets around them.
SS: Well, the fortunate thing we have in Australia is quite a controlled planning regime around the country where there are activity centres and the government very much controls what land is designated to be shopping centre or retail development and what land is meant to be residential. So I think it’s not as easily as what, I would say, you categorise as the service station boom, but it very much is led by population and residential growth corridors.
AK: Are you also trying to derisk your portfolio from the Internet?
SS: Well, because we have such a small proportion of rent linked to apparel and we only have five department store tenancies across the whole…
AK: What proportion is it to apparel?
SS: About 11 per cent of the whole portfolio’s income is apparel and even that statistic, while 11 per cent, some people would say still is a risk. The apparel that exists in our shopping centres, because they are supermarket anchored shopping centres, I would categorise more as commodity type apparel. So, it’s children’s wear. It’s underwear. You wouldn’t go to one of our shopping centres typically to buy, you know, a fancy outfit for a formal. So, you know, it is a different market. And I think you have to look at the fact that our sales growth at the moment is positive across all of our categories, which I think goes to the heart of the fact that we do offer a more nondiscretionary type retail offer than would necessarily be impacted by online retail.
SB: Steven, you said earlier that the portfolio has almost halved. As your balance sheet capacity continues to open up, can you see a time when you actually start growing that portfolio again?
SS: Our greatest use of the capital that we’ve got available and our plan, our sole plan, is to acquire the assets that we’ve identified from the syndicate business and to organically grow the properties that we have in the portfolio to reinvest back into the properties that we have on the balance sheet today. So, we do not have a strategy of acquiring additional properties. And we think because we’ve had so many years in administration that we have a growth profile that will continue for many, many years to come and certainly keep us pretty busy.
SB: Apart from the balance sheet I assume that after that long period of trauma there would have been an issue of talent. Have you restocked?
SS: We have. We’ve brought in some of the corporate activities in the business that had been neglected or minimised during the period of distraction, so people and culture, remuneration, performance management, corporate communications, media relations, investor relations and also development activity.
You know, the business basically put a clamp on development activity. We now have a very large team across three hubs in Perth, Melbourne and Sydney of development managers and financial analysts to support that level of activity. So, we’ve refreshed the team, but effectively we reorientated the organisation’s structure to what the objectives are of the company: as I said, to redevelop and spend money and grow the income of the existing properties that we have.
SB: And you’ve rebranded. I assume it wasn’t directed at your customers because Centro out there in the suburbs is not a bad name. Financial markets I assume were the driving force.
SS: It was certainly a factor. When we looked at the transformation of the business from a balance sheet perspective and from a corporate objective perspective, when we got to the second half of last year we realised that we were a different organisation and we were also keen to obviously put the past behind us and present a different face to the market. We were also, with the balance sheet strength that we have, looking to issue bonds and debt into the domestic market as well as offshore to diversify our funding sources. And our clear advice was to rebrand the company and move away from the old branding of Centro.
RG: You’ve got a negotiation with David Jones?
SS: We do.
RG: And they’re threatening to leave. Do you think they will?
SS: They’ve got only one store. It’s at The Glen.
RG: Yes.
SS: We were interested in their categorisation that the demographics were less than robust or some sort of terminology. On our assessment the demographics of The Glen are actually quite healthy. In fact, when we look at the population growth, the income and the retail spend in the catchment – in fact the retail spend in the catchment around The Glen on our assessment, independent assessment, is nearly 6 per cent higher than the Australian average. What we are aware of is that a number of other landlords around The Glen are looking to attract David Jones to come in as a tenancy, so I suspect there’s some negotiating, posturing in their categorisation of The Glen as a store.
RG: So therefore they only want you to lower the rental price. That’s what that’s about. And will you do that?
SS: Well, I think that for us the negotiation is that we would love David Jones to stay. It’s a great store at The Glen. The Glen is in a very strategic, advantageous position at the junction of two major streets. It has very convenient car parking. It has a multi-level, high quality mall and is anchored by David Jones, as well as discount department stores. Now, we are in discussions with the David Jones company about refurbishing, repositioning and re-energising their store, which has not had a lot of money spent on it for a long period. And we’d very much like them to stay, but again that’s a commercial negotiation with the company.
RG: But will you reduce the price?
SS: Well, I think if they wanted to reduce the footprint, we’d look at reducing the rental, of course. We’d also be willing to contribute to refurbishment of their store and repositioning of their store as we will contribute to the redevelopment of the property. And certainly the local council, the Monash City Council, is very supportive about our potential introduction of hotel operations on the site, serviced apartments. We’ve actually moved out of our office tenancy and we were 180 people in our office tenancy. MYOB are fitting out at the moment to put nearly 500 people into the office tenancy. The actual location is moving very substantially.
RG: Do you think Myer will take it?
AK: I think that’s a no, Bob.
(Laughter)
SS: Well, that’s of course the alternative – or other users that would like to come into The Glen. And we do have a lot of other retailers that see that as a very prime location.
AK: We’ll leave it there. Thanks very much, Steven.
SS: Thank you.