Robert Swift presents his views on myths about deflation, Amazon and Socially Responsible Investing, and some folks that died a few hundred years ago.
Prices, bad policy, Amazon, socially responsible investing and Thomas Hobbes – how on earth are they connected and why should I care? Robert Swift
Capitalism works because companies are free to enter and leave businesses. Labour is also free to move from one activity to another. Returns on capital, human and physical, are then mean reverting in that more competition and capital enter attractive businesses and vice versa. The modern version involves government regulation and redistribution but the principles are roughly the same. We would argue that the last 20 years has seen too much government and government agency involvement, and it is that encroachment, including too many rounds of quantitative easing, that is a primary cause of the wealth and income inequality which is in turn the source of so much dissatisfaction.
The natural state of affairs in capitalism is for prices to fall. These falls in prices drive companies to create new products and to do existing things better to maintain returns on capital. Falling prices are good for consumers since their incomes go further. The drive to create new products is beneficial for all because the capital expenditure and R&D, to create new products and services, drives employment and productivity. Real, or inflation adjusted, growth in productivity is strongly associated with dividend growth from equities. Investors receive dividends and should like them to grow in real terms. In summary the whole thing hangs together and while it has occasional problems it has created significant advances for everyone. To mis-quote Winston Churchill, “Capitalism is the worst possible system for an economy, apart from all the others”.
At the moment though there is a desire, by central banks, to create inflation as though this is going to suddenly produce stronger, more equitable and sustainable, growth, more wage increases and generally lead to a much improved future. The argument is that higher nominal growth facilitated by this inflation, will allow us to reduce the burden of the debt relative to the size of the economy.
The truth however is that if inflation returns, and there are clear signs that inflation expectations have returned in asset prices in some countries, then we are actually in for a rough time. It is arrogant to assume that exactly the right amount and the right sort of inflation can be achieved through constant tinkering.
Let’s try and bring some myths about inflation down to earth first.
1 – Deflation is bad…
The first myth is that deflation in goods and services prices is bad. Not true. In a paper from economists at the Bank for International Settlements in March 2015, (Borio et al) they conclude that:
“…once we control for persistent asset price deflations and country-specific average changes in growth rates over the sample periods, persistent goods and services (CPI) deflations do not appear to be linked in a statistically significant way with slower growth even in the interwar period. They are uniformly statistically insignificant except for the first post-peak year during the post war era – where, however, deflation appears to usher in stronger output growth. By contrast, the link of both property and equity price deflations with output growth is always the expected one, and is consistently statistically significant.”
There are other papers out there from existing and former BIS staff and, since they are truly independent from central banks, we believe they are having a prod at what they believe is poor policy.
In short, deflation in goods and service prices is not a problem, but asset price deflation is very dangerous and asset bubbles need to be avoided. Guess what endless rounds of QE have done? Yup that’s right – created a variety of asset bubbles which are now dangerous to prick. You couldn’t have got a worse response to the GFC than a decade of zero interest rates and central bank interference in capital market prices! Well done lads, you have brought about the very condition which under no circumstances should you allow to occur. Not only have you allowed it to occur but you were cheerleaders for it. Enjoy academia and the lecture circuit while we pick up the pieces from the results of your unelected experimentation.
2 – Deflation hurt Japan
The second myth concerns deflation and economic performance in Japan. We have endured endless ‘animated discussions’ about how Japan has ‘suffered’ from years of deflation and it has been a lost 25 years since their equity market bubble popped. All they need in Japan is a little more inflation? This is another myth to be dispelled. Japan has actually been one of the better performing economies when adjusted for demography – it’s not the price deflation that is the cause of low levels of nominal economic growth, it is demography. Once you bother to adjust for demography and for inflation, then Japan has been one of the better performing economies. There have been mistakes but it’s not deflation at fault. Do the same adjustment for the UK and Australia and you get a rather less impressive picture of economic performance. Adding to population will of course grow nominal GDP since that is how the statistics are calculated, but in per capita terms it is not quite so good. You need productivity growth. In the immortal words of Michael Caine “Not a lot of people know that”. Using Japan as an example of the perils of deflation is mistaken.
3 – There is no inflation…
The 3rd myth we want to dispel is that there is currently no inflation. There is and worryingly it is in the form of inflation expectations for asset prices, especially in those countries most burdened by debt. Once inflation expectations are rampant then it typically requires a nasty recession to bring them back. The places most indebted are also most likely to have a problem if things go ‘phut’ since their currencies are also likely to come under downward pressure which will trigger further inflation. They really actually do not want inflation expectations to build further! Many official inflation indices exclude property and asset prices and consequently central banks and politicians turn a blind eye to clear evidence that asset bubbles are forming because there is no visible evidence of a problem. It is always ‘someone else’s problem’ and asset bubbles get ignored. Thankfully this time round USA banks are going to be better at self-regulating and we applaud reductions in auto loans as an example but really, you do want your civil servants to be better, smarter, and braver. More of that when we refer to Thomas Hobbes later.
Amazon
So why do we have a problem with Amazon, or rather the system that has allowed Amazon to flourish? It has been responsible for driving down prices and driving a lot of physical retailers to the brink. It has been a spectacular success and all credit to them. If we believe goods and services deflation is a healthy aspect of capitalism then why does Amazon concern us? “OK”, says almost everyone, “so you like price deflation then why is the price deflation threatened by Amazon so bad in your eyes, and the stock prices of supermarket companies is justifiably walloped when Wholefoods, now an Amazon supermarket, cuts prices?” If Amazon did indeed create a better strategy, then other companies need to learn to fight back or, replace management who can or, be replaced by companies which can. This is true.
We actually think that Amazon is a great business but that its success lies less in its skill and strategy and more in its tax planning and the inadequacies of the current corporation tax system. Amazon pays a fraction of the corporation tax that its competitors pay and consequently has more retained and free cashflow available to reinvest back into a price reduction and volume strategy. Its tax policies are common practice and there are many versions, but it is currently legal and produces remarkably low rates of tax relative to headline rates and to what their competitors pay.
It is the absence of a level and fair playing field that concerns us. Once the high street retailers decide they can’t compete and close, then local municipalities lose their revenues from the tax base and the multiplier effect means other business on the high street suffer too, such as cafes and restaurants. Amazon is the Death Star in retailing propelled by clever tax planning and the tacit support of bureaucrats who need to wake up and be braver in changing and uniformly applying policy.
Until this anomaly in taxation is removed there will be no level playing field and the creative destruction of capitalism will be mostly destruction because of the inability of competing firms to fight back while hampered by unequal taxation and less retained cashflow. A global arbitrage whereby larger companies can pay minimal tax hampers smaller companies which cannot do this and the importance of smaller companies in providing employment is well documented. We are on the way to a monopoly in certain areas of economic activity because our civil servants haven’t woken up to the need to bring accounting and policy into the internet era; if they are awake they aren’t brave enough and they are not performing their part of the bargain in what is known as the Social Contract. This will also be referred to later under Thomas Hobbes.
We would actually prefer all companies paid less tax but if you do want to raise tax from corporate activity, at least make it roughly equal and then companies compete on innovation, service, value for money, and execution of strategy? That is capitalism but what we have right now is biased.
We find it bemusing that Australian investors can be so keen on Socially Responsible Investing Principles (SRI) and see no problem with divesting from coal mines, that provide employment, on the basis that is anti-social, yet remain invested in companies that are frankly anti-social in their active and complex planning to avoid paying what everyone else does. This non-payment of course places a burden on either others to pay more or services to be cut. Does no one else find the Google BHAG “Do no evil” ironic?
Governments love bribing you with your own money and so like raising lots of it. We suspect that governments desperate for revenue, will be looking at non payment of tax in quite a lot of detail. We would prefer they went after companies rather than individuals because we as individuals already pay quite a lot, but that requires bravery. This is a serious risk to Amazon and other companies, and let’s hope our bureaucrats and politicians wake up to the internet era, and to their role in the Social Contract.
So finally, who was this Thomas Hobbes fellow we have referred to above, and what did he say? What is this Social Contract? He was a philosopher who lived in the 1600’s which in the UK was quite a time of political change when the King was beheaded and Parliament declared supreme; to be followed by the restitution of a reduced monarchy. His argument was that individuals should cede some of their rights to a collective, the State, in exchange for sensible regulation and protection. This came to be known as a ‘Social Contract’ and the idea was developed by others such as John Locke and even by a Frenchman Jean Jacques Rousseau in the 1700s. (The latter had the quaint notion that ordinary people didn’t know their real will and required a supreme Legislator to tell them what they really wanted. And there you have the source of the clash between the French and the Brits today over the EU, the EU Commission, and Brexit and what democracy really is!)
The point about the Social Contract is that it is a deal whereby citizens believe that their elected (and unelected) legislators will be looking out for them. No one likes to feel they are stranded at the bottom and especially not that their children will not be better off than they. If this social contract continues inviolate then the system of capitalism will carry on with the occasional hiccup as it has for a few hundred years. If this contact is broken and the bureaucrats stuff up with very poor policy and/or become beholden to the corporations, then we are in for a problem. We fear this contract is at risk and this is the source of the political changes (or ‘populism’ if you are a ‘liberal’ and want to sneer). We believe folks have been quite patient but have finally snapped and that we could see either a return to sensible policies or something more dangerous. We currently look at the capital markets, wealth inequality; economic and social policy and give the bureaucrats and politicians a ‘Fail’ grade. We wish them to stop trying to set asset prices. We wish them to bring corporate regulation and policy up to date so we have a level playing field. We wish them to reduce social engineering and create equal opportunity but not equal outcomes. Once they have done that – we wish they would then make themselves invisible. As Ronald Reagan said “Government isn’t the solution, it’s the problem”
And that is how we managed to mix our views on myths about deflation, Amazon and Socially Responsible Investing, and some folks that died a few hundred years ago.
As a small cap portfolio manager we are in the business of investing on behalf of others. While investing may be a simple concept it is never easy in practice. We highlight a number of key lessons we have learned over the past decades that you can apply to managing your own portfolio.
“Ultimately, nothing should be more important to investors than the ability to sleep soundly at night.” – Seth Klarman
Lesson 1: Focused portfolio strategy
Whether you are a professional or part time investor, the key take away we have learned over the years is that you always need a plan. This plan is what we like to call our investment strategy and our investment process is the discipline we use to successfully achieve our strategy. One of the great benefits of having a focused and disciplined process in place as a portfolio manager, is that you are always somewhere on the investing learning curve. This means you are constantly learning from your mistakes and working against your emotions to ensure that you are benefiting from the market’s behavioural biases, rather than following the herd and falling into the same traps. Your mistakes and successes should continuously be incorporated into your process.
Without a plan or a documented process, it is hard to maintain focus on what you are trying to achieve. It is arguably more challenging for individual investors to find the necessary spare time and energy required to consistently maintain this discipline but it is vitally important to your success as an investor.
Lesson 2: Risk controls
As a professional investor we believe you always need to consider a worst case scenario in order to have the appropriate risk controls in place:
We have met many great individual investors who are no doubt well versed in risk control, but in our experience controlling risks tends to be a lower priority for the vast majority of individual investors as it is arguably the least “fun” part of investing. As an investor you should work on understanding your risk environment and whether your comfortable with this in the context of the returns you may be able to generate. For us, the portfolio management team, our key focus is avoiding capital loss as this is what we define as our key risk. What is your key risk?
Lesson 3: Understanding management exposure
In our experience, getting to know and understand management makes a significant contribution to understanding the fundamentals of a business. This is not a case of receiving non-public information, it is a case of understanding the thinking behind management’s strategy and vision for a business.
As portfolio managers we have the resources (and time) to access management for one-on-one meetings, and to attend management roadshows and presentations. These opportunities may not be generally available to individual investors however this may be changing as technology improves information and digital access is becoming increasingly available. At the very least you should have an understanding of who the management team is, their history on delivering on their stated objectives and what their forward looking plan for the business is.
Lesson 4: Stress Less
The feedback we generally receive from investors is that they find investing stressful at times. In small cap investing this could be for a number of reasons:
The universe is enormous with well over 2,000 ASX listed smaller companies to pick from;
Many smaller companies are concept stocks and don’t have revenues or earnings which makes valuing these businesses challenging;
It takes a lot of time to truly remain on top of how a business is evolving over time.
As discussed above, by having a focused strategy and process for investing as well as understanding the risks you are willing to take on, you are able to reduce your stress levels. We have learnt over the years that by accepting you will make mistakes and having a process in place to minimise the negative results of those mistakes you are able to invest with a clear and focused mind. Your other option is to find a professional investment manager to carry these stresses for you.
Lesson 5: Understand Liquidity
We are all aware that markets can remain irrational for longer then we would normally expect. However sometimes we all need to exit our investments due to unforeseen events. When this happens it can be challenging to know when to sell a holding given stock prices tend to move around. By having a clear understanding of the liquidity profile of your investment and having a plan to deal with unforeseen circumstances you will be able to improve your investing results.
Conclusion
While we have been professional investors for decades, we acknowledge that when it comes to investing you are always learning. It is important to keep an open mind, learn from your mistakes and always challenge the commonly accepted thinking of the day. As we have said on many occassions you need to remain actively engaged with you investment portfolios to ensure the best outcome. If you would like to discuss how TAMIM can help you with this process please feel free to contact us via phone or email.
Remember the Tech Media Telecom (TMT) bubble of the late 1990s? Australia didn’t participate because of an absence of such companies on the ASX, but elsewhere it produced a frenzy of deals and some ludicrous valuations which mostly came unstuck. Although it eventually got out of hand with crazy valuations, and a subsequent bursting of the bubble, there was clear logic to the excitement it generated. Much of the infrastructure we use today, and some of the companies we know today, were built and cut their teeth, during the TMT bubble and subsequent burst.
So you’ve sold Telstra… Now what? Robert Swift
Indeed, with the advances in smartphone technology and the growing importance of social media these forces have only strengthened. The younger generation especially expect to find TV, internet, video and social media all on a smartphone and delivered in one bundle or billable package. Latest evidence shows that the younger generation rarely watch a large TV in the home! Furthermore, further pressure has been put on incumbent telecom providers in most western markets, as regulators have forced them to share their infrastructure with other potential telecom providers.
Party like it’s 1999?
Due to this demand for bundling, and the downward pressure on margins imposed by the regulators, corporate deals have been on the rise – TV providers moving in to Telecoms (Sky providing internet, mobile and fixed line services) and Telecoms providers buying media companies (AT&T buying DirectTV and trying to buy Time Warner; Verizon buying AOL and, eventually, Yahoo). Just recently there was a bid for Scripps Interactive (owner of such awesome entertainment as The Food Network and Travel Channel) by Discovery Communications (Animal Planet). This brings a female and male content provider together in a cable TV package but it is not going to be enough to save the Cable TV business from the threat of a better internet and the 5G buildout by AT&T and Verizon and other Telecoms. In all probability, once this Scripps deal is consummated, it will make the enlarged group an even more attractive target for a Telecoms or Social Media giant company to acquire. Even a sector giant like Walt Disney with a market value of US$172bn cannot be immune given its relatively modest valuation these days trading on 16x earnings for next year. We note with interest that Disney have just told Netflix that they are no longer going to be an offering on the Netflix platform. It seems that content providers now have more choice as more platforms gear up, or it may be that Disney have just stated they are willing to talk strategically to all comers as an independent content company?
Deals cost
We also understand that Apple and Google are talking about an increase in price of $2bn for the iPhone to use Google’s app as the default for search. In 2014 Google paid Apple $US1bn for this! Some price increase! Verizon’s purchase of Yahoo may have been brilliant IF (and a big IF) they can reinvigorate that community to monetise it.
It’s not just party time in the USA. SKY in the UK, which owns satellite TV platforms in the UK and a number of other countries, and also moving in to mobile, fixed line and internet services, is currently in the middle of a takeover from Rupert Murdoch’s 21st Century which already owns just under 40% of SKY. Liberty Global (USA) continues to raise its stake in ITV (UK) and is widely seen as a prelude to a full bid. Altice, the large Dutch based telecoms operator, is rumoured to be looking to put a bid together for Charter Communications which is the 3rd biggest pay TV company (Spectrum) in the USA serving 25m customers.
Great content costs! Look how much Sky TV in the UK has to pay for premiership football rights – over £4bn for a three year deal! So, to pay for great content, you need scale and deep pockets! A large potential customer base with sufficient discretionary income is scale. You also need a strong balance sheet or high free cash flow to be able to finance such a deal and continued investment in the infrastructure.
It appears that there is more activity building in the TMT space. Given that investment bankers all talk the same concepts to the same companies it is likely these deals continue. This time the Telecoms companies seem to be on top of this and are aggressively playing in this space to become more vertically integrated. We believe these Telecoms have the distribution bandwidth, the customers from their telephony business (fixed line and mobile) and, are now hunting for content – think Optus buying the rights to live broadcast of the English Premier League football in Australia – to add more services to existing customers, more subscribers and, most importantly, the advertising $.
A second chance for Telecoms?
When we think back to what the incumbent telecom companies owned, what resources they had, and the strength of their balance sheets in 2000, it is extraordinary to think that they let the likes of Facebook, Google and Netflix in and to take from them so many potential subscribers and advertising $. These Telecoms had a vast customer database on which much detail was known, they had a comprehensive billing system that dealt with millions of customers, they had a network of engineers on the ground, and a high street presence through the mobile telephony shops, and they had the technical infrastructure to deliver a wide range of services. They also had great cashflow from their business and nicely mixed the need for dividends with acquisitions, debt repayments and capital expenditure. They still have these attributes and while they were asleep at the wheel they are not now and the competition with Google, Facebook and Netflix is hotting up. Given the discrepancy in P/E multiples between FANG stocks and Telecoms, we think that some telecom stocks especially in the USA are an attractive proposition right now. They have the bandwidth, the hardware, know the customers directly, and good technicians. They just perhaps need a new management culture to deal with this opportunity?
Meanwhile in Australia…
So where does Telstra the Australian incumbent fixed line and wireless company go? Can it join this revolution? Probably not without cutting its dividend (as it has done today!), or using leverage on its balance sheet, or, entering a JV. It actually has a big problem. Its dividend yield may be high which is attractive to investors, but as a result it has little money left over, or limited retained earnings, to expand organically. Also, its home market is small in comparison to say the USA or Europe and therefore it has fewer potential subscribers in which to spread the cost of expensively acquired content. Its home market is also fabulously competitive in both fixed line and mobile telephony so margins are under pressure and the new National Broadband Network (NBN), which is effectively Telstra’s own infrastructure is now open to all entrants. Telstra will have to compete with new comers on content and service but has no free cash flow after the dividend to pay for content or build a community to be monetised. Despite its attractive high dividend yield Telstra has significantly underperformed both the Australian stock market and its global telecom peers, as investors have recognised its limited scope to grow. Of course, it can continue to buy in rights to content but it is more of a price taker in such situations.
For a full delivery of a range of services you need the technical capability to deliver the media (which the Telecom companies have), the content itself (which the pure media companies like a Disney provides), and ideally then end distribution mechanism (a TV channel or these days just the internet will do). These developments look a lot like a move to vertical integration, which is a logical strategy given that ‘net neutrality’ laws may be revoked in the USA, allowing an internet service provider to narrow the range of services and content via its portal to only those subscribers it bills.
So, there is a lot of activity in this whole TMT space right now across the globe throwing up lots of potential investment opportunities. As more deals get done it will put more pressure on those who haven’t participated, who feel sub scale and vulnerable, and force them in to doing deals. Sadly, Telstra is being left behind and Australian investors need to be looking to their global equity portfolios for quality exposure to the TMT sector.
As mentioned last month, with reporting season in full swing, we will address the trading outlooks and our expectations around the upcoming results for some of our core holdings. Last month, we discussed Pioneer Credit, Fiducian and Zenitas, whilst this month we will focus on Apollo Tourism and Leisure, Elanor Investors and Konekt.
ATL is a leading integrated, global player in the RV (recreational vehicle market) – manufacturing, importing, retailing and renting RVs in Australia, NZ, United States and Canada.
The company was recently profiled in the Australian.
In early May, ATL provided a strong trading update, expecting FY17 NPAT to be between 5% and 10% above its forecasts. Management commented that forward rental bookings were ‘looking positive’ in all geographies, with bookings for the upcoming USA season tracking ahead of last year. In relation to ATL’s retail operations, Management noted that continued growth in new vehicle sales was expected in Australia and New Zealand, particularly for the Adria and Winnebago brands.
We believe beating the company’s prospectus forecasts will give the market increased confidence in the ATL strategy. Growth into FY18 for ATL will be supported by earnings contributions from its recently acquired Australian caravan and motorhome retail operations and its new wholly-owned Canadian RV subsidiary, CanaDream Corporation – one of the largest RV rental and sales companies in Canada. Both acquisitions are expected to be earnings accretive in FY18. Ongoing tourism growth from ATL’s key markets, particularly Europe, and increased RV fleet utilisation is expected to result in strong profit growth for ATL in FY18.
During FY18, to support its Australian retail RV footprint, management expects to relocate it Brisbane manufacturing facility to larger premises, resulting in an incremental ~$1m operating cost in FY18. This incremental cost will diminish in future years when the existing facility is fully exited. Notwithstanding this additional FY18 expense, ATL continues to trade on an undemanding multiple for a growing global company of ~12x FY18 earnings.
Konekt provides workplace health solutions, helping organisations prevent workplace injuries and minimise the impact of workplace injury costs by assisting injured employees return to work. KKT is an Australian market leader (~11-12% market share) in a very fragmented market.
In May, Konekt confirmed its revenue guidance in the range of $51.0 to $53.5m and EBITDA margin in the range of 10.5% to 11.5% (of revenue).
In H117 KKT recorded revenue of $26.3m at 11.3% margin and noted it was well positioned going into 2HFY17 with some good momentum across the business. We would expect a result at the top end of guidance which implies earnings per share of c. 5 cents. This places KKT on a price/earnings multiple of c. ~11x FY17 earnings.
We do not think that is demanding pricing for a market leading national business, very well led by Damian Banks, and with a strong track record of very high earnings growth (EPS was just 1.4 cents in FY14). The business has the potential to take further market share in a fragmented market and/or expand its range of service offerings to become a diversified corporate health provider. To drive organic growth, KKT continues to open new offices (to add to its existing network of 40+ services) and to offer to existing clients a wider range of services (ie workplace mental health).
Notwithstanding a significant CAPEX program undertaken for FY17 (approximately $1.8m), KKT’s free cash flow and acquisition funding facility of up to $10m positions it nicely to take part in industry consolidation and provides further potential upside to organic growth. Given the sector consolidation, KKT also may be seen as an attractive takeover target itself at some stage.
Elanors Investors (ENN.ASX)
ENN guidance: not provided
TAESC estimate of core earnings: $12.3m
(FY16 Earnings: $11.6m)
Property and hotel fund manager and investment company, Elanor Investors, is a portfolio holding where we are expecting a small increase in earnings for the year, but a weaker earnings per share result relative to the prior year due to share issues during the year. While ordinarily this would be concerning, for the reasons set out below, we believe ENN now represents compelling value for investors.
After a strong first half where ENN delivered a record result on the back of significant performance and acquisitions fee, ENN’s second half will be softer with reduced contributions from performance and acquisition fees.
However, based on a market update in June, as a result of recent valuation uplifts to its hotel and tourism assets and the mark to market of a development asset, ENN’s underlying net asset value is now approximately $2.00 per share, almost equal to its current share price.
What this means is that the market is essentially valuing ENN based only on the value of its hard assets (its hotels and property investments and some minor non-core assets) and is attributing almost no value for ENN’s actual ‘operating business’ – its highly regarded fund management operations.
This fund management business currently has $700m funds under management, and generated segment EBITDA of $8m in FY16 and $7.8m in H117 (driven by $5m in performance and acquisition fees), and has significant leverage to ongoing FUM growth and significant potential performance fees. ENN management are optimistic about converting their strong pipeline of new fund initiatives which should support growth into FY18 after a relatively quiet last 6 months in terms of FUM initiatives and divestments.
As value investors, we believe that this represents a compelling value opportunity, and we like the ability to buy a share of a high quality funds management business with a top class management team for next to nothing. Catalysts to potentially unlock this value include the sale of non-core assets, new fund initiatives and asset realisation / generation of performance fees.
Note: All three stocks mentioned here are currently held in the TAMIM Australian Equity Small Cap IMA portfolio.
Australia has a love affair with property, however you can’t go a week without seeing a newspaper headline proclaiming the next property crash. The low level of global and local interest rates over the last 9 years has caused property prices to go up significantly due to low financing rates and investors searching for an investment vehicle to provide them with a better yield then they are able to receive from the banks. The apparent benefits of property are good long term return potential.
Generally property is an asset class with lower levels of volatility and when added to an existing portfolio of shares and bonds it is an excellent diversifier of overall portfolio risk. Headlines, as always, are dangerous as they are designed to sell newspapers and don’t provide the full picture. With property (as with equities) there are a large number of factors to consider. This includes the ever important location, location, location as well as the yield on the property. You also need to consider which sector of the property market you are looking at, is it residential housing? Commercial buildings? Industrial factory space? Or retail shopping centres to name a few. At TAMIM we are constantly researching investment markets for opportunities to deliver returns to clients and over the next few months we will be sharing our thoughts on investing into the various property sectors starting with retail.
There are a lot of significant factors that impact the performance of a shopping centre be it regional or metropolitan.
Anchor tenant:
One thing that is noticeable is that the performance of the anchor tenant be it a supermarket or discount department store has a very strong bearing on the overall returns of a shopping centre. The anchor tenant can, amongst other things, be impacted greatly by opening hours, the range of goods on offer, the price point, and the ratio of car parking. This, logically, can impact the performance of the adjoining specialty stores. If customers visit the centre for their staples then the surrounding stores will, in turn, benefit from increased foot traffic.
Catchment Areas:
As can be expected, the retail sector will always face cyclical and structural economic issues. Several cyclical issues are beginning to move in the sectors favour. With strong growth in four or five sectors and dwindling numbers in four or five other sectors, employment is a cyclical issue significantly impacting the performance of any given shopping centre. The jobs gained and lost are not necessarily in the same locations. It follows that certain catchment areas are doing better than others.
The catchment area for the shopping centre impacts the performance of the centre. Accessibility (i.e. the surrounding road system and the actual points of access to the centre) is a factor while location in relation to competing centres is also important when projecting performance. As you can imagine, the size and demographic (age etc.) of the population as well as the potential for its growth in the long term can have a material and critical impact on performance. In today’s world, with greater fluidity of the global population and increased levels of immigration, ethnic factors are increasingly playing a role in determining the performance of shopping centres too.
Demographics:
Continuing this discussion around employment and catchment areas, the size and shape of the workforce has a weighty influence on retail property. Wages dictate spending and jobs roughly delineate catchment areas. Australia is one of a small number of countries that have enlarged their workforce over the last ten years. The Australian workforce continues to grow in size while unemployment creeps lower. This has occurred in part because growth in wages has been borderline stagnant allowing for the hiring of more workers than may otherwise have been the case. Inflation in asset prices has boosted household wealth despite household income growth being restrained. Growth in household disposable income remains below average despite positive contributions to household spending capacity coming in the form of increasingly low interest rates, depressed petrol prices and increased comfort regarding job security.
Spending patterns:
It appears that changes in consumer spending patterns in the last decade have had a negative effect on apparel, department store, and discretionary retailing turnover in general. This has affected tenants in many regional and some sub-regional centres. Many sub-regional shopping centres have been immune from this though. The turnover statistics from ABS in the table below show robust growth over the long term in many of the significant retail categories found in your average shopping centre. Supermarkets have been seeing solid turnover growth as have the liquor stores that come under their stable. Discount department stores dealing in discount clothing, electronics, and household goods including furniture have also been experiencing decent turnover growth. Specialty shops associated with shopping centres such as bakeries, chemists, newsagencies, take away food stores, and other local service providers such as dry cleaners may be in the tenancy mix too.
Source: Savills
The Amazon factor:
In addition to these broader issues, there is the imminent arrival of Amazon on our shores to consider when looking at retail property. There is no doubt that Amazon arriving here will have a significant impact on retail. Having said that, there will be a grace period of sorts before the impact is truly seen. Amazon will need to set up the infrastructure they need to properly compete with shopping centres and follow that by winning over the trust of the Australian public before taking significant market share. In looking at the entry of Amazon to the Australian market one must also consider that regional and sub-regional shopping centres will unlikely be affected anywhere near as quickly or as much as those located in the major cities as Amazon will look to establish itself and win over major population centres like Sydney and Melbourne ahead of places like Newcastle or Ballarat. To this point, Amazon recently confirmed it will open a 24,000 sq metre warehouse in Melbourne’s Dandenong South.
The Trend for 2017:
Smaller stores are in; larger stores are out.
Changing consumer preferences will push more and more “big box” retailers to focus their attentions on smaller-format stores. Less is more in 2017 when it comes to store size. Retail giants such as Target, Best Buy, and Ikea are already adjusting to this trend by increasingly spending on smaller-format stores instead of their traditional borderline-warehouses. The importance of convenience and accessibility in todays world of instant gratification is key to understanding why shoppers are moving away from larger stores. People just don’t want to waste their valuable time roving the never-ending aisles of huge stores these days. They want things to be made easy for them with smaller stores offering specialised selections. Additionally, smaller stores cost less to establish and run. They also take up less space in urban environments which allows retailers to capitalise on the potential of more densely populated areas.
“Retailtainment”, as may be evident from the name, is the combination of retail and entertainment. The concept is a concerted effort by retailers to offer shoppers a fun or unique experience that incorporates lifestyle elements into their stores. Things like boutique coffee offerings or reality experiences that are more likely to engage retailers and keep them coming back for the shopping experience. For an international example one can look at Fortnum and Masons, a department store in Piccadilly in London. The 3rd floor has been transformed from menswear (which is offered in overabundance in other local outlets) to a cocktail bar.
The opportunity:
The structural issues facing retail property can be formidable but certainly not insurmountable. TAMIM anticipates that the retail sector will evolve to take advantage of these structural issues rather than be over-whelmed by them. An ageing population will not stop creating challenges for the retail space as they compete for the all-important spending of retirees. Retirees can usually be expected to show preference for services over goods and will not necessarily continue to dwell in their traditional catchment areas. Online shopping has already had a great impact on retailing for certain categories of goods and, with the imminent arrival of Amazon, it will no doubt continue to present challenges for the sector. Retail has already been forced to begin adapting without the world’s biggest player arriving and will continue to do so. Certain areas, notably regional and sub-regional centres, will likely hold out longer and more effectively than their metropolitan counterparts.
