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