Readers of TheBull.com.au will recall I had a contrarian view on retail stocks and listed retail property trusts last year when the sector was on its knees. Several retail stocks have rallied this year and Westfield Corporation agreed to a $32.8 billion takeover in December.
That is not to downplay the immense challenges facing retailers or their property landlords. Technology-driven disruption will kill more retailers, reduce demand for shopping-centre space and pressure landlords to lower rents to maintain tenant bases.
Dozen of retailers plan to close hundreds of stores at shopping centres in Australia. Handbag chain Oroton Group is the latest insolvent retailer that will demand hefty cuts in rents to remain at shopping centres, lest it walks away from leased properties. 
Recent Macquarie Research suggests up to 1,000 possible retail-store closures. That’s bad news for shopping-centre owners forced to renegotiate leases or cut rents. 
Then there’s the closure of discount department stores at shopping centres across Australia. Myer, Big W, Kmart and Target have huge store footprints, but the future of some of these stores is uncertain. They are big tenants for shopping-centre owners to lose.
The threat of store closures weighed on retail property trusts such as Westfield Corporation, Scentre and Vicinity Centres. Analysts argued that growth in online spending would shrink demand for physical shopping-centre space – a growing trend overseas.
I was less bearish for three reasons. First, the big shopping-centre owners had maintained tenancy rates and rental yields despite the consumer slowdown and the effect of online retailing. Retail-property owners looked a smarter way to play the recovery than retailers. 
Second, retail leases, particularly for discount department stores, are costly and time-consuming to exit. Some discount stores find it cheaper to maintain underperforming stores in shopping centres than exit their lease and pay shop-fitting removal costs and the like.
Moreover, top shopping centres have a long queue of potential tenants. Notice how upmarket furniture and other homeware stores are emerging in shopping centres and absorbing lots of space. Much could be done with old Myer or Target stores. 
Third, the so-called “fortress” shopping centres are fabulous assets that are hard to replicate. As I have written for The Bull previously, the top shopping centres in capital cities, here and overseas, are retail destination experiences and are benefiting from a changing mix of stores (more dining outlets and services, for example).
New fortress-mall developments will have residential, office and hotel accommodation, and many more leisure and service outlets. They will be more like suburbs and town centres than traditional shopping malls with a few big anchor tenants and lots of small shops.
Nevertheless, investors need care with retail property trusts. The power imbalance between retail landlords and tenants will not last forever. Growth in online retailing will surely spark other casualties and intensify pressure on even the best centres to lower rents.
My strategy in retail property has been to stick with owners of fortress (a-grade) malls and avoid those with second-tier shopping centres. Suburban centres that sit between neighbourhood malls, which have an anchor grocery store such as Woolworths and a dozen or so shops, and fortress malls will be increasingly challenged by online retailing.
Westfield Corporation, a favoured retail-property idea of mine last year, shows the value in fortress malls. Some say Westfield’s sale was a sign that retail shopping centres have peaked. I believe the evolution of fortress malls has a long way to run.
Scentre Group is an option. Created through the 2014 merger of Westfield Retail Trust and Westfield’s Australian and New Zealand operations, Scentre owns 39 shopping centres worth $33.6 billion. Several of them are among the largest in their city.
Scentre has fallen from a 52-week high of $4.58 to $4.07 in line with the broader sell-off in retail property trusts and weakness in the retail sector. Like other shopping-centre owners, Scentre is facing a slowing sales environment and pressure to maintain occupancy rates and costs.
Scentre has a good pipeline of development opportunities and is doing a good job of remixing its assets in areas such as Sydney’s Bondi Junction. Notice how established tenants are moving more often within prime shopping centres, to maximise store performance, and how new retailing names are taking up space. Done well, these initiatives can partly offset retail weakness.
After falling in the past few months, Scentre’s price more than reflects its challenges. A 12-month price target of $4.49, based on the consensus of 12 broking firms, suggests Scentre is a touch undervalued. Macquarie has a $4.51 target.
With an expected yield of around 5 per cent, the total return for Scentre over 12 months could be about 15 per cent, based on the consensus forecast. The return will be higher if the recent bounce in retail sales growth proves more than a one-off and the economy strengthens.
Scentre will not star if consumer lethargy persists and more retailers becoming insolvent because the migration to online shopping, requiring less space. But it is a higher-quality stock that looks modestly undervalued – provided contrarians can hold it for at least a few years. 
Technical analysts will look for Scentre to stay above $3.85-$3.90 – a band of previous price support.
Chart 1: Scentre GroupSource: The Bull 

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• Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. It has been prepared without considering your objectives, financial situation or needs. Before acting on information in this article you should consider the appropriateness and accuracy of the information, regarding your objectives, financial situation and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at January 16, 2018.