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Think Big - AREITs

By UBS (Pat Barrett)Market OverviewMar 14, 2017 15:00
au.investing.com/analysis/think-big---areits-200178754
Think Big - AREITs
By UBS (Pat Barrett)   |  Mar 14, 2017 15:00
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Originally published by UBS Asset Mangement

Donald Trump once said, "If you're going to be thinking anyway, you might as well think big.” Channelling that logic, this edition will cover some of the contentious issues such as the impacts of Amazon.com Inc (NASDAQ:AMZN), Snap Inc (NYSE:SNAP) and housing affordability.

We attended a call with Rick Moritz, the former Director of Worldwide Product Management for Amazon.com, who outlined the overseas experience and what it means for Australian real estate. Pleasingly it wasn’t as shocking as expected.

Amazon

Amazon simply works with retailers to distribute their product, with their stock having IPO'd in 1997. It is estimated that Amazon accounts for ~5% of US consumer expenditure, up from 3% in 2014 and estimated to grow to 7% by 2018. The crux of the model is the 'flywheel', where sales speed up over time until they pass the 'moment of inertia'. Amazon starts with a few sellers with low prices (some loss-lead) to attract customers, then sales volumes increase to a point where more sellers participate and prices get lower, then sales rise further and even more sellers step forward, etc. By purchasing on-line the prices are estimated to be ~30% lower than a bricks and mortar retailer because you don’t have to cover rent and all the labour costs. In return suppliers pay Amazon a fee. Suppliers can either pay Amazon an advertising fee, or you can upscale and use Amazon's supply chain (more fees), or if you're a top seller Amazon might purchase your goods directly (as inventory) and on-sell them. Amazon prides itself on quality and reliability and each seller has to meet certain standards. They monitor every transaction with bad reviews or quality impacting a 'sellers scorecards'. Amazon has order defects <1%. When compared to items emanating from other e-commerce operators, Amazon is a trusted brand and you can return items with ease. That's not the case with many other e-commerce operators. The speed of delivery is a crucial point of difference. In the key cities they are aiming at 30 minutes for some items, which is quicker than getting to the store and selecting the goods! Rick mentioned how each country's model has to be adapted depending on infrastructure and density, with deliveries in India for instance going to the local convenience store.

Rick also talked about the way Amazon is influencing consumer behavior, with Amazon Prime a clever initiative. For a small fee per month (~US$10-15), customers get guaranteed two-day shipping, unlimited deliveries with no minimum order size. In select metro areas, Prime members get same-day delivery on over a million items and two hour delivery with Prime Now on daily essentials and groceries. Members also get access to Prime Video (popular movies and TV shows), over two million songs via prime Music, audio series via Prime Audible, video games via twitch Prime and the list goes on. Once you're on the flywheel, it's hard to get off.

Although Australians have been able to access Amazon goods for a while, this has been done via the US with the exchange rate impacting our purchases. It now appears that Amazon will be rolling out their model to our shores, with recent job ads looking for IT, marketing, sales and HR. There's explicit reference to work on Amazon Fresh, which is their grocery offering. Anecdotally, Amazon has already sounded out local agents and operators with requirements for distribution facilities ~100,000m2 around 30 minutes from major cities. East coast looks like it'll be the initial focus and they likely won't be ready before 2018 given build times, staff hiring and training. The big winners will be industrial landlords like Goodman Group (AX:GMG) who have already developed fulfilment centres for Amazon in the US (Eastvale), Germany (Leipzig) and France (Lauwin Planque). In terms of the last-mile delivery, don’t be surprised if the local service station is used as a collection point (Viva Energy Reit Ltd (AX:VVR) would benefit), or maybe a fast food operator with large coverage (Domino’s Pizza Group Plc (AX:DMP) or McDonald’s Corporation (NYSE:MCD) or KFC). It may be that drones use such local locations as a base for home delivery.

Amazon's arrival is reasonably good news for local employment, with the fulfillment centres requiring staff, albeit robots are also required. In Goodman's Eastvale property (California), the 100,000m2 facility would traditionally require ~5,000 workers but this time they have 2,000 staff and 2,000 robots. In fact, one article suggested that Amazon now has 45,000 robots across 20 fulfillment centres (source: The Seattle Times). Kiva's systems robots (they bought the firm in 2012) automate the picking and packing process at large warehouses and although only ~40cms tall, they can haul packages weighing around 300kgs. Then there's the robotic arms moving pallets.

Amazon's entry will no doubt impact the retail landscape, with price deflation to continue. However the impact will be a slow burn given the lack of relative population (24m vs 1bn in China), lower densities and vast distances to travel between major cities. The cost base is higher here due to those factors. We are not an ideal market and that's why it's taken 20 years to get here. Their entry will further impact department store sales albeit most of the damage has already been done, with major landlords happy to work with them to reconfigure / downsize their tenancy. Shopping centre owners have constantly adapted to changes in the retail landscape and will continue to do so. There's been a lot of noise about Amazon Fresh (fresh food), but I'm not too concerned medium term given how hard it is to set up. As Coles and Woolworths Ltd (AX:WOW) have proven, you need massive refrigerated premises and a proven delivery system. Then there's the issue of quality control with every delivery seemingly containing a bruised piece of fruit! In other cities the market share is <2%. It won't help the supermarkets but I don’t think it will destroy them. Pay-TV operators on the other hand should be nervous about the freebies on offer from Prime Video/TV/Radio.

Snapchat

Another big event was the successful listing of Snapchat. From US$10 to $24 on opening, and for a company with no earnings! One analyst from Aegis Capital Corp listed eight concerns, namely:

"Our concerns about Snap’s business and upcoming stock are eight-fold:

1) slow user growth and no growth in some regions – same issue with Twitter Inc (NYSE:TWTR);

2) the ease by which Facebook Inc (NASDAQ:FB) has been replicating parts of Snapchat’s product across its ecosystem – perhaps our most focused concern;

3) Snap’s lack of an ecosystem;

4) the ad mix is heavily weighted towards brand versus direct response;

5) ad targeting capabilities are inferior to Facebook’s and Google's (NASDAQ:GOOGL), and marketers cite analytics as a weakness relative to Facebook;

6) a large percentage of advertisers view Snap as experimental spend – similar to Twitter at the time of its IPO.

7) lack of a clearly defined path towards profitability, and

8) corporate governance – investors have zero control."

Despite those concerns, Snapchat now has the same market cap as Woolworths, which makes $1.5bn net income and $60bn in sales. Or if you want diversification it's the same market cap as AGL Energy Ltd (AX:AGL), Insurance Australia Group Ltd (AX:IAG) and Tatts Group Ltd (AX:TTS) combined, which make $1.7bn net income and $25bn worth of sales. Next time people say REITs are trading expensive think about Snapchat.

Housing Affordability

It's good to see the Treasurer being pro-active about the issue via the Affordable Housing Implementation Taskforce. A rational housing affordability strategy is in everyone's interest, however, it won’t happen anytime soon. You can tinker with taxes (lower stamp duty, change negative gearing), tinker with grants (FHB and downsize grants), tinker with lending to the private sector and rates (banks raise margins, RBA lifts rates, APRA tightens controls), tinker with supply (zoning and approvals) or tinker with demand (cut immigration). It's a very complex system with lots of self-interest. Local councils rely on the rates to fund works, the state governments want councils/developers to pay for infrastructure, all governments want population growth for more taxes, the banks want growth, the RBA doesn’t want to disadvantage the West Coast, a government that negatively impacts house prices will be voted out, etc. The list is endless. Anyone who thinks there's a quick fix will be disappointed. The WA election has seen the Coalition propose a grant for seniors to downsize, following the SA governments footsteps (anecdotally called the 'last home buyers grant'). Short term I don’t think REITs have anything to worry about in terms of changes, in fact better affordability would arguably assist Stockland (AX:SGP) to sell more land lots. Having said that <5% of the sectors earnings are from the residential sector.

That's enough big thinking for one week…

Think Big - AREITs
 

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Think Big - AREITs

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