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Online boom shifts retail power balance

The COVID-inflicted online shopping boom could signify a shift in the balance of power between retail tenants and landlords.

lockdowns has taken place in the retail sector.

While there was already a shift from instore purchases to online, global lockdowns have pressed fast-forward on the process, leaving consumers with little choice but to digitally purchase goods. 

At the coalface of this lies thriving online shopping company KGN), which in April saw its sales increase by 100 per cent and profit over 150 per cent thanks to the global lockdown caused by the coronavirus pandemic.

In an interview with Alan Kohler last week, Founder of the company, Ruslan Kogan, said the forced push for consumers to move shopping online has “caused the e-commerce industry to accelerate a few years within the space of a few months.”

He followed that comment up with a tweet that provided evidence of this shift occurring in the US, titled, ‘I think e-commerce in Australia has advanced a few years within the space of a few months. I wonder what this picture will look like for Australia when numbers come out next month...’ and the below graph:


The comment comes at a fascinating time for the industry, with retail stocks that operate in physical stores, and online, beginning to re-open as the federal government pushes for the easing of restrictions and increased economic activity. 

There is a looming question that retailers now face though – is it financially viable to continue operating bricks-and-mortar stores given the acceleration of online shopping?

For the past two months, the answer for many companies has been no, given the forced store closures, but the problem is exacerbated because larger companies still have to pay rent to landlords, or at least they’re meant to…

Australia’s biggest retail tenant and Chairman of Premier Investments (ASX: PMV), Solomon Lew, struck fear into landlords two weeks ago, declaring that the company will be playing by its own rules with regard to paying rent.

Premier owns retail conglomerate The Just Group and has brands in its portfolio including Peter Alexander, Smiggle, Just Jeans and Jay Jays. Lew, who is the major shareholder of Premier, said the company will be paying rent based on a proportion of its gross sales during the re-opening and recovery phase.

This comes after several months in which Premier has paid no rent globally during the period of forced closures, which dates back to March 26.

The basis of Lew’s move stems from rental relief measures announced by the federal government for commercial tenants, which includes retail, office and industrial tenancies. 

Rent reduction comes in the form of waivers or deferrals based on the tenant’s decline in turnover, however, the issue for Lew and Premier Investments is these measures apply to small to medium businesses with an annual turnover of up to $50 million, well shy of the $1.27 billion in global sales Premier had last year. 

So, what happens if landlords call BS on Lew and Premier’s hundreds of retail shops? 

Simple, it can just walk away from its leases, given 70 per cent of its Australia and New Zealand stores are either set to expire this year, or are already in holdover – meaning the lease has ended but the tenant occupies the premises on a month-by-month basis.

Some might say this is a big gamble, but this is where the online boom comes in, providing retailers with leverage over landlords to lower rent or threaten to walk off.

Scarily for landlords, this trend is occurring across the board for other retailers such as Wesfarmers and Kathmandu, with the COVID-19 restrictions revealing just how profitable the shift to online could be.


The leverage: Online shopping

Premier’s most recent update to the ASX spoke volumes about the changing landscape of the retail sector:

“Prior to the global health crisis, customers were already increasingly electing to shop online. The COVID-19 pandemic has significantly increased that existing trend and could hasten the substantial retail restructure already underway.”

The group's results throughout April and the early part of May are evidence of this shift with plummeting instore sales and surging online transactions.

In the six weeks to May 6, its global retail store network sales were down 99 per cent while online sales surged 99 per cent compared to the same period last year. 

Premier’s largest online brand, Peter Alexander, saw its online sales up 18 per cent compared to last year’s total sales across both online and its entire 122 store and concession network in Australia.

While Premier began reopening the balance of its stores in Australia from May 15, except for in Queensland and the Northern Territory which opened from May 7, there remains an air of uncertainty around how the rental situation will play out. 

For the moment it seems to exist more on the basis of negotiation between landlord and tenant, and this isn’t isolated to Premier alone.

Kathmandu Holdings (ASX: KMD) was similarly forced to close all except two of its 327 international stores from late March, and similarly to Premier, has only recently begun to reopen.

Kathmandu said on May 5 it had started reopening stores in New South Wales and Queensland on a trial basis, with the majority of its Australian Kathmandu and Rip Curl stores being expected to reopen by the week ending May 8. 

The two and a bit months of store closures has also sent Kathmandu’s online sales skyrocketing – up two and a half to three times higher than last year.

Despite this, Kathmandu undertook a NZ$207 million equity raising and implemented further cost cutting initiatives, including taking a similar approach to rental agreements as Premier.

As the economy opens up, Kathmandu has said it is “negotiating with landlord partners to achieve a fair outcome that sees rental costs aligned to sales performance.”

Last week we saw a glimpse of what could happen if retailers like Kathmandu have poor performance in physical stores.


A sign of the times

The big retail news coming out of last week was Wesfarmers’ (ASX: WES) decision to close or convert to Kmart around half of its Target stores in Australia – up to 167 of 284 stores.

This includes the closure of 10 to 25 large stores and 50 small Target Country stores, while also converting 10 to 40 large format Target stores to Kmart and 52 Target Country stores to small format Kmart stores.

While this is set to reduce costs in the long term, a significant restructure like this isn’t cheap – it includes restructuring and provision costs of $120-$170 million and a non-cash impairment of between $430 million and $480 million on Target’s brand name, property, leases and other assets.

This is why Wesfarmers dropped the line “subject to landlord support” when referring to its store conversions.

The expectation from Wesfarmers is that landlords must bear some of the financial burden of these store conversions, or alternatively, the number of store closures could be a lot higher.

At the heart of this is a message to shopping centre owners and landlords that is eerily similar to Solomon Lew’s, that being, negotiate with us or we’re out. 

Again, Wesfarmers’ leverage stems from increasing its exposure to online shopping.

The company said the reduction in the Target store network will coincide with increased investment in digital capabilities given the strong growth in online sales across Kmart Group and the progress of online store Catch since its acquisition in August last year.

The expansion of its digital channel will provide customers with access to Kmart and Target products alongside the 2 million products offered on Catch, through home delivery or click and collect.

It begs the question of whether this is the beginning of a larger trend, where retailers are cutthroat in selecting which brick-and-mortar stores they keep. Could this lead to a reduction in rental prices or worse for landlords, a spike in vacancies?

Investment bank Goldman Sachs published a research report earlier this week which looked at Wesfarmers’ restructure, emphasising that “the range of these conversions and closures is dependent on the level of support from landlords, primarily around rental negotiations and refurbishment conditions.”

If successful, the restructure means Wesfarmers’ lease commitment will have fallen by one third to around $1.1 billion by the end of the 2021 financial year, compared to $1.6 billion.

However, Goldman analysts note that should landlords not contribute, Wesfarmers will have further doubts about the Target brand, potentially risking its performance and subsequently the performance of the shopping centres.

This turns our attention to the landlords and owners of the shopping centres that house these retailers and looking at the impact that potentially more retail store closures will have on rent and occupancy rates.


Are physical stores a thing of the past?

Operator of Westfield Shopping Centres, Scentre Group (ASX: SCG), is at the forefront of this changing balance of power between retail tenants and landlords, but its CEO, Peter Allen, is putting on a brave face.

While all 42 Westfield Living Centres remained open throughout the pandemic, a large portion of the retail stores closed, sending the Group’s share price off a cliff in March, down 65 per cent to $1.43 from its January highs of $4.04.

However, as restrictions ease, more retailers are opening, with the number of those trading standing at 57 per cent as at Scentre Group’s operational update on May 11.

That 57 per cent of retailers makes up 70 per cent of the Group’s gross lettable area and since then, the number of retailers open has gone up to at least 70 per cent according to CEO Peter Allen.

 Its share price is beginning to recover, sitting at $2.44 (at time of writing).

While the lockdown sent customer numbers plummeting in March and April to 39 per cent of last year’s level, they have since picked up with the weekend of May 9 bringing in double the visitors compared to five weekends prior. 

As retailers emerge from the lockdown period and begin to re-open, Scentre Group highlighted negotiations may take place, particularly among its 2,600 SME retailers, which represent around 30 per cent of its rental income:

“We are in discussions with our retail partners, on a case by case basis, to determine appropriate ways we can assist with their potential cash-flow issues, whilst recognising that their contractual lease obligations remain in place.”

This forms part of the SME Commercial Leasing Code of Conduct, which has been legislated in Victoria and New South Wales and relates to negotiating amendments to existing commercial tenancies. 

How these negotiations will impact Scentre Group is the question. The company’s CEO Peter Allen thinks rent could actually increase in the long-term as well-situated shopping centres become more important. 

In an interview with Alan Kohler, Allen told Eureka Report he expects a big differentiation of retail space, pointing to what occurred in the UK and the US during the GFC where many secondary shopping centres were forced to close.

“Retailers are going to have to rationalise their store footprint and our sense is that that rationalisation will happen where the better centres, those ones with the most traffic, will be the ones where the retailers want to be located,” he said

“Therefore, there’ll still be a continued demand for space and therefore some pressure on rents and rental growth.”

While recognising the shift to online shopping is undeniable and accelerating at pace, perhaps unsurprisingly, Allen insists there is still room for shopping centres to co-exist with online offerings.

“I think there needs to be a balance in terms of both online and physical… what we’re seeing is the importance of the physical store in terms of the impact it has on the online sales, it’s quite dramatic,” Allen explained.

“When you’re looking at shopping centres such as the Westfield centres that we own and operate, where last year we had over 540 million customer visitations to our centres. That’s an important part in terms of a retailer being able to sell their product, their good or their service to a customer.”

“Having that brand recognition with those names is really important, and to be in those locations where people want to go to rather than they have to go to is important.”

Nonetheless, the changes in consumption have meant Scentre Group has needed to adapt, highlighted by the launch of its Westfield Direct drive-through, click and collect service.

This enables customers to acquire product through multiple retailers and was due to be implemented further down the track, however, the lockdowns have accelerated the process.

“Click and collect is a really important part in terms of being part of that dynamic for a retailer, because when you think about online as a pure play, the cost of being able to provide delivery and to get that product to the customer is pretty expensive,” Allen explained. 

“When you’re in close proximity to the customer in easily accessible locations, click and collect is a really great opportunity for that retailer to be able to interact with the customer.”

It seems that regardless of who you believe in terms of operating in physical stores, online or both, retailers are needing to adapt in some way to the evolution in consumption methods from COVID-19.

Wrap up

With companies becoming increasingly careful with costs, the balance of power between retailers and landlords is at a delicate point.

As retailers discover what the ideal mix is between online and physical store presence, it seems this will determine where the power lies in terms of rental prices moving.

If the success of Kogan and its pure online strategy is anything to go by, retailers could have greater bargaining power, sending rental prices down.

However, if Peter Allen is right and well-located shopping centres prove to be an essential part of the shopping experience, perhaps over the long-term rental prices could increase.

The flow-on effect for shopping centre stocks such as Scentre Group and Vicinity Centres, which rely on leasing and rental contracts as revenue, would obviously be positive.

For investors, the thing to look out for over the coming months is whether the spike in online shopping is sustainable and movements in customer visits to shopping centres, as that will play a key role in determining the performance of retail and shopping centre stocks going forward.


Alex Gluyas is a Finance Journalist  at Eureka Report. For EOFY get 10% off Eureka Report membership.