Australia | Apr 05 2018
Several brokers believe the A-REIT sector is starting to look more attractive as bond yields head lower.
-Spread to bond yields justifies direct real estate carrying values
-Attractive investment opportunities although macro headwinds may prevail short-term
-Australian specialty retailer margins remain above global peers
By Eva Brocklehurst
Australia's yield curve is flattening and this may be bullish for the relative performance of Australian real estate trusts (A-REIT). Australia's 10-year bond yield has contracted by over -30 basis points since it touched 2.6% on February 5.
Shaw and Partners is not sure why bond yields are heading lower but suggests A-REITs are starting to look attractive. The broker concedes the sector is not immune to the geopolitical headwinds such as trade wars, and whether bond markets stabilise remains to be seen.
What is worth highlighting, in the broker's opinion, is that many of the larger capitalised A-REITs are actually trading at a discount to net tangible assets (NTA). This includes Charter Hall Retail ((CQR)), GPT ((GPT)), Investa Office ((IOF)), Mirvac ((MGR)), Stockland ((SGP)), Scentre Group ((SCG)) and Vicinity Centres ((VCX)).
The sector's weighted average capitalisation rate is around 5.57%, representing a spread over bonds of 2.97%, and this indicates to the broker a sufficient enough buffer to justify direct real estate carrying values.
More importantly, Citi notes the 10-year bond yield is contracting faster than the 3-year yield, creating what it terms as a bull flattening yield environment. Such an environment has recently been positive for A-REITs.
Citi prefers Goodman Group ((GMG)), Charter Hall ((CHC)) and Lend Lease ((LLC)). Goodman is delivering sector-leading growth in earnings per share of 8.2% and the broker believes 6%-plus growth is sustainable in the medium term.
Meanwhile, a good way to get exposure to the office segment is considered to be via Charter Hall, as 43% of the company's assets under management are in office, a segment where Citi observes rental growth is improving.
Moreover, given the company receives fees based on asset values, the broker argues the earnings benefit is more immediate from a recovery in office versus rent-collecting A-REITs.
Citi does not believe Lend Lease will increase its provision of $160-190m taken in the engineering division for underperforming projects. The broker observes the company has progressed more than 50% through these projects and has enough information to make a reasonable assessment of potential future costs.
Shaw and Partners notes buybacks continue at Charter Hall Retail, Dexus ((DXS)), Lend Lease and Mirvac. The broker still believes Vicinity Centres should be buying back its own stock, as it share price is down -8% since the first half results and now trading at a -18% discount to NTA.
The broker's forecast 12-month total shareholder return for the sector is now 15.4%, including a yield of 5.4% based on a weighted average pay-out ratio of 82%. At a stock level, Shaw and Partners envisages attractive investment opportunities although acknowledges the macro headwinds may prevail in the short term.
CLSA has looked at the impact of declining retail margins on rents for shopping centre owners. Australian specialty retailer margins remain healthy, and above global peers, although at the EBITDA level margins are declining, consistent with tougher trading conditions and rising expenses.
The broker estimates that if gross margins fall -10% and retailers desire to recover earnings, rents need to fall -10%. Assuming a decline of -10% in re-leasing spreads for five years DCF valuations are lowered by -2% on average.
CLSA acknowledges this analysis does not take into account the quality of the portfolio but believes the discounting of A-REITs appears overdone. Preferred retail A-REITs remain Scentre Group and Mirvac.
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