The Wrap: A-REITs, Casinos and Retail

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More dividend shock ahead for Australian investors in A-REITS; private health insurers should remain defensive despite industry shrinkage; Deloitte sees a challenging outlook for retailers.

– Retail and Office REITs expected to lower payout ratios
– Social restrictions taking a toll on casinos
– Seventh Community Pharmacy Agreement bodes well for wholesalers
– Retail spending and the six degrees of shopping in 2020

By Angelique Thakur

Lower payout ratios: A bitter pill to swallow

Morgan Stanley analysts expect rent structures for retail properties to be revised downwards over the next 6-18 months along with an increase in office vacancies. Both will drive down the value of retail and office property.

The payout ratio is a metric to measure the proportion of earnings that is distributed to the shareholders. Traditionally, real estate investment trusts (REIT) have had high payout ratios – some even going as high as about 100% of their adjusted funds from operations (AFFO).

Stockland ((SGP)) and Mirvac Group ((MGR)) are classic examples here, known for generally distributing all of their passive income.

However, given the current environment, Morgan Stanley analysts feel now may not be a prudent time to have such high payout ratios. They consider payout ratios across some real estate stocks to be too high, more so when seen against the backdrop of flat to declining asset values.

Instead, they suggest a cut to payout ratios to 50% for the next two years, retaining the funds in order to strengthen balance sheets. This will offer the twin benefits of keeping gearing in check and offsetting a decline in asset values.

Morgan Stanley expects stocks more exposed to retail (Scentre Group ((SCG)), Vicinity Centres ((VCX)) and Stockland) are more likely to revise down their payout ratios. Also expected to join in are office owners like GPT Group ((GPT)), Mirvac Group and Dexus Property Group ((DXS)).

Lower payouts will also translate to a decline in FY21 yields for some REITs (Scentre Group, Vicinity Centres and Stockland). The analysts acknowledge that while this may be a bitter pill to swallow, it is a temporary measure to ensure financially stability.

On a more positive note, a visit to a local regional mall and super-regional mall undertaken by Macquarie analysts saw a decline in retail store closures to 5-7% in June from 22-23% four weeks ago. This improvement seems to be driven by reopening of apparel and other services.

Macquarie analysts highlight some headwinds to the re-openings which include tapering of stimulus measures and unfavourable rent renegotiations. They expect vacancies to increase over the rest of 2020.

For pure-play retail stocks, Macquarie suggests moving towards defensive options like Aventus Group ((AVN)) in large format retail and non-discretionary convenience retail options, like Charter Hall Retail REIT ((CQR)).

Macquarie is Neutral on Vicinity Centres and Scentre Group, preferring exposure to retail large-caps via diversified REITs like GPT Group and Stockland, rating both as Outperform.

Casinos and Gaming: As luck would have it

Australian casinos, ordered to close on account of the pandemic in mid-March, have not seen their fortunes change much even with the reopening of the economy.

Casinos are not as defensive as other gaming stocks, comment Morgan Stanley analysts while expecting the current downturn to be more prolonged due to travel restrictions, social distancing requirements and capacity constraints.

Measures like keeping every second machine switched off in some venues and only allowing half the number of customers per table will definitely put a dampener on the gambling spirits.

The analysts expect a recovery that is phased over the next two years rather than an L-shaped one and predict a recovery back to FY19 levels only by FY22.

Investors prefer less complexity in times of uncertainty, which is why the analysts prefer Crown Resorts ((CWN)) which funds 100% of its projects. This, they elaborate, is better than Star Entertainment Group ((SGR)) which has a complex joint venture-led project structure.

The analysts also highlight Star Entertainment has a weaker balance sheet and project risk with large projects still pending (Queen’s Wharf Brisbane worth $2.5bn).

On the other hand, capital expenditure of Crown Resorts is expected to peak soon with the company having liquidity of $1bn and 100% ownership of its assets.

Morgan Stanley rates Crown Resorts as Overweight while moving to Underweight on Star Entertainment Group.

A company expected to recover in a few months rather than a few years is Aristocrat Leisure ((ALL)).

The slot machine and mobile games developer is aided by an industry that is rational and has not yet lowered prices, its participants choosing to offer deferred pricing rather than offering promotions/discounts.

Tabcorp Holdings ((TAH)) can expect upside from its lotteries business which remains relatively unimpacted by the shift towards digital. However, the outlook for racing, considered to be Tabcorp Holdings’ strength, remains uncertain with sports returning and the economy reopening.

Seventh Community Pharmacy Agreement signed

The Seventh Community Pharmacy Agreement (7CPA) has been finalised with the new five-year deal commencing from July 1, 2020.

Notable features of the agreement include additional funding worth $92m allocated to the Community Service Obligation (CSO) pool and the introduction of a floor price of $5.50.

UBS analysts note the additional funding implies an increase of $18.4m per annum over the term of the agreement. Assuming 90% of this goes to the three major wholesale and distribution businesses (Sigma Healthcare ((SIG)), Ebos Group ((EBO)) and Australian Pharmaceutical Industries ((API))), the analysts expect an impact of $5m per annum (each) to operating incomes.

They also point out the floor price of $5.5 will equate to a wholesale markup of $0.41, uplifting earnings. However, the analysts want to wait for more clarity before changing their forecasts.

UBS prefers Ebos Group with its sound balance sheet while moving away from Sigma Healthcare, for which they see the market paying a notable premium.

Private Health Insurance: On a downslide

Citi believes covid-19 will accelerate adverse trends in private health insurance with industry penetration expected to fall along with a fall in coverage.

The market is expected to shrink by about -2% over the next two years due to slowing population growth and a fall in health insurance penetration.

Citi expects listed insurers to remain resilient, helped by earnings flexibility from benign claims, and deliver safe dividend yields. In particular, the analysts highlight both Medibank Private ((MPL)) and nib Holdings ((NIB)) as defensive plays, expected to outperform in case of a falling market.

Medibank Private is expected to maintain a strong capital position and a dependable dividend stream, enough to drive performance in a cautious market, believe the analysts. They retain their Neutral rating, noting limited upside potential due to a weak industry.

Net margins are higher for international students and overseas workers and with both expected to fall, this will hit insurers’ profitability with nib Holdings more exposed than Medibank Private.

Thus, growth prospects of nib Holdings will be weighed down by the fall in international inbound insurance and travel insurance.

The Australian resident health insurance segment will present challenges, but the insurer should be able to achieve target margins. Citi retains its Buy rating.

Infrastructure: Fading resilience

Infrastructure as an asset class is considered to be highly defensive in an environment as rife with uncertainty as the one we are facing currently.

However, some infrastructure assets have been hit hard by the pandemic-induced lockdowns, report Morningstar analysts.

Even with restrictions easing now, there is still the risk of a second wave and along with it, the risk of another disruption. The experts believe this uncertainty will continue till a vaccine is found (expected in the first half 2021).

Morningstar notes Auckland International Airport ((AIA)) and Atlas Arteria Group ((ALX)) have been the first to blink and raise equity. These two have also suspended distributions for this year. The analysts suspect Sydney Airport ((SYD)) could be the next in line to go for an equity raising.

Morningstar does not anticipate any lasting impact on infrastructure revenues. Electricity and gas are considered the best placed and least impacted by the pandemic. Spark Infrastructure ((SKI)) and AusNet Services ((AST)) are the most preferred options, continuing to generate attractive yields.

Airports are the worst hit with passengers down more than -97%. The analysts expect Auckland International Airport to return to 2019’s peak volumes not before 2023. Sydney Airport is expected to fare better and see a strong traffic rebound in 2021 from an improving outlook for domestic travel.

Toll roads suffered a sharp drop but have since recovered, boosted by easing restrictions. Traffic volumes on Transurban Group’s ((TCL)) Australian toll roads fell -40-50% at the peak of the crisis but are expected to recover quickly as lockdowns ease, aided by people avoiding public transport.

Morningstar warns near-term earnings will be hurt, predicting operating-income to fall by -5.2% in 2020 although clarifying there will be no lasting long-term impact.

Retail: Topsy turvy

Deloitte’s Access Economics team released its quarterly report covering the second quarter of 2020, titled Retail Forecasts: Six degrees of shopping in 2020.

In it, Deloitte declares 2020 is to be the worst year on record for Australian retail, with the sector expected to contract by -1.4%.

Not all segments fared badly in Q2, with supermarkets, liquor, specialty foods and home improvement doing very well for themselves. However, this may be more from one-off purchases rather than a definite trend, the report warns.

Deloitte suggests 2020 will see six different phases in retail spending rather than just one economic theme prevailing throughout.

The analysts point towards a pre-covid normal till February where it was business as usual for most retailers and then move to the stock-up in March with people spending extra on essentials, leading to the strongest monthly growth in retail sales to date.

The third phase saw a slump in April once consumers had stocked enough items and here the slowdown in discretionary spending (which had started in March) became even more pronounced.

May, the fourth phase, saw a return to some semblance of normality with resumption of activities and reopening of shopping centres.

Retail spending has seen a pick-up, aided by pent-up demand and government stimulus measures. The team points out the economy continues to be supported by measures like JobKeeper, early access to superannuation, and deferral of mortgages.

June is experiencing a recovery growth with people increasing spending, albeit cautiously, and the team highlights the continuing support from the stimulus and other measures.

Deloitte is worried as to what might happen around September with JobKeeper support set to end and what this might imply for retailers. This period will see support to many businesses withdrawn and the economy will be expected to operate by itself.

Deloitte anticipates a rather subdued end to the year.

Short term risks stem from unemployment, frugal attitudes towards spending and unwinding of the fiscal stimulus, while longer term risks include a slowdown in population growth and less migration.

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