Weekly Reports | Apr 30 2021
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Weekly Broker Wrap: City office demand; online’s rocky road; Oz telcos; CBD; rent’s CPI impact
-Rental down-cycles typically follow a sharp increase in vacancy
-Time to reweight back into e-commerce and pure online quality names
-Purchasing maximum amount of spectrum in all markets helps Telstra maintain network advantage
-Post-covid, firms will only require 80% of their existing CBD footprint
By Mark Story
Based on research undertaken by Citi, evidence from past office cycles indicates that year two of a cycle is worse than year one, with higher vacancy typically coinciding with or preceding significant rent declines.
Anecdotal evidence suggests a pick-up in leasing enquiries while market rents continued their decline in first quarter 2021, driven by higher incentives and increased vacancy (more than double pre-covid levels). Citi believes the weaker cyclical fundamentals are yet to be completely reflected in portfolio rents for landlords, with longer term impacts from flexible working also yet to play out.
Citi research of past rental downturns also suggests prior rental down-cycles have lasted between two to four years, with year two of a cycle typically seeing larger rental declines than year one. Secondly, rental down-cycles typically follow a sharp increase in vacancy.
How has this cycle played out to date? Driven by rising incentives amid weaker demand, Sydney and Melbourne CBD office rents declined again in first quarter 2021, being down -17% and -8% respectively versus December 2019 (pre-covid).
Market vacancy has increased by more than 2x in Sydney and Melbourne CBDs, with the rise in vacancy tracking in-line with the 1990s cycle in Sydney, and above the 1990s office cycle in Melbourne. While anecdotal evidence suggests a pick-up in leasing enquiry over recent months, Citi believes it remains to be seen whether this will be sustained.
In the absence of a significant and continued demand pickup, higher market vacancy and incentives, in the broker’s view, this will lead to lower portfolio rents as leases expire.
Citi notes, analysis of prior rental downturns does not account for a shift in preferences for flexible working. The broker believes the next 9-12 months it may take for REIT management teams to finalise their longer term plans represents an overhang on the office market, over and above the cyclical impacts.
As a result, the broker remains cautious on passive office exposures, with a Sell on Dexus Property ((DXS)), target price $7.86. The broker believes Dexus faces certain risks with regard to a range of fundamental and quantitative factors inclusive of average beta and high yield.
Online retail: Time to reweight
E-commerce and 100% online players experienced a bumpy ride over the last six months as the re-opening thematic post-covid played out. Shaw and Partners suspects the next 3-6 months might also be tough for the entire sector given the transition and re-rating currently underway in some big names.
However, rather than throw out the proverbial ‘baby with the bathwater’ the broker believes it’s time to balance out the portfolio and reweight slightly back into e-commerce and pure online for those specific quality names whose growth trajectory pre-covid was already very healthy and attractive.
Shaw notes both groups are now on average trading multiples at similar price-to-sales ratios of around 2x, a long way from the 3-4x multiples some of the higher profile and longer established names commanded up until recently, like Kogan.com ((KGN)), Redbubble ((RBL)) and Temple & Webster ((TPW)).
The broker reminds investors quality names are continuing to eke out improving top-line growth and healthier earnings following key endogenous drivers (like innovation, and improving supply chain and logistics). Then there are the positive macro drivers, including structural shifts to online, high consumer confidence, positive post easing of lockdowns, and relatively low unemployment.
Equally encouraging for the sector, adds Shaw, are tailwinds provided by the covid pandemic, leading to Australians spending more time at home and in many cases, working and entertaining at home more often. This has had a beneficial impact for the majority of retailers (from supermarkets to electronics to beauty and personal care and apparel providers).
According to Frost & Sullivan, the Australian online retail market is projected to reach $38.5bn in calendar year 2020, a 92% increase from 2019. However, the broker believes the longer-term question is whether online retail sales will be maintained at the same levels.
Euromonitor estimates the Australian online retail market will reach approximately $47.3bn by 2024 following an estimated step change from 2019 to 2020 of 20.7%.
The implications of covid may have potentially accelerated the adoption rate of online retail. But despite this acceleration, Shaw notes, the level of online penetration in Australia as a percentage of total retail sales relative to the larger US and UK markets has been lower. For example, online penetration rates in the US and UK are currently 16% and 19% respectively.
The broker’s preferred names in the retail online and e-commerce space, all notable by (current) attractive valuations versus three-year forecasted growth quantums, include: Dusk ((DSK)) Buy, price target $3.60; Shaver Shop ((SSG)) Buy, price target $1.40; Booktopia ((BKG)) Buy, price target $4.04; Zebit ((ZBT)) Buy, price target $2.00, and Adore Beauty ((ABY)), Buy, price target $8.30.
Oz Telcos: Telstra maintains its network advantage
Goldman Sachs believes TPG Telecom’s ((TPG)) lower than expected share of the mmWave spectrum – 400MHz across Melbourne/Sydney/Perth and 600MHz across other geographies – could limit overall capacity on their fixed wireless networks (launching in 1H21). Goldman Sachs views this as somewhat surprising given the broker believes it is a key focus.
Meanwhile, for Telstra ((TLS)) the auction outcome was broadly as expected at 1,000MHz. The broker forecasts Telstra’s Fixed Wireless to grow to a meaningful level – greater than 10% penetration of broadband subs by FY24 – noting a Fixed Wireless product launch is expected in coming months.
Goldman Sachs has a Buy rating on Telstra, with a target price of $4.00, and notes key risks as increased competition, disappointing cost-out, unfavourable regulation, and potentially unsuccessful asset monetisation.
By comparison, the broker rates TPG Telecom as Neutral, with a target price $7.10, and notes key upside/downside risks as better/worse than expected market share gains, better/worse merger synergies and disruption, and potentially unfavourable regulation.
While prices paid for the 26 GHz ("mm-Wave") spectrum auction were in line with UBS’s expectations, the broker believes by purchasing the maximum amount of spectrum in all markets, Telstra will maintain its network advantage. UBS notes Telstra remains further progressed with its 5G network rollout, currently available in 2,450 suburbs nationally (3,200 sites covering almost two thirds of the Australian population), versus 450 suburbs for TPG Telecom.
UBS has a Buy on Telstra, with a target price of $3.70, and on TPG Telecom with a target price of $7.60.
For the combined mmWave and 850 MHz auction (to be conducted later this year) UBS has factored $600m of costs for Telstra and $400m for TPG. The broker reminds investors the three ways for a network operator to increase network capacity is through densification (more base stations in a geographic area), purchasing additional spectrum, or technology/upgrades.
CBD: Muted rebound
National Australia Bank’s ((NAB)) most recent consumer insight report reveals that while Australia’s CBDs have borne the brunt of social distancing requirements, trading restrictions, job losses, and people working from home, spending is recovering.
While Perth is experiencing the strongest rebound, Melbourne continues to be the most impacted, especially for accommodation, cafes and restaurants. Unsurprisingly, NAB data suggests the suburbs have grown in importance as hubs for retail and recreational activity in metropolitan Australia.
By state, a thriving and vibrant CBD was most important in Tasmania and the ACT, while the least important was WA where only 14% indicated it was very important.
Based on survey responses from 2000 Australians conducted over 10-23 March, NAB data reveals that six in ten Australians have either stopped visiting their CBD or are visiting less. In Melbourne, the most impacted CBD, over seven in ten people have stopped visiting or are visiting less.
While 30% of consumers said free/subsidised car parking would encourage them to visit their CBD more often, over one in four consumers said nothing would encourage them to do so. Other common drawcards were free or subsidised public transport (21%), and more security/better safety (13%).
The change in visitation behaviour is broadly similar by region, with 57% in regional cities and 54% in rural areas having stopped visiting their CBD completely or going less often. But by age, significantly more consumers over age 50 (23% 50-64, and 22% 65-plus) stopped visiting the CBD, while in contrast only 13% in the 18-29 group and 16% in the 30-49 group stopped visiting completely.
In the NAB fourth quarter 2020 Commercial Property Survey, property professionals’ estimated only three in four (77%) white collar workers would return to CBD offices post-covid, and that firms would only require 80% of their existing CBD footprint.
Rents: A cyclical barometer/driver of inflation
Given that they have historically been sensitive to labour markets and the housing cycle, and a key barometer of core inflationary pressure, rents are a key component to watch in the consumer price index (CPI), NAB believes.
While it’s still unclear how movements between states will play out, the bank expects targeted rent reductions at the start of pandemic are also likely to revert to current market rates.
While rents will remain a cyclical barometer and driver of inflation, NAB doesn’t expect a rebound from pandemic impacts alone to be a signal of broader inflationary pressure.
NAB notes that while vacancy rates are a key driver of rents, the same contrast has played out in rents, with advertised rents nationally 3.9% higher than pre-pandemic March 2020 levels nationally.
Vacancy rates spiked higher across Australia in April 2020 at the onset of the pandemic. In sharp contrast, NAB data reveals vacancies fell sharply outside capital cities and in those capital least affected by the pandemic.
However, NAB doesn’t expect any regional outperformance to be reflected in measured inflation. That’s because CPI captures rent in eight capital cities, and hence does not capture all the surge in regional rents and house prices of the pandemic period. NAB also notes, within the CPI, Melbourne together with Sydney comprise two thirds of the rent basket – and hence driving most of the CPI rents dynamic.
Meantime, Melbourne vacancies remain elevated, but vacancies have declined notably elsewhere as an offset, leaving the national vacancy rate largely unchanged at 2.1%.
In coming quarters, NAB expects a lift in rent inflation. But the bank notes, the long tail of pandemic impacts means NAB would be extrapolating a sustained lift in cyclical inflation from the next couple of quarters of rent inflation alone. The bank also expects broader cyclical components, like personal services, restaurants/takeaways, plus direct wage inflationary pressures to be an important monitor.
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