Small Caps | Aug 04 2021
This story features CENTURIA OFFICE REIT. For more info SHARE ANALYSIS: COF
Centuria Office REIT has sustained reliable income despite the travails of the Australian office sector during the pandemic, yet will FY22 show signs of improvement?
-Dividend yield implied by FY22 guidance among the highest in the sector
-Yet earnings growth likely to be modest for another year
-Will Centuria Office require equity for further acquisitions?
By Eva Brocklehurst
The Australian office sector has been battered by the pandemic yet Centuria Office REIT ((COF)) has managed to sustain reliable income. Vacancies have been minimised and weighted average lease expiries (WALE) have increased for some assets.
Moelis highlights this is a strong and stable income producer and the dividend yield implied from FY22 guidance is amongst the highest in the sector. Execution of leasing across 18% of the portfolio over FY21 also demonstrated the reliability of its income.
UBS is more inclined to believe the challenging leasing profile created by the pandemic will mean earnings growth is anaemic over the next 18 months. FY21 did benefit from the impact of a lease surrender payment, following the early departure of Foxtel from the Gold Coast, and management has noted there was no meaningful change in leasing duration relative to pre-pandemic levels.
Vacancies fell to 6.9% in June from 8.7% in December and the main vacancy is 818 Bourke Street, Melbourne, which is being refurbished. Valuation gains of 5-15% occurred across seven of the company's 22 office assets.
Around 6.3% of the portfolio will expire in FY22, although 1.7% of that is the call centre at Robina, which took up the space vacated by Foxtel, and brokers expect the current tenant will probably exercise a three-year option. A further 2.3% in South Brisbane will not expire until June next year so the vacating tenant will not affect current year earnings.
Morgan Stanley considers the outlook provided for FY22 is rather conservative in terms of occupancy and lease extensions and remains bullish on both the stock and the office market.
At first glance guidance may be disappointing yet the broker ascertains that even if Centuria Office maintains existing tenancies, it will be in a position to upgrade operating earnings (FFO), guided at $0.180 per security, by 1.5-2.0%.
Guidance for FY22 includes a distribution of $0.166 per security which implies growth of 0.6% and a yield of 6.8%. Management has factored in ongoing rent relief from current lockdowns while Moelis notes improving vaccination status and an early opening up of Australia would have positive implications for earnings.
Morgan Stanley agrees and believes the deterioration across the market will slow over the next six months and coincide with the return of workers to the office and factors in around $500,000 in rent relief in the first half to account for the ongoing lockdowns.
The broker also notes the high rent collection has been maintained throughout the onset of the pandemic and averaged 97-98% of normal levels. The broker slightly reduces pay-out forecasts for FY22/23 and assumes Centuria Office will be paying out 90% by the second half, having previously expected this move down from 100% would transpire more slowly over a 3-4-year period.
UBS was underwhelmed by the FY22 outlook although acknowledges guidance is likely to be conservative and assumes operating earnings per security of $0.184. The broker also assumes pandemic-related tenant support will be just $800,000 versus management's expectations of around $1.2m.
Furthermore, UBS is concerned that Centuria Office is paying out 92% of FFO above a target of 85-90% and not enough earnings will be retained to cover maintenance expenditure and fit-out incentive contributions.
The broker also suspects, if the stock outperforms, there is increasing risk of further acquisitions, which will require equity. Credit Suisse agrees any acquisitions could require equity, given gearing is 33.5% and there is around $106m of undrawn debt capacity, yet this is not part of its base case.
The broker has no concerns about the company's capital position and, while the average cost of debt is up slightly, to 2.4%, this is traded off by longer average debt duration of 4.2 years.
Credit Suisse considers FY22 a trough year, expecting more growth in FY23 and FY24 and assuming an improvement in occupancy beyond FY23 as well as annual lease increases. The portfolio may be 2-4% over-rented yet the broker does not envisage meaningful negative rent reversion in the short term.
Centuria Office has been among the best performers in Jarden's coverage of A-REITs over recent months, attributed partially to potential inclusion in the FTSE EPRA Nareit index along with related buying. Yet the broker, not one of the seven stockbrokers monitored daily on the FNArena database, envisages better value elsewhere and retains a Neutral rating with a $2.35 target.
Moelis, also not one of the seven, has a target of $2.53 and downgrades to Hold from Buy on valuation grounds. The database has one Buy (Morgan Stanley), two Hold and one Sell (UBS). The consensus target is $2.48, suggesting 4.3% upside to the last share price. The dividend yield on FY22 and FY23 forecasts is 7.1% and 7.2%, respectively.
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