The Wrap: REITs, Asset Allocation, Oz Banks

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Weekly Broker Wrap: Market conditions favour alternative REITs, time to reallocate to value-based assets, banking sector revenue under pressure

-Delta variant is not a showstopper for alternative REITs' solid rental growth
-Re-emergence of value investing to mirror recovery upswing
-Banks to execute $26bn in rolling buybacks over next two years

By Mark Story

REITs: Alternatives shine

Due to key defensive characteristics including long lease terms to essential services with minimal near-term lease expiries, strong rental escalations, and government support to operators, alternative REITs (real estate invetment trusts) saw minimal impact from covid, and Goldman Sachs expects similar results into the end of 2021.

Despite the current economic backdrop, Goldman Sachs doesn’t expect the impact from an uptick in the delta variant to derail what has been solid rental growth. There are three drivers of the broker’s upbeat outlook for a handful of alternative REITs.

Firstly, they have strong balance sheets with capital to be deployed, which may make it easier to source acquisition opportunities, especially in light of strong market pricing for assets.

Secondly, the broker believes that positive asset valuations highlight the underlying resilience, and cites recent asset valuations in childcare, healthcare, hotels, and residential land lease community (RLLC) assets, that have been underpinned by strong investor demand and continued cap rate compression.

Then there’s RLLC housing which the broker notes is currently benefitting from strong structural and economic growth dynamics, including an aging population and relatively low interest rates. Also lending support, adds Goldman, are supportive property market conditions, and further contraction in cap rates underpinned by low risk, annuity rental income.

Based on these dynamics, Goldman Sachs' key Buy recommendations remain Charter Hall Social Infrastructure ((CQE)), Lifestyle Communities ((LIC)), and Waypoint REIT ((WPR). The broker remains Sell rated on National Storage REIT ((NSR)) due to risks around first half FY22 settlements and sales with ongoing restrictions in Melbourne.

Goldman expects Charter Hall Social Infrastructure to put capital into social infrastructure assets based on its broad mandate and debt capacity: $207m at FY21. The broker notes while childcare assets remain the REIT’s top preference, the fund is executing on its strategy to broaden its investments in social infrastructure, with management planning to target from 30-50% of exposure outside of childcare.

Goldman estimates an additional $150m of acquisitions will leave the REIT’s gearing below the middle of its target 30-40% gearing range. The REIT is currently trading at a 14% premium to its net tangible asset (NTA) value versus its historical average premium of 13% (since 2014), and the broker’s target of $3.81 implies an 8% total return.

Turning its attention to Lifestyle Communities (target price $21.60), Goldman Sachs believes strong 3-year guidance for FY22-FY24 new home settlements and deferred management fees (DMF) resales, should drive materially higher annuity rental and DMF earnings over the long term – both of which are high-multiple earnings streams.

The broker also expects the upsizing of the debt facility by $100m to $375m to allow for further property acquisitions, accelerate the pace of new home settlements, and hence result in larger rental and DMF annuity.

The upgrade to debt facilities, coupled with the recent acquisition of a site at Cowes (Phillip Island), gives the broker greater certainty in the ability of the REIT to increase its development velocity. While Goldman sees some risk around first half FY22 settlements and sales with ongoing restrictions in Melbourne, the broker expects a strong rebound post-lockdown, as witnessed previously.

Meanwhile, Goldman believes Waypoint’s (target price $2.95) first-half FY21 result reaffirms the broker’s positive view on the REIT and the service station sector, with its visible and steady income streams.

Having divested numerous non-core assets during the period, Goldman Sachs believes the REIT has sufficient means to undertake future initiatives, and/or fund potential acquisitions.

While guidance allows for no acquisitions in FY21, management has indicated a proposed $150m of capital management initiatives, including a $75m initiated buy-back. Management also hinted at the possibility of a potential capital return in fourth quarter FY21.

The broker notes minimal near-term lease expiries contribute to the REIT reiterating its FY21 guidance of 3.75% growth in distributable earnings per share.

Asset allocation: Don’t write value investing off just yet

While the dramatic comeback staged by value-style investing last November gave way to a resurgence in growth style six months later, courtesy of the tech sector reasserting its performance leadership, Wilsons believes it’s a mistake to write the former off just yet.

Aiding the swing back to growth was the renewed fall in bond yields, plus fears over the return of economic normalisation being stalled as the delta variant led the re-emergence of covid case numbers globally.

But assuming there’s a continuation of the above-trend growth witnessed over the past 12 months, as economic re-opening continues and pent-up household demand is released, the broker expects value’s recent performance slip to be reasonably brief.

Overall, Wilsons expects the path to recovery over the next 18 months, while unlikely to be perfectly smooth, to support another decent stint of outperformance for value investors. With vaccines proving to be the primary driver of a return to economic normalisation, the broker expects Australia to be back on the recovery path before year-end, with a strong growth year in store for 2022.

Wilsons also believes slow-moving demographic trends, notably the continued aging of the global population, and the slowing growth of the working-age population, create headwinds for growth. In the absence of an unexpectedly strong productivity wave, the broker believes it’s difficult to become overly optimistic on the outlook for global growth over the next 5-10 years.

Assuming there aren’t as many growth winners as the market is currently pricing in, Wilsons believes stock selection and valuation discipline will most likely become more critical for growth investors.

Meanwhile on the inflation front, Wilsons envisages higher levels over the next few years but doubts it will truly break to the upside 1970’s style. But assuming inflation does prove more problematic over the next few years, the broker thinks value exposure is likely to be a better hedge than growth.

The broker reminds investors that value doesn’t hold appeal purely because of the prospect of an extended cyclical revival in the global economy. What’s also important is how much the rubbery valuation nexus between growth stocks and value stocks has been stretched in recent years.

In short, Wilsons concludes that while they are by no means a magic pudding, value stocks have a lot less to live up to over the next few years than the growth high-flyers of recent times.

Relatively cheap valuations and the likelihood of an extended “recovery upswing” in the global economy suggests a preference for value over the next 12 months.

However, Wilsons also sees some longer-term “value themes” in stocks linked to what are likely to be structurally strong growth cycles and cites selected stocks related to the emerging markets consumer and numerous global industrials linked to infrastructure spending.

Oz Banks: Sustained weakness ahead

Despite positive margin outcomes in the first half and improvement in housing loan growth, FY21 is shaping up to be another year of weak revenue trends at the major banks. During the August 2021 reporting season, Credit Suisse made earnings changes of -1% to 2% across the sector, with lower bad debts being offset by lower revenue and higher expenses.

Morgan Stanley’s forecasts indicate that revenue ex-notable items will be down -1% year-on-year. The broker believes margins will be the key swing factor for revenue in second half FY21, with cost control remaining important given revenue growth remains relatively modest. While Morgan Stanley forecasts major bank revenue to grow by an average of 3% in FY22, the broker sees upside risk to loan growth forecasts, but the potential for this to be offset by any additional margin pressure.

Overall, Morgan Stanley thinks National Australia Bank ((NAB)) offers the best near-term combination of improved operating momentum and confidence in earnings estimates.

Looking forward, Credit Suisse expects balance sheet momentum to slowly improve from here and expects margin pressure to be affected more by competition and mix rather than low rates per se.

While Credit Suisse is witnessing benefits from the funding mix, notably deposits and term funding facility (TFF) benefits, the broker notes competition continues to drive front/back book pressure on net interest margins (NIM).

The broker foresees rolling buybacks over the next 24 months and forecasts a total of $26bn across the majors and a material contributor to earnings per share (EPS) growth.

For the second consecutive reporting season, Credit Suisse has downgraded a major bank recommendation. It’s stock-specific factor rather than macroeconomic themes that the broker suspects will dictate relative share price performance and has Outperform ratings on Westpac ((WBC)) and NAB; and Neutral and Underperform ratings on ANZ Bank ((ANZ)) and Commonwealth Bank ((CBA)) respectively.

Following bank reporting season, Credit Suisse’s fundamental outlook for the major banks includes average earnings per share (EPS) growth of 8% for FY22 and FY23, revenue growth of 1-3%, and underlying profit growth of 6-10%, with productivity benefits coming through and a reduction in investment spend.

With key factors that sustained a period of outperformance now fading, Wilsons has pulled back an overweight outlook on banks. With ‘part one’ of ANZ’s capital management program having now played out, the broker has reduced its weighting in ANZ which has not grown its balance sheet since first-half FY21.

This suggests to Wilsons that the prospects of above sector earnings growth in FY22 and FY23 now look more challenging.

Looking further across the sector, Wilsons notes bank earnings continued to be supported by lower bad debts and impairment charges, while capital management featured prominently, with all major banks announcing share buy-backs.

For the sector overall, the broker notes consensus pre-provision earnings led to single-digit downgrades over the past month. Wilsons thinks there is some upside risk to cash earnings due to further capital management initiatives, which the broker doubts are fully reflected in market estimates.

While consensus expects return on equity (ROE) to hover around the 12-13% level over the next three years, the broker believes any relief in net interest margin would see bank earnings and ROE materially higher.

While there remains some upside to dividends with an allowance for further buy-backs, the broker notes the outlook for dividend growth also moderates in FY22, with payout ratios across ANZ, NAB, Westpac reaching 70%, with Commbank at 80%.

While bank share prices outperformed the market by around 20% over the past 12 months, Wilsons reminds investors that the significant ‘head room’ in consensus earnings estimates observed in late 2020 does not exist today.

But assuming the banks continue along their capital management journey, Wilsons estimates that over FY22 and FY23 cash EPS could be upgraded 1.5-3.0% in each year, and over 4.0% for Westpac – given it is yet to commence a capital return program.

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