The Case For Charter Hall

This story features CHARTER HALL GROUP, and other companies. For more info SHARE ANALYSIS: CHC

RBA rate hikes have weighed heavily on Australia’s property market, but since a better than expected FY24 result, and the assumption the RBA is soon to cut, brokers believe Charter Hall shares have seen the trough.

-August saw better-than-expected FY24 result from Charter Hall 
-Signs of a pick-up and an earnings trough
-Guidance typically conservative
-Central banks now cutting rates

By Greg Peel

In late September, Morgan Stanley reversed its “rather bearish” assumptions to formulate a revised price target for Charter Hall Group ((CHC)). The broker took its target to $18.50 from $15.80.

This put Morgan Stanley’s target well ahead of the pack, but the broker’s update is the most recent from said pack. Six brokers monitored daily or frequently by FNArena cover Charter Hall.

Charter Hall Group is a property developer and property fund manager operating across the core real estate sectors of Industrial & Logistics, Office, Retail and Social Infrastructure. The group offers both unlisted and listed real estate investment trusts (REIT) the latter including Charter Hall Retail REIT ((CQR)), Charter Hall Social Infrastructure REIT ((CQE)), and Charter Hall Long WALE REIT ((CLW)).

The Retail REIT is a landlord to retail businesses (shopping centres). Social Infrastructure can include childcare centres and education facilities, health and transport assets and government services (e.g. justice and emergency facilities). Long WALE (weighted average lease expiry) offers the security of longer-dated tenancy.

Charter Hall was flying high in late 2021, trading over $20 per share, when the spectre of runaway inflation loomed over the Australian and global economies. The share price began to drop in January 2022 as the market anticipated the first RBA rate rise, which was duly implemented in May.

The last RBA rate hike was in November 2023, to 4.35%, where it has remained ever since. In October 2023, shares in Charter Hall bottomed out under $9.00. Higher cash rates lead to higher government bond rates. While REITs typically yield above bond rates, they are risk assets, and they do not attract dividend franking.

Relief Ahead?

Treasurer Jim Chalmers goes to bed every night dreaming of the day Michele Bullock announces the first RBA rate cut. The RBA has been a laggard in the rate cutting game, given the ECB, Bank of England, RBNZ, and the central banks of Canada, Sweden and Switzerland, among others, have all now done so, along with, most importantly, the US Federal Reserve last month.

Since the Fed cut its rate by -50 basis points, the S&P500 and the ASX200 have both hit new all-time highs. Bullock has remained stubborn, but economists assume the first RBA cut will come if not by the end of this year, at least by early next year. It is important to note most of the above central banks had hiked to peak rates above that of the RBA.

The anticipation of a sooner rather than later RBA rate cut, along with a better than expected FY24 earnings result announced in August, has sent Charter Hall’s share price back up from its October 2023 trough to around $15.70 currently. The result alone triggered a 20% jump in share price on the day.

Trough Earnings?

UBS noted post the result release the quality of management’s earning’s guidance is better than expected with no performance fees assumed, and a bullish tone suggests the property valuation cycle is near its nadir, with transactions to pick up again in FY25.

Higher interest rates have led to falling property valuations over the RBA’s rate hike cycle.

Despite UBS’ positive view, the broker saw the day’s share price jump as overdone, and as a result downgraded its rating on Charter Hall to Sell from Neutral. All other brokers retained their Buy or equivalent ratings. The common view among brokers was that Charter Hall had now reached an earnings trough, that there were signs of a pick-up in activity and investment opportunities, and the devaluation cycle was also nearing its nadir.

Charter Hall surprised the market with stronger than expected FY25 operating earnings guidance, despite asset under management headwinds. Jarden believes this suggests management is seeing signs of transactional activity and investment opportunities pick up. This, combined with cost discipline, an attractive and well managed development pipeline and operating leverage, should set the group up for a strong earnings recovery over the next two to three years, in Jarden’s view.

The broker further suggested while many REIT peers are trying to build (new) fund management capabilities, Charter Hall’s strong track record will allow it to outperform, which is not reflected in valuation.

Valuation heading into the FY24 result was at a 14x PE compared to a long term average of 17x, Macquarie noted, which informed the broker’s Outperform rating at the time. The subsequent share price rally had taken the PE to 20x by Morgan Stanley’s late September update.

Aside from the result itself, and rate cut anticipation, Charter Hall received an added boost in early September by being included in the FTSE EPRA Nareit Global Real Estate Index. That index was rebalanced in late September leading to additional shares being purchased by funds tracking the index. This phenomenon was also witnessed for shares in Goodman Group ((GMG)) earlier.

Too Expensive Now?

As noted, UBS saw Charter Hall as overvalued on the back of its result rally. The stock’s long term average PE is 17x but Charter Hall has more recently traded at 20x, based on management’s guidance of 79c earnings per share in FY25. Yet, as Morgan Stanley highlighted, from early 2019 to early 2022 the stock traded on 25-26x multiples.

Through that period, the market had anticipated around a 10% compound annual growth rate for assets under management and earnings per share growth. At present, Morgan Stanley points out, the market is not substantially lower at 7-8%.

Conservatively, in Morgan Stanley’s words, assuming 15% of assets under management is a fair representation of deals per year through-cycle, plus some very modest performance fees, the broker estimates 86cps is a fair normalised earnings per share number, under current operating conditions. So from a top-down perspective, 22-23x PE, on 86c EPS, translates to a valuation of $19-20 per share, which is broadly in line with the broker’s revised bottom-up driven $18.50 price target.

Morgan Stanley has an Overweight rating.

Another common theme among brokers is to point out Charter Hall has a track record of posting conservative guidance. Between FY17 and FY23 guidance upgrades averaged 20%, Macquarie notes, and that includes only 4% in FY23 as RBA rates were on the rise.

To Sum Up

Brokers agree Charter Hall has likely now seen a trough in earnings, and that management’s guidance may well prove conservative, as has typically been the case. Property valuations may have further to fall, but by the second half of FY25 should be back on the rise again, courtesy of expected RBA rate cuts.

Having updated on the August result, Macquarie (Outperform) set a target of $14.30, Ord Minnett (Accumulate) $14.50, and Jarden (Overweight) $14.50. UBS (Sell) was the outlier on $12.80.

Citi (Buy) had set a $14.70 target, which it retained when Charter Hall was added to the above-mentioned global REIT index.

Morgan Stanley (Overweight; $15.80) has posted the most recent update. At the time of writing, the stock is trading at $15.70.

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