Oz Residential REITs Undervalued

This story features STOCKLAND, and other companies. For more info SHARE ANALYSIS: SGP

– Recent sell-off has created value among Oz REITs
– Stocks in sector trading at discount to asset values
– Fundamentals suggest residential developers the preferred exposure

 

By Chris Shaw

In the view of Morgan Stanley, the recent sell-off among Australian REITs leaves the sector looking oversold on both relative and absolute terms. While volatility is likely to continue for a while longer, the current value on offer suggests share prices should at some point return to recent trading levels.

BA Merrill Lynch agrees, pointing out with the sector on average declining by 4% over the past two weeks, average forecast total return for the next 12 months now stands at 16%. Included in this is an average dividend yield of 6.1%.

Within the sector, BA-ML notes the residential developers have been heavily sold off, underperforming the REIT Index over the past two weeks. This sector includes the likes of Stockland ((SGP)), Mirvac ((MGR)), Lend Lease ((LLC)), FKP Properties ((FKP)), Peet & Company ((PPC)) and Australand ((ALZ)). 

The sell-off comes despite sector fundamentals remaining intact, something that gives BA-ML confidence the recent weakness will be reversed. The recent share price falls mean improving fundamentals are not being priced in, as recent cap rate compression and moderate sector gearing are expected to improve net asset value growth over time. 

Cap rate is calculated by dividing a property's net operating income by its purchase price. BA-ML estimates the market implied cap rate for the sector is 7.9% against a book cap rate of 7.0%. This implies a 12% discount to asset values.

Adding to this view is a solid earnings outlook, BA-ML forecasting 5-year capitalised annual growth in development EBIT (earnings before interest and tax) of 15%. This should reflect both volume growth and market share gains.

Volumes may not lift in all markets, as UBS notes there are some signs volumes in the Victorian market are slowing. But any weakness in that market should be balanced by recovery in markets such as Queensland and New South Wales.

Given an agreement with BA-ML's positive view, UBS continues to recommend a slight overweight position in residential developers. This reflects both continuing upward momentum and an expectation market shares continue to be increased. Affordable land developers are preferred given a better margin outlook.

In terms of what stocks are most attractive among Australian REITs, BA-ML's top picks are Stockland, Mirvac and CFS Retail Property ((CFX)). Stockland is considered attractive given a pure Australian domestic exposure, a diversified range of assets and given the stock is trading near net tangible asset (NTA) backing.

Mirvac is another pure Australian play with a fixed rent review structure that can generate above average net operating income growth. BA-ML estimates the stock is trading at a more than 30% discount to NTA at present. 

CFS Retail offers a defensive Australian retail exposure with scope for benefits from any pick-up in retail spending through this year. There is also scope for expansion within part of the group's portfolio. 

Buy ratings have also been ascribed by BA-ML to Westfield Group ((WDC)) and Westfield Retail Trust ((WRT)), Astro Japan Property Group ((AJA)), Charter Hall Group ((CHC)), Charter Hall Office ((CQO)), Cromwell Group ((CMW)), ING Office ((IOF)) and Peet.

In contrast, UBS rates FKP Properties, Lend Lease, Peet and Stockland as Buy, Lend Lease and Stockland having been upgraded from Neutral previously. UBS retains Neutral ratings on Australand and Mirvac.

Stockland is also a preferred exposure for Morgan Stanley, while the broker also has a positive view on Goodman Group ((GMG)).

To compare this with overall market views on Australian REITs, the FNArena database shows Sentiment Indicator readings of 1.0 for Astro Japan and Cromwell, 0.8 for Peet and Charter Hall Group, 0.7 for Mirvac, 0.6 for Lend Lease, FKP Properties and Goodman Group, 0.5 for Westfield Retail, 0.4 for Stockland and ING Office, 0.3 for CFS Retail, 0.1 for Westfield Group, 0.0 for Australand and minus 0.3 for Charter Hall Office.

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