Solid Outlook For Australian REIT Sector

This story features CHARTER HALL RETAIL REIT, and other companies. For more info SHARE ANALYSIS: CQR

By Chris Shaw

Australian REITs outperformed strongly in January, delivering a total return of 2.4% against an overall market return for the month of just 0.2%. According to JP Morgan, the lack of specific news in the sector implies much of the outperformance is likely explained by a lowering of the shorter end of the interest rate curve.

JP Morgan sees this as a reflection of the market adjusting its interest rate assumptions, as the Queensland floods and the associated levy mean timing expectations for any further rate hikes have been pushed out.

In sector terms JP Morgan notes Office and Retail were the best performers for January, the former driven by favourable office data in the Sydney CBD market. Relative underperformance was delivered by the Diversified and Industrial sectors.

Looking beyond January, Macquarie expects the fact many REITs continue to trade at a significant discount to the broker's valuation and to net tangible asset backing means capital management is increasingly likely to become a point of focus in 2011.

What supports this theory according to Macquarie is an improvement in the overall credit environment , the fact REITs generally have excess capital available and many are not highly leveraged at present. The process may have already started given Charter Hall Retail ((CQR)) has recently announced a share buyback of $20 million worth of units.

Elsewhere in the sector, Macquarie suggests the metrics in support of some sort of capital management appear very favourable for ING Office ((IOF)), Stockland ((SGP)), Dexus ((DXS)), Charter Hall Office ((CQO)) and Commonwealth Property Office ((CPA)). 

Another positive identified by Macquarie is the potential for capital management initiatives to deliver an improvement in the sector outlook over the course of 2011, as debt restructuring including the reduction of costly excess liquidity implies some potential earnings upside.

As well, Macquarie notes a moderate increase in distribution payout ratios would still leave the sector in a cash neutral position this year and a cash positive position in FY12 based on the broker's estimates, so making such moves more likely.

There is also scope 2011 turns into a below average year with respect to equity raisings in the sector, this as companies continue to reposition their portfolios and given a lack of acquisition opportunities. Add in cash being received from asset sales and Macquarie suggests the usual capital raising drag on the REIT sector may be somewhat less than in recent years.

To reflect this, Macquarie is forecasting a total shareholder return for the Australian REIT sector for 2011 of around 13%, a return the broker views as attractive given the relatively low risk profile of the sector.

The Sydney and Melbourne office sectors have a positive outlook this year according to Macquarie, with rental and yield data already offering evidence a recovery has begun. As well, the broker's forecasts for the Perth office market have been increased given an increase in net absorption rates. In contrast, a further recovery in the industrial market is not expected until 2012.

Leading into the December half results season this month, Macquarie suggests there should not be too many surprises. The key risk relates to outlook comments for FY11 from residential developers, particularly as a result of recent bad weather and the floods experienced in Queensland.

Within the sector Macquarie's key Outperform ratings are given to CFS Retail Property ((CFX)), Charter Hall ((CHC)), Dexus and GPT ((GPT)). Macquarie also sees strong value in Westfield Retail ((WRT)), estimating a total shareholder return for the stock of around 16% given a target price of $2.90. Leading into their respective results, Macquarie's key Underperform ratings are given to Stockland and Australand Property ((ALZ)).

An appreciating Australian dollar has negative near-term implications for the NTA (Net Tangible Asset) of companies with equity invested offshore. For Macquarie this implies NTA falls for Charter Hall Office and Charter Hall Retail, ING Office, ED Retail ((EDT)) and Westfield Group ((WDC)), but evidence of a recovery in the US economy is a positive for Westfield Group, Dexus, Charter Hall Office and EDT Retail over the medium-term.

BA Merrill Lynch has also looked at the REIT sector, but from a perspective of how big a threat online shopping is to margins in the retail sector and for owners of retail shopping centres. The analysis is timely given Australian industry figures suggest online sales may account for between 3-7% of total retail sales.

Taking a long-term view, BA-ML suggests the types of goods likely to do well in an online environment are those of relatively high value that are easy to ship such as books, CDs, DVDs and small electrical items, and specialised niche items that cannot justify a dedicated retail store presence. Other categories such as food and staples appear more protected, as do large ticket items and fashion goods. 

On the broker's estimates, the growth in online sales could cost Australian retailers about 1% annually in sales growth terms. As well, in BA-ML's view the very high returns on equity and margins for the Australian retailers have and will continue to come under pressure as the internet increases competition and removes some barriers to entry.

Even allowing for this, the broker expects Grade A malls will continue to enjoy gains in sales volumes. In FY11 BA-ML expects mall rental growth of 3% for the major Australian REITs, with almost nil vacancies to be reported in February. 

Given a relatively robust Australian economy and a recovering US consumer environment, BA-ML continues to prefer retail REITs in comparison to the office sector. In order of preference, BA-ML rates CFS Retail, Charter Hall Retail, Stockland and Westfield Group as Buy, while Westfield Retail is rated as Neutral.

The broker's forecasts suggest a total return for the Australian REIT sector of 10-12% in 2011, which is below BA-ML's forecast for a 20% total return from the broader Australian equity market.

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