Australia | Jul 13 2011
– Oz Office REITs have outperformed year-to-date
– JP Morgan unwinds positive bias on valuation grounds
– Asset sale likely to prompt capital management by CPA
By Chris Shaw
The Australian office REIT sector has outperformed in relative terms by 14% so far this year, performance strong enough for JP Morgan to unwind its positive bias towards the sector.
As JP Morgan notes, REITs typically revert to the mean over time, so the office sector's outperformance year-to-date is enough to suggest there is now more compelling value elsewhere. The new sector weight has impacted on individual ratings, as both Dexus ((DXS)) and Commonwealth Property Office ((CPA)) have been downgraded.
In the case of Dexus the downgrade is to Underweight from Overweight previously, while for CPA the downgrade is to Neutral from Overweight. Investa Office ((IOF)) retains an Overweight rating, JP Morgan seeing some potential valuation upside from the sale of offshore assets and an expected share buyback.
JP Morgan has Charter Hall Office ((CQO)) as an Underweight as any sale of US assets would see the group's earnings growth profile fall back in line with sector peers. Debt not fully marked-to-market remains an issue for Dexus.
The downgrade of the office sector leads JP Morgan to suggest better value can now be found in residential and retail listings Stockland ((SGP)), Mirvac ((MGR)) and Westfield Group ((WDC)). All three stock are rated as Overweights, while Sentiment Indicator readings according to the FNArena database stand at 1.0 for Westfield Group, 0.7 for Mirvac and 0.6 for Stockland.
With respect to Commonwealth Property Office, JP Morgan notes a key for performance will be the health of the Sydney CBD office market as this poses some potential income risks. The Sydney market is increasingly important for CPA as the group has been exercised on an option to sell three properties in Perth.
While the option will see GDI Property Group acquire the three properties at slightly below book value, UBS notes the sale will remove significant leasing risk for Commonwealth Property Office in FY12.
There will also be a capital gain of $70-$75 million from the sale, UBS expecting this will allow for a special distribution to CPA shareholders. A distribution of 2.0-2.5c is expected by UBS.
BA Merrill Lynch sees scope for proceeds from the sale to first be used to pay down debt within Commonwealth Property Office's portfolio. Such a move could leave 0.7c per share for a distribution, while the alternative is a share buyback estimated to be around 0.3% accretive to earnings per unit.
To reflect the property sale, Macquarie has trimmed earnings estimates in FY12 but lifted its numbers in both FY13 and FY14, the end result being a trimming in price target to $0.95 from $0.98 previously. The consensus price target according to the FNArena database stands at $0.96.
Macquarie has retained a Neutral rating on Commonwealth Property Office on news of the asset sale. This reflects the view while near-term earnings are improved, cash flow generation is still low. This is a function of some refurbishments being undertaken at properties being retained.
For Macquarie, Dexus and Investa remain better plays in the Australian office REIT sector. Macquarie rates both stock as Outperforms, while the FNArena database shows respective Sentiment Indicator readings of 0.1 and 0.4.
Following JP Morgan's downgrade, the FNArena database shows Commonwealth Property Office is now rated as Hold five times and Sell twice. Deutsche Bank had earlier this week downgraded to Sell from Hold following a review of the REIT sector.
Shares in Commonwealth Property Office today are unchanged, last trading at $0.905. Over the past year the stock has traded in a range of $0.81 to $0.99. The current share price implies upside of around 7% to the consensus price target in the FNArena database.
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