Still Value In A-REIT Sector

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 – Strong balance sheets and locked in revenues supportive for A-REITs
 – More capital management initiatives expected as a result
 – M&A activity could help close valuation gaps
 

By Chris Shaw

Initial reviews of the Australian real estate investment trust (REIT) sector earnings post the recent interim reporting season suggested the sector displayed good resilience, as in most cases companies met previous guidance despite tough operating conditions (See: A-REIT's Show Earnings Resilience).

Macquarie has again touched on this point in a review of the sector, while suggesting Australian REITs should continue to perform well this year thanks to a combination of strong balance sheets and locked in revenues.

The strength in balance sheets will deliver more in the way of capital management initiatives according to Macquarie, with the likes of CFS Retail ((CFX)), Mirvac ((MGR)) and Dexus ((DXS)) expected to announce buybacks over the course of 2012 in the broker's view.

What should also support share prices in the sector is the strategy of selling assets at net tangible asset (NTA) value and buying back stock at a discount to NTA, one Macquarie sees as a good approach in the current environment.

Across the sector Macquarie's key Outperform recommendations remain retail-centric, with the broker ratings CFS Retail, GPT ((GPT)) and Westfield Retail Trust ((WRT)) as Outperforms. In the office sector Macquarie rates Investa Office ((IOF)) as Outperform, while the broker has recently upgraded Dexus to a similar rating.

JP Morgan also picked up on the capital management theme for the A-REIT sector, suggesting it may be time the market removed the discount stemming from a history of equity raisings and dilutive recapitalisations.

Actions by A-REITs over the past 18 months suggest a reassessment is appropriate, as the past 18 months has seen only one capital raising compared to $800 million of equity bought back and a further $3 billion to be completed in active buybacks.

A-REITs have become net sellers in that period, disposing of around $13 billion more in assets than have been bought in 2011 and 2012. JP Morgan notes as this has mostly been done at book value, balance sheets have been strengthened in the process.

As a result JP Morgan suggests there are now minimal signs of balance sheet stress in the sector, as average gearing stands at around 30% and average terms to debt expiry are around 4.0 years. Both measures have improved over the past year. 

With many A-REITs continuing to trade at discounts to NTA, JP Morgan sees scope for further M&A activity in the sector. This expectation is supported by the fact the prime grade commercial transactions market has returned to more normal levels in recent months, the cap rate cycle appears to have peaked and NTAs are moving higher for well managed REITs.

In earnings terms JP Morgan sees upside from re-setting of fixed rate debt, a process the broker also suggests would assist in share prices re-rating towards NTA. If all interest rate swaps in the sector were reset to market rates JP Morgan estimates earnings per share (EPS) in the sector would increase by around 4%.

Given the A-REIT sector is trading at a weighted average discount to its price targets of 11%, JP Morgan continues to see value. The broker's preferred large cap exposures are Stockland ((SGP)), Goodman Group ((GMG)), Investa Office, Westfield Retail and Mirvac.

The attraction of Stockland is solid performance, a growing market share in residential operations, a strong balance sheet and a compelling valuation. Goodman Group's leading global player position is a positive, while JP Morgan notes margins are being maintained as the group's workbook grows and earnings growth should be better than peers in coming years.

Investa Office offers a cheap valuation relative to peers and the move to internal management is another positive in the view of JP Morgan, while Westfield Retail has the best portfolio of assets and the strongest balance sheet in the sector while trading at a discount to NTA of more than 20%. Mirvac continues to strengthen its balance sheet, this while residential returns are slowly beginning to trend in the right way for the company.

JP Morgan has Neutral ratings on GPT, CFS Retail, Australand Property ((ALZ)) and Centro Retail ((CRF)), while Underweight recommendations are ascribed to Westfield Group ((WDC)), Dexus, Commonwealth Property Office ((CPA)) and Charter Hall Office ((CQO)). 

Among smaller cap exposures JP Morgan prefers FKP Properties ((FKP)), Charter Hall Group ((CHC)), Carindale Property ((CDP)) and Astro Japan Property ((AJA)). Neutral ratings are given to Challenger Diversified Property ((CDI)) and Ale Property ((LEP)), while Abacus Property ((ABP)), Tishman Speyer Office ((TSO)), Bunnings Warehouse Property ((BWP)) and Charter Hall Retail ((CQR)) are rated as Underweights. 

Goldman Sachs has introduced 2015 EPS estimates to its models across the A-REIT sector, the changes to models indicating the strongest earnings growth in the sector in that year is likely to be found in the likes of Charter Hall Group, Lend Lease ((LLC)), Peet ((PPC)) and Westfield Group ((WDC)). Factoring in earnings for 2015 has not prompted any changes to price targets or ratings for stocks in the broker's coverage. 

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