Brokers Review A-REITs Favourites

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 – A-REITs outperformed last week
 – REITs generally perform well when bond yields are falling
 – Retail A-REIT sector analysed
 – Brokers update preferred A-REIT exposures

By Chris Shaw

For the week ending May 25, BA Merrill Lynch notes the A-REIT Index rose by 0.5%. This represents outperformance relative to broader equity markets, which were down 0.4% for the period.

At current levels BA-ML estimates A-REITs offer an average implied total return of 10.1%, of which 6.2% is average dividend per unit yield. On BA-ML's numbers the sector trades at an average discount to price objectives of 3.5% ex Westfield Group ((WDC)), while the average forward earnings multiple is 12.7 times.

While not directly applicable to Australian REITs, BA-ML notes its US REIT team has increased its bias to high quality exposures. The change reflects the risks of European macro concerns spilling over to the US market and sees the broker suggest investors should trim exposure to lower quality REITs with weak balance sheets.

Among A-REITs under coverage, BA-ML has Buy ratings on Dexus ((DXS)), Mirvac ((MGR)), Westfield Group ((WDC)), Astro Japan ((AJA)), Challenger Diversified ((CDI)), Centro Retail ((CRF)), Charter Hall ((CHC)), Cromwell Property ((CMW)), FKP Property ((FKP)) and Investa Office ((IOF)). 

Analysis by UBS suggests REITs generally perform well in an environment of falling bond rates. Given the expectation global bonds will rally or at least yields will stay low as a risk-off move, UBS sees higher yielding A-REITs as attractive at current levels.

The other positive in UBS's view is the large spread between current applied discount rates and the 10-year bond rate offer a large margin of safety to valuations. This reflects the fact there is significant room for the maintenance of existing cap rates and discount rates in the sector. 

This is a positive for low beta plays such as Westfield Retail ((WRT)), CFS Retail ((CFX)), Commonwealth Property Office ((CPA)) and Westfield Group. Further analysis of changing betas within asset classes is warranted in the view of UBS, as there is some evidence of a switch in the retail and office sectors given the current relative safety of the office market compared to the historical safe haven of retail exposure.

Having reviewed its models, Centro Retail is UBS's top pick in the A-REIT space as litigation issues have been settled and as management executes on stated strategy. Westfield Group is also preferred given its exposure to an improving US consumer and development upside but is rated as Neutral, while Investa Office and Commonwealth Property Office are preferred given their office exposure. Investa is rated as a Buy, while the latter is rated as Neutral by UBS.

At the same time UBS has revised Goodman Group ((GMG)) to midweight within the sector while retaining a Buy recommendation. Least preferred are CFS Retail and Mirvac, both of which are rated as Neutral by UBS. Others to score Neutral ratings are GPT Group ((GPT)), Stockland ((SGP)) and Dexus.

Looking more closely at retail exposures, Deutsche Bank has attempted to benchmark the A-REITs using the same mix of tenants across retail assets while factoring in productivity and occupancy cost averages. This allows for better comparison of the various retail plays.

Under such an analysis Deutsche suggests Stockland's portfolio appears the best positioned, followed by Westfield Retail. In contrast, the portfolio averages of GPT and CFS Retail mask significant variability between assets, while Centro Retail produces uninspiring results under such an analysis. 

As a result, Deutsche's top picks among retail A-REITs are Stockland, Goodman Group and Lend Lease ((LLC)), all of which are rated as Buy. In Contrast, RFS Retail, Centro Retail, GPT, Westfield Group and Westfield Retail Trust are all rated as Hold by Deutsche Bank. 

Still on retail, a report by Morgan Stanley suggests the retail environment in Australia remains challenging, this given higher household savings, declining household wealth, increased online competition and a stronger Australian dollar. 

This has combined to generate weaker sales growth, at a time when rising input costs and higher rents as a percentage of sales are squeezing retailer margins. This trend is expected to continue.

Despite this, Morgan Stanley notes Australia is an attractive choice for global apparel brands, to the extent a number of global brands are likely to target the Australian market for expansion. Such a move will be helped by an ability to compete aggressively on price, range and quality against existing local players.

Morgan Stanley estimates new global apparel brands could achieve apparel market share of 6% by FY16, with upside to this estimate assuming more aggressive store roll-out assumptions. On base case store roll-out assumptions global apparel brands will represent 3.2% of existing gross lettable area in Australia's top 50 malls, though any roll-outs will likely be selective in terms of store positioning.

As initially flagship type stores are likely, Morgan Stanley suggests early entries will be restricted to major redevelopments such as CFS Retail's next stage at Chadstone and possibly Emporium in Melbourne's CBD.

The global brands entering the Australian market are likely to pay anchor tenant rent in Morgan Stanley's view, which implies longer leases and lower than average rents for the quality of space provided. 

With the global brands likely to be targeting malls that already have long waiting lists, Morgan Stanley's view is the entry of such companies may not prove to be a saviour for mid-tier malls, especially those with unsupportive demographics. 

Among A-REITs under coverage, Morgan Stanley has Overweight ratings on Westfield Group, Charter Hall Retail ((CQR)), Commonwealth Property Office, Investa Office, Dexus, Goodman Group and Lend Lease. 

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