More Upside For Property Trusts

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 – A-REITs continue to outperform broader market
 – Trend can continue given high yield spreads and cap rates and lower debt levels
 – Underweight positions in the sector should insulate prices
 – Brokers update sector preferences leading into profit results

By Chris Shaw

For the week ending August 3 the Australian real estate investment trust (REIT) sector outperformed the broader market, the A-REIT Index gaining 1.4% against a 0.3% rise in the market overall. This followed similar outperformance in July, when the A-REIT sector rose by 5.6% against a 4.3% gain for the broader market.

The outperformance has continued a trend evident over the past 12 months, where the sector has outperformed by 24.3%. JP Morgan attributes this to investors seeking stability and high yields given the uncertain macro environment at present.

At current levels, BA Merrill Lynch suggests the A-REITs offer an average 11.7% implied total return. Of this, the average dividend yield on offer is 5.9%, which the broker notes is 273-basis points ahead of the 10-year bond yield.

Leading into reporting season for the sector, BA-ML expects an average of 2.6% in earnings per share (EPS) growth in FY12. This should be achieved through a combination of modest net operating income growth, falling debt costs and capital management initiatives.

JP Morgan notes the outperformance of the sector in July came despite on-market share buyback activity coming to a halt for the month. Just $22 million in stock was repurchased, as companies enter their blackout period prior to releasing earnings results this month.

Buybacks have been accretive to net tangible assets (NTA) in the sector, as JP Morgan notes the $1.7 billion of stock repurchased through operational buybacks have been completed at an average discount to NTA of 8.2%. This is the equivalent of paying $1.2 billion for $1.5 billion of book value, which implies NTA accretion of 0.8%.

Further buyback announcements are not expected with upcoming results according to Deutsche Bank, this given the re-rating of the sector in recent months. With low gearing across the sector and recent falls in marginal debt costs, Deutsche expects further accretive acquisition activity and ongoing hedge book restructuring.

Despite the outperformance so far this year, Deutsche Bank notes Australian equity managers on average maintain a large underweight exposure to the sector. A recent survey of managers suggests an average exposure to the A-REIT sector of 2.2% against a market weighting of 7.1%. In contrast, overweight positions in other defensive sectors of the market appear overcrowded at present.

In Deutsche's view this suggests at the least if the market sees any risk-on shift out of defensives, pricing in the A-REIT sector should be relatively insulated. The A-REIT sector currently trades on a forward earnings multiple relative versus the S&P/ASX200 Industrials of 0.95 times and Deutsche suggests downgrades to forecasts for the broader market should see this multiple trend towards or below the 10-year average of 0.91 times.

Goldman Sachs agrees the recent outperformance of A-REITs can continue, as yield spreads relative to 10-year bonds are at historical highs and high cap rate spreads and reducing debt costs offer potential for strong NTA growth.

For the upcoming profit reporting season Goldman Sachs expects top line net operating income growth will moderate for office and retail plays, but an increased focus on lowering debt costs could still see an acceleration in EPS growth.

From a sector standpoint Goldman Sachs expects more volatility among residential REITs, while the broker has upgraded its outlook for residential construction plays to reflect factors such as improved affordability and lower mortgage rates.

With profit results upcoming, Deutsche Bank has adjusted sector earnings forecasts from FY13, which flow through to changes in ratings and price targets. The changes reflect recent relative performance as well as adjustments to expectations for the office market in particular.

The result is Deutsche Bank has downgraded Commonwealth Property Office ((CPA)), Dexus ((DXS)), Investa Office ((IOF)) and GPT ((GPT)) to Sell ratings from Hold previously as each stock now appears relatively expensive. Charter Hall Group ((CHC)) has similarly been downgraded to Hold from Buy.

At the same time Deutsche has upgraded Westfield Group ((WDC)) to Buy from Hold, while the price target has increased to $10.70 from $9.60. For Deutsche, a more positive rating is justified as Westfield should be able to deliver $1.25-$1.5 billion in development starts annually on a sustainable basis. 

Elsewhere in the sector Deutsche rates Charter Hall Retail ((CQR)), Goodman Group ((GMG)) and Stockland Group (SGP)) as Buy, while CFS Retail ((CFX)), Cromwell ((CMW)), Centro Retail ((CRF)), Mirvac ((MGR)) and Westfield Retail ((WRT)) are rated as Hold.

Ratings are somewhat different for Goldman Sachs, with Buy ratings retained on Lend Lease ((LLC)), Stockland and Westfield Retail. The broker has sell ratings on Westfield Group and GPT.

Neutral ratings dominate for Goldman Sachs, with Astro Japan ((AJA)), Australand ((ALZ)), Challenger Diversified ((CDI)), Charter Hall, Dexus, Mirvac, BWP Trust ((BWP)), CFS Retail, Charter Hall Retail, Centro Retail, Commonwealth Property Office, Investa Office and Goodman Group all scoring such a rating.

BA-ML is more bullish and has a larger range of Buy ratings, these including Investa Office, Centro Retail, Westfield Group, Astro Japan, Australand, Challenger Diversified, Charter Hall, Cromwell, Dexus, FKP Property ((FKP)), Mirvac and Stockland.

Neutral ratings for BA-ML cover BWP, CFS Retail, Charter Hall Retail, Westfield Retail and Peet ((PPC)), while BA-ML is Underweight on Commonwealth Property Office, Goodman Group, GPT and Lend Lease. 

 
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