Value Opportunities Emerge In AREITs

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-Value emerging in AREITs
-Several upgrades to ratings
-AREITs well placed as Oz economy slows
-Capital management, acquisitions continue
 

By Eva Brocklehurst

Australian real estate trusts (AREITs) were looking expensive of late and increasingly lacking in opportunities. The past month has changed that somewhat. The sector sold off by 7% over May, underperforming the ASX by 1.3%, although in the past week it has relatively outperformed.

Citi believes there is some good value emerging. Earnings growth is positive and opportunities exist for accretive purchases of assets using debt. Citi has refreshed valuations to account for recent transactions, equity issuance, currency and interest rate assumptions. From this comes the key picks, being Stockland ((SGP)), Australand ((ALZ)), Westfield Retail ((WRT)), Federation Centres ((FDC)), Goodman Group ((GMG)) and Investa Office ((IOF)). Both Westfield Retail and Investa were upgraded to Buy.

Despite the pullback in the sector the price/earnings multiple remains significantly elevated against long-term averages. Goldman finds the value opportunity has switched from stapled AREITs to passive ones which now trade below net tangible assets (NTA) on average. Over the past month CFS Retail Property ((CFX)) was the worst performer of the sector followed by Westfield Retail, for Goldman this highlights a trend of avoiding consumer discretionary linked investments. BWP Trust ((BWP)) had some extreme price movements during May and Goldman finds it expensive against underlying NTA, retaining a Sell rating. Shopping Centres Australasia ((SCP)) recorded the second highest price rise during the month and the broker initiated on the stock with a Buy rating during May.

Commentary regarding tapering of the US quantitative easing and rising interest rates in Japan has been the focus for the sector. The AREITs are better placed than some global peers, in BA-Merrill Lynch's view, and for several reasons. The Reserve Bank's cash rate is 2.75%, still well above the other markets and more cuts are considered possible. Rising interest rates are an indicator of improving growth, but that's the global outlook. Australia is expected to slow as the mining boom peaks. The distribution yield on the spread of the AREITs is still 190 basis points above 10-year bonds, about 60bps above the long term average. Cyclical equities are expected to remain under pressure and this makes the earnings certainty of the lower-risk AREITs appealing. Market transactions have shown some strong pricing of prime assets but, overall, Merrills does not find it extravagant.

Another recent feature Merrills highlights is the fact AREITs have minimal direct exposure to the Australian dollar. The falling currency has a small positive benefit for Westfield Group ((WDC)) and Goodman, given international exposures at 65% and 60% respectively, but both employ significant notional gearing offshore, reducing the impact. The rest of the sector is strongly Australian based.

CFS Retail may have more earnings and rent risk than peers, given the higher proportion of B-grade malls, but Merrills sees this fully reflected in pricing. Mirvac ((MGR)) has a strong 11% earnings growth forecast for 2014 and 60% of development earnings are locked in. Dexus ((DXS)) is making good use of the current low cost of capital to further exposure to prime office and growth potential from acquisitions.The biggest weakness over the past week has been in FKP Property ((FKP)), Peet ((PPC)) and Charter Hall ((CHC)), while Merrills found value emerged in CFS Retail, Mirvac  and Dexus, upgrading all three to Buy. Both Westfield Retail and Lend Lease ((LLC)) have underperformed the benchmark by around 3.5% in the past month and are down 10% in absolute terms. Merrills thinks this is overdone and retains Buy ratings on the two.

Capital management remains at the forefront of AREIT plans. JP Morgan notes debt costs have fallen, particularly for the large cap AREITs, which currently have access to five-year debt at around 5.0%, below the FY13 average debt cost for the sector of 5.4%. Balance sheets are in good shape too, on average. The AREITs are around 29% geared and sector refinancing risks are low. Nine AREITs have accessed the debt capital markets in the last 12 months, altogether issuing $3.1 billion at an average 196bps for 10 years, diversifying funding sources away from banks and extending average debt duration. These are all positives, in the broker's view.

Acquisition strategies appear to be shifting and vary significantly. Westfield Group is increasing returns by selling down part shares of assets. Federation Centres is also selling part shares and then buying some assets out of syndicates. GPT ((GPT)) is reducing retail exposure. Stockland is increasing retail exposure and remains tactical on office. Dexus, Investa and Charter Hall Retail ((CQR)) are selling offshore assets while Commonwealth Property ((CPA)), Investa, Dexus, Charter Hall Retail and BWP Trust are pursuing domestic acquisitions.

JP Morgan expects AREITs to become more aggressive on acquisitions, using cheap debt where gearing capacity is available and new equity where appropriate. Further cap rate compression is also likely because of lower debt costs. Learning from the liquidity crisis during the GFC, AREITs have continued to reduce reliance on bank debt. Domestic and offshore bond markets are being targeted more aggressively and bonds now represent 47% of the total debt, roughly in line with bank debt at 49%. Buy-backs have slowed substantially this year. The only two AREITs still buying back stock are the two Westfields – WDC and WRT, albeit intermittently.

JP Morgan observes the sector's average earnings per share would lift by 4% if each AREIT re-based interest rate hedges to current market rates. Those that would get the most traction in this way include Westfield Group, Australand, Goodman Group, Challenger Diversified ((CDI)) and CFS Retail. The least upside lies with Dexus, Investa and Federation Centres. JP Morgan would not be surprised to see pay-out ratios increase further. The broker forecasts six AREITs will pay out more than 100% of free cash flow in FY13, including Westfield Retail, CFS Retail, Bunnings Warehouse and Carindale Property ((CDP)).
 

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