A-REIT Outlooks Diverge

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-Modest retail A-REIT growth likely
-But valuations still favourable
-Housing well placed despite likely curbs
-Scentre Group sells stake in NZ assets
 

By Eva Brocklehurst

The backdrop for retailing landlords is challenging. Macquarie expects comparable income growth will remain in the low single digits for Australian shopping centres. Given fixed escalators for specialty leases of 4-5%, the broker expects negative re-leasing spreads will prevail and this is not a particularly attractive growth profile.

This may be surprising as occupancy levels are resilient across most portfolios and the broker observes an improved spending outlook is finding its way into the shopping centres. Still, for the landlords, the spending recovery is not expected to be reflected in better rents. Given extensive supply additions this will largely absorb retail sales growth in shopping centres. Given the significant amount of capital that is still seeking high quality retail real estate, and lower total return requirements, Macquarie continues to anticipate a favourable backdrop for valuations over the next few years despite the modest income outlook.

On that basis, noting a cautious stance on sub-regional assets, Macquarie retains Underperform calls on Federation Centres ((FDC)) and Stockland ((SGP)). The broker's survey of consumers in the sector also reveals a growing trend towards online grocery shopping, which will be to the detriment of specialty tenants at supermarket centres. The broker's survey indicates local landlords are competing for a sales portion that is insufficient to support fixed rental escalators and supply additions. This supports an Underperform rating for Charter Hall Retail ((CQR)) and Shopping Centres Australasia ((SCP)).

Macquarie is Underweight the large regional mall owners as well – Scentre Group ((SCG)) and Novion ((NVN)) – formerly CFS Retail – given low earnings growth and dividends that remain in excess of free cash flow. GPT ((GPT)) remains the broker's preferred exposure, given its expectations for superior earnings growth into FY15.

Morgan Stanley concurs that the outlook for the retail sector is dimming because of soft wages and weak jobs growth but believes Australian real estate investment trusts (A-REITs), overall, can outperform. Despite limited absolute upside, the broker points to the sector's relatively high degree of earnings certainty. Moreover, some stocks offer yield appeal as well as above-market earnings growth and low downside risk.

Those with exposure to housing remain the best placed. On this aspect, the broker expects policymakers will attempt to curb house price growth to more moderate levels via jawboning, increasing risk weightings for mortgages and through some form of macro-prudential policy. Morgan Stanley believes there is no room for complacency in the housing-led growth story but remains confident the authorities will not err by killing the golden goose, assuming policy will be calibrated to hold house price growth to 4-6%.

Stock selection remains key in this regard for the broker, with Goodman Group ((GMG)), Scentre Group, Dexus ((DXS)) and Lend Lease ((LLC)) considered the best positioned of the A-REITs for outperformance. Those Morgan Stanley considers most likely to underperform are Novion, Charter Hall Retail and GPT.

The A-REITs sector outperformed in October, with the sector up 21.7% in absolute terms and 14.7% against the broader market. Moreover, JP Morgan observes re-leasing spreads have become less negative. The broker observes this outperformance was assisted by compression in 10-year bond rates of 20 basis points and, among the large caps, was led by Dexus, Scentre Group, Stockland and Shopping Centres Australasia. The broker notes Scentre Group has had its best specialty sales growth in Australia since 2009 during October.

Scentre Group has entered into a joint venture to sell a 49% stake in five NZ shopping centres and the sale reflects an 8.2% premium to the June 2014 book value in NZ dollars. The pricing is attractive, in JP Morgan's view, and Scentre Group will retain full management and development rights over the assets. The broker considers the sale a strategic move but believes the company will eventually exit lower quality assets. JP Morgan considers the stock offers the best quality portfolio of any A-REIT, and the best track record. Deutsche Bank is also keen to dispel the idea that de-leveraging will kill earnings growth, estimating this latest sale for Scentre Group will result in free funds dilution of just 0.4% per annum per share out to FY18, for a 210 basis point reduction in gearing.
 

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