Opportunities Still To Be Found In A-REITs

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-Conditions support A-REIT outperformance
-Disagreement on MGR, SGP outlook
-Potential for tie-ups in A-REITs?
-Disappearing retail travel agents
-Office on the recovery trail
 

By Eva Brocklehurst

The outlook for Australian Real Estate Investment Trusts (A-REITs) is increasingly attractive versus the rest of the market as balance sheets are solid and gearing is generally falling, in UBS' view.

The sector has outperformed the market by 4.0% over the year to date with the best performers being those with long-lease assets such as Shopping Centres Australasia ((SCP)) andr BWP Trust ((BWP)) and business models such as Scentre Group ((SCG)) and Goodman Group ((GMG)). On fundamentals, the sector is trading at a 6.0% discount to the broker's fair value measures with a distribution yield of 5.1%. UBS expects conditions will support outperformance for the rest of 2015 based on slowing economic growth. The broker's economists are below consensus on GDP growth forecasts for 2015, at 2.3%.

UBS also dismisses the overly bearish argument surrounding the US Federal Reserve's eventual raising of interest rates. Of more importance is the US long bond and the broker expects, despite 200 basis points of Fed Funds tightening factored to the end of 2016, 10-year treasuries will rise by just 60 basis points, to 3.0%.

The broker believes Mirvac Group ((MGR)) and Stockland ((SGP)) could surprise the market at the results with net tangible asset gains, boasting diversified holdings with potential revaluation gains on developments. Mirvac's earnings are expected to surprise to the upside in FY16. The company has put 25% of Green Square up for sale which UBS estimates will be 3.7% accretive to FY16. Morgan Stanley, on the other hand, has downgraded its rating on Mirvac to Underweight from Overweight. This broker's analysis suggests consensus earnings estimates are too optimistic and moderating house price growth is likely to drive a price/earnings de-rating.

Of note, house prices do not need to decline. Only the rate of growth has only to slow for the de-rating to continue. Morgan Stanley notes the current cycle is the first since 1990, ex the GFC, in which the two stocks have underperformed the A-REITs index. Notable differences in the current cycle include regulatory involvement, historically low rates and uneven house price growth across capitals, as well as declining affordability. Morgan Stanley retains an Underweight rating for Stockland on a similar basis, as well for its material exposure to the weakening Western Australian residential market.

In contrast, UBS cites Mirvac's third quarter contract exchanges, which were at record highs. UBS expects pre-sales by year end to be nearing $1.4bn. The broker expects 13% growth in FY16 in terms of lots sold. Stockland has also recorded the highest number of net deposits in its year to date since 2011, while Lend Lease's ((LLC)) apartment pre-sales are expected to rise 50% in FY16. Morgan Stanley disagrees, with forecasts for flat residential volume growth being the key difference that sets it apart from consensus.

UBS envisages upside potential in Stockland's distribution and pay-out ratio in FY16. Stockland has maintained a flat distribution for a number of years after re-basing earnings. The case against a slightly higher pay-out ratio is the investment that is currently occurring in early stage master-planned communities. Macquarie believes Stockland's strong growth stands out, but also notes the distribution currently exceeds the targeted pay-out ratio.

Macquarie contemplates the potential for Mirvac to become a takeover target at current share prices. The broker also believes a tie up with Stockland could be modestly accretive because of a requirement for a majority scrip-funded deal, given balance sheet constraints, and Stockland being likely to have to raise equity at a much higher earnings yield relative to the earnings yield on the bid price for Mirvac. The broker also suspects other types of buyers could pay a higher price for Mirvac in an M&A scenario.

Other A-REITs high on Macquarie's list for potential M&A include Westfield Corp ((WFD)), which the broker suspects is likely to again restructure or be taken out in its existing form. Also, the broker does not envisage material synergies emanating from being an integrated operator across retail, office and industrial segments and speculates whether GPT Group ((GPT)) is ripe for breaking up. Whilst acknowledging a break-up would be a complicated transaction, the high quality nature of the company's real estate suggests there is value to be discovered in the process.

Outside of the residential sector the other aspect likely to feature in the FY15 results is specialty sales. UBS notes recent feedback on David Jones suggests a strong second half while Country Road sales in Australasia grew 11.5%. UBS expects discretionary retail will outperform over 2015 driven by a continuation of the wealth effect – strong house price growth and supportive equity markets — while a lower Australian dollar supports increased inbound tourism and less online expenditure.

Macquarie takes a closer look at shopping centre tenants and finds travel agents is another category which is contracting. This is because of growth in online travel facilities and reduced total transaction value. A lower Australian dollar is also a negative for the industry, given around 55% of revenue is derived from Australians travelling overseas. Many international tourists book Australian holiday activities either from home or online, thus bypassing domestic travel agencies. Suppliers such as airlines and hotels have launched their own online offerings in order to secure direct bookings.

The broker cites data which reveals travel agents are the most productive retailers in a shopping centre, with low occupancy costs reflected in the bundled nature of items sold. While there is limited disclosure from the A-REIT sector in relation to travel agent exposure Macquarie suspects, when coupled with an already challenged backdrop in other categories, this supports a view that income growth from shopping centres will remain low in the future. With moderate earnings and distribution growth profiles Macquarie remains underweight pure retail A-REITs.

One segment that appears on the recovery trail is office. Macquarie still expects incentives to remain elevated over the next 12 months but they are easing. Hence, as its share price has de-rated and the operating environment is marginally better, the broker upgrades its recommendation on Dexus Property ((DXS)) to Outperform from Neutral.
 

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