Yield Stocks Continue To Find Favour

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-A-REITS offer most certainty
-Yet limited value opportunities
-Internal growth opportunity in utilities
-DB prefers SYD in infrastructure
 

By Eva Brocklehurst

The environment for yield stocks remains favourable, particularly Australian Real Estate Investment Trusts (A-REITs), which brokers consider offer another strong year of returns in the midst of stable bond yields.

Volatile global markets should ensure the A-REITs remain at the forefront, in JP Morgan's view. The broker does acknowledge total returns will be more modest in 2016, around 5-10% after three years of strong performance, amid expectations the asset cycle has peaked.

JP Morgan retains a preference for Westfield Corp ((WFD)), Stockland ((SGP)), Mirvac Group (MGR)) and Lend Lease ((LLC)). The broker is underweight on small cap A-REITs.

Macquarie compares several sectors that offer the best yields and finds, in terms of the initial yield versus a total return, utilities actually offer the highest at 6.9%. A-REITs are in second place with 5.7% and infrastructure in third with 5.3%.

When it comes down to certainty, the A-REITs offer the most, although Macquarie accepts there have been few negative surprises from the other two over the last few years. Infrastructure stocks offer the highest total return to shareholders over the medium term but this is matched by a higher level of leverage.

All these sectors are capital intensive and Macquarie finds limited earnings or value accretive opportunities are presenting for A-REITs. In contrast, the utility sector has internal growth opportunities via capacity additions that are underpinned by long-dated contracts.

Among its key ideas for the three sectors Macquarie singles out GPT ((GPT)) in A-REITs, given its attractive earnings and cash-flow growth profile. Preference also lies with stocks that have tangible earnings/asset value drivers such as Westfield, Goodman Group ((GMG)) and Lend Lease.

Preferred stocks across road and airports are Macquarie Atlas ((MQA)), Transurban ((TCL)) and Sydney Airport ((SYD)) as these all provide dividend growth of over 10%. Issues surrounding regulatory re-sets and technology disruption limits any re-rating for utilities, in Macquarie's view.

Deutsche Bank has never had an issue with the quality of the infrastructure sector, just the valuation. The broker reviews the cost-of-equity discount rate applied to stocks under coverage and observes a trend for values to increase via reduced risks, as assets mature, as well as through the compression of the discount rate that is applied.

The issue for the broker is how much to pay for these high quality assets during volatile times. The required rates of return have continued to fall over time as the understanding of the assets has increased and, hence, the risk is reduced as well.

Deutsche Bank believes the downward trend in returns is likely to continue into the foreseeable future, because of the low interest rate environment that prevails. Still, the broker remains cautious applying a lower long-term discount rate, given the long-dated nature of the assets exposes them to interest rate risks and technology changes.

Rates are likely to remain at similar levels for the foreseeable future and Deutsche Bank chooses an 8.0% discount rate out to 2020, reverting to 9.0% for the long term. This effects an increase to the price targets for Sydney Airport, to $6.65, Macquarie Atlas, to $4.45, and Transurban, to $10.20. Deutsche Bank prefers Sydney Airport of the three, expecting increased benefit from growth in international capacity and other commercial developments.

UBS anticipates another strong year for the real estate sector, with 5.0% distribution yields, 4.0% growth and a discount to fair value that leads to a 10% total return forecast for 2016. The broker envisages a risk to pricing when 10-year bond yields being to rise but so far 2016 appears benign.

The broker observes key investment themes include a re-rating of the residential developers as the cycle moderates, defensives delivering on core returns and confidence improving for previously unloved names. In the latter case, UBS has upgraded Vicinity Centres ((VCX)) to Buy. The broker prefers Westfield over Goodman for international exposure.

Morgan Stanley retains a preference among A-REITs for those with clear disposal and development strategies. Office names are expected to report the strongest increases in net tangible assets while supermarket-anchored landlords are expected to make smaller gains.

The broker expects demand for Australian commercial property will be maintained. This underscores a preference for those names which sell non-core assets into strength and redeploy proceeds to improve portfolios via re-development.

Morgan Stanley avoids those stocks which are maintaining strategies to make acquisitions for near-term earnings accretion such as Charter Hall Retail ((CQR)) and Charter Hall ((CHC)). Morgan Stanley's top picks in the sector are Goodman Group, Lend Lease, Westfield and Vicinity Centres.

The decision by Woolworths ((WOW)) to exit its Masters hardware chain has implications for retail A-REITs, Macquarie asserts. Those with the most exposure to Masters include Aventus Retail Property ((AVN)), Charter Hall and Shopping Centres Australasia ((SCP)), although the broker concedes this is not significant at a group level.

The broker suspects the A-REITs are well placed to recoup unpaid rent, with the average term remaining on the leases typically 12-20 years. If the site is located in a metro location the A-REITs are expected to agree a deal early if they can secure and alternative tenant.

The Masters rent per square metre is typically quite low compared with other retail uses yet a lot of space will have to be re-leased and the capex cost for re-fit could be elevated if the intention is to divide into smaller tenancies. The broker expects, if the entire Masters network is closed, this would be a positive for Bunnings' anchored real estate, BWP Trust ((BWP)).
 

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