BWP Trust Battles Market Sentiment

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This story features BWP TRUST, and other companies.
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The company is included in ASX200, ASX300 and ALL-ORDS

BWP Trust, the vehicle which owns the Bunnings Warehouse sites, is facing a battle with market sentiment as it deals with upcoming vacancies at some sites. Are the risks factored in?

-Combination of re-leasing, re-development and disposals expected
-Sustainability of pay-out ratio under scrutiny
-Does the distribution yield compensate for the re-leasing, development risk?
 

By Eva Brocklehurst

BWP Trust ((BWP)), the vehicle which owns the Bunnings Warehouse ((WES)) sites, is facing a battle with market sentiment as it deals with upcoming vacancies at some sites. Are the risks factored in?

BWP Trust reported FY17 earnings per security (EPS) of 17.51c, up 4.3%. Distribution forecasts are unchanged for FY18. The result reinforces Citi's view that the company is facing operating as well as sentiment headwinds. The stock is priced at a premium to reflect income security but the broker believes investors will increasingly question this status.

The reasons are several and include the potential for vacancies to rise, tenant quality to weaken, shorter leasing terms and higher gearing. Management needs to reposition a number of properties, up to 5% of the portfolio in FY18, which Bunnings is likely to vacate. Citi expects a combination of re-leasing, redevelopment and disposals.

The impact of lost rent will probably build into the second half and rise again in FY19, based on the timing of lease expiries. The broker contends the ultimate impact on earnings per security and distributions probably depends on the mix of redevelopments, which are generally accretive, and disposals, which are typically dilutive.

Ord Minnett believes this is the start of a challenging period for the company. Management would not quantify the extent of the expected decline in underlying earnings over the next 12 months but the broker estimates it to be around -2%.

On the other hand, management calculates that re-positioning and/or development capital expenditure, along with incentives, could be in the order of $200m for the next two years. This is a lot of money to spend in a relatively short period of time, Ord Minnett suggests.

The broker reduces forecasts for EPS by around -1% to reflect lower rental growth and estimates $175m for expansion & re-leasing capital expenditure and incentives over the next four years.

UBS does not believe the 6% distribution yield compensates for the execution risk that now lies with the re-leasing and redeveloping of a material proportion of the portfolio. The lack of clarity surrounding capital expenditure over the next two years and the returns does not instill confidence either.

Hence, while the transaction market for Bunnings warehouses remain strong, so do other real estate asset classes, and UBS maintains a Sell rating on the stock. Given the leasing profile, the broker anticipates FY19 and FY20 will also be under pressure.

Core Portfolio

Management has introduced the concept of a core portfolio, which includes 68 properties, or around 85% of the portfolio. The remaining assets are designated as non-core based on current status, i.e. looming vacancy, rather than underlying attributes of location and size.

This suggests to Citi that the non-core assets need to be sold, or could resume a place in the core once leases are settled. Meanwhile, the current core outlook appears reasonable to the broker, with the company reporting organic growth of 2.1%. Regardless, the stock trades at a generous price/earnings ratio and given the elevated uncertainty a Sell rating is maintained.

Valuation Question

Morgan Stanley explains it thus: BWP has been traditionally held for its simplicity, being close to 100% leased with a long weighted average lease expiry (WALE) and in the past there has been limited capital expenditure, supported by a growing Wesfarmers-backed tenant. Now, changes to the business may cause investors to reassess the value proposition.

The WALE has declined to five years and downtime is due to materially increase from FY18. In tandem, capital expenditure is due to materially step up. As a result, this could raise questions on the sustainability of the pay-out ratio.

Yet, Moelis believes that despite some re-leasing and repositioning that needs to be completed in FY18 and FY19, the implied yields on "at-risk" assets arguably reflect this risk. Therefore, the broker is comfortable that there is minimal downside risk to the company's net tangible assets.

Moelis believes the outlook for FY18 may be flat and affected by sites going off-line, being vacant or disposed of, but in the context of the broader portfolio the impact is largely factored into valuations.

Despite a shift in home hardware in recent years, direct market transactions are frequently traded on yields in the 5% range, the broker observes, which is not necessarily reflected in the company's better quality assets. Moelis, not one of the eight stockbrokers monitored daily on the FNArena database, retains a Hold rating and $2.95 target.

There are three Sell ratings and one Hold (Ord Minnett) on the database. The consensus target is $2.77, signalling -3.8% downside to the last share price. Targets range from $2.60 (Morgan Stanley) to $3.10 (Ord Minnett).
 

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