Diverging Growth Outlook For A-REITs

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This story features MIRVAC GROUP, and other companies.
For more info SHARE ANALYSIS: MGR
The company is included in ASX100, ASX200, ASX300 and ALL-ORDS

Brokers find picking and choosing A-REITs since the reporting season is mostly about identifying divergent growth trajectories.

-Earnings outlook diverging along sub-sector lines
-A-REITs taking advantage of global debt markets
-M&A activity remains prevalent
 

By Eva Brocklehurst

Australian Real Estate Investment Trusts, A-REITs, have underperformed recently as bond yields have risen, signalling the potential for considerable downside to valuations in the sector.  Despite this, Goldman Sachs observes the trajectory for global bond yields appears to be shifting to a slower rate of increases, versus what was originally expected at the onset of the reflation trade. This may ease the immediate valuation pressures on A-REITs.

The broker believes, if spreads to bonds are maintained, the higher-growth active A-REITs are most likely to outperform in a rising rate environment, retaining a Buy rating for Mirvac ((MGR)) and Propertylink ((PLG)) and a Sell rating for GPT ((GPT)).

The former two, as well as Stockland ((SGP)) and Goodman Group ((GMG)), provided initial FY18 guidance for growth in the mid to high single digits. Goldman Sachs likes Mirvac's leverage to Sydney and Melbourne urban locations as well as largely pre-sold commercial and residential development. GPT has a large exposure to retail, which is less appealing.

The broker notes A-REITs have taken advantage of the liquidity in global debt markets and sources of debt across the sector have diversified. As a consequence, most are now relying less on domestic banks for funding and are, therefore, less susceptible to changes in costs and the availability of bank debt. This has also allowed A-REITs to secure longer-dated debt.

Mergers & Acquisitions

Macquarie observes M&A activity remains prevalent in the sector given the limited organic growth opportunities in most sub-markets. Capital is still relatively inexpensive, so a number of A-REITs have acquired strategic equity stakes in others over the last year or so.

The list includes Growthpoint Properties ((GOZ)) taking a stake in Industria ((IDR)), Cromwell Property ((CMW)) in Investa Office ((IOF)) and Shopping Centres Australasia ((SCP)) in Charter Hall Retail ((CQR)).

The broker takes a closer look at the speculation that Charter Hall Group ((CHC)) and Ascendas-Singbridge are separately considering taking a 25.3% stake in Cromwell from its larger shareholder, Redefine. At this stage any structure is highly uncertain but the broker considers the impact would be neutral if Charter Hall acquired the stake in isolation, assuming 100% equity funding.

The broker presumes Charter Hall would prefer to acquire Cromwell in its entirety. The Corporations Act requires an offer to be launched if the shareholder's interest increases over 20%. Macquarie estimates earnings accretion would be around 3.6%.

Moreover, acquiring an established portfolio would be an efficient method of growing the platform more broadly. Macquarie retains a Outperform rating for Charter Hall and, whilst there is a risk of corporate activity, an Underweight rating on Cromwell as it continues to trade above valuation, carries elevated gearing and distributions remain well above free cash flow.

In upgrading Lend Lease ((LLC)) to Overweight Morgan Stanley lifts its sector weighting towards the capital-light developers that have better growth. The broker prefers names that capture the real fund flow benefits from rising asset values. Hence, Lend Lease is a top pick as it has low gearing and an expanding funds platform, which will allow it to increasingly capture the upside from global real estate markets.

In contrast, elevated execution risks, limited free cash flow and relative outperformance versus US peers means the broker retains a Underweight rating on Westfield ((WFD)).

Retail

Morgan Stanley remains Underweight on all pure retail-exposed A-REITs. Strong cap rate compression over the past year has helped drive strong growth in net tangible assets and the broker expects this to be more subdued going forward, as compression eases to around 15 basis points. Rental growth expectations are lower, while assumptions regarding capital expenditure increase, particularly for those exposed to retail.

In this way, given investor caution regarding other large cap retail A-REITs such as Scentre Group ((SCG)) and Vicinity Centres ((VCX)) because of the worsening outlook for Australian physical retail space, Goldman Sachs believes GPT's share price is getting ahead of its underlying portfolio.

Citi finds a clear divide between retail and office/industrial A-REITs, noting only retail-exposed A-REITs experienced negative FY18 revisions to earnings per share since June 30. Furthermore, the broker is not convinced that the revisions to retail earnings have bottomed.

Macro factors such as low wages growth, increased living expenses and a declining savings ratio, as well as rising mortgage rates, combine with sector-specific factors to indicate the earnings risk is skewed to the downside.

The greatest downside risk to consensus views the broker calculates comes with Westfield. Citi prefers Goodman, Investa Office and Charter Hall for office and industrial exposure while Vicinity Centres and Stockland are protection against a tactical rally in retail A-REITs.
 

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