Rudi’s View: Selective Opportunities Among Discounted REITs

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In this week's Weekly Insights:

-Selective Opportunities Among Discounted REITs
-Conviction Calls & Best Buys

By Rudi Filapek-Vandyck, Editor

Selective Opportunities Among Discounted REITs

Central bankers will lower interest rates, though the exact timing remains unknown. Bond markets will try to anticipate these reductions and rally in advance, lowering bond yields as a result.

Bank shares in Australia have rallied hard and many suggest today's share prices are unwarranted given the weak fundamentals that dominate the sector, including a benign outlook 18 months out.

That other source for regular investment income, A-REITs listed on the ASX, is still offering securities trading at a discount to underlying asset values. No double-guessing why the local REITs sector remains on many an investor's radar.

In February, REITs as a group outperformed the broader market by no less than 4.3% (returning 5.1% against 0.8% for the ASX200).

As per always, the devil hides into detail, as the sector is operating under a cloud of ongoing threats, headwinds, (valuation) traps, and challenges.

Bond yields might be below last year's peak, but they are still high and for many REITs the costs from carrying debt is restricting how much can be paid out to shareholders.

Many in the sector are effectively ex-growth, for the period ahead, as price inflation, devaluing assets and polarising consumer spending offer additional negatives.

In some cases, asset sales are the only way out of the stasis.

One additional factor to keep in mind is that while your average REIT is trading at a discount to implied asset valuations, the general consensus is there will be further asset devaluations occurring in the year ahead, though maybe not as large as is currently priced in.

Post the February results season, which offered positive surprises, led by sector-leader Goodman Group ((GMG)), as well as predictable disappointments, we run through updated sector assessments by those analysts whose daily job revolves around REITs and investing in them.

Evans and Partners

Sector analysts at Evans and Partners thought Goodman Group dominated the good news delivery in February while the rest of the sector was mostly treading water.

There is no doubt in the analysts' mind, the sector offers great opportunities longer term, though investors generally might hold off for a while longer until more clarity exists around where bond yields and central banks cash rates are heading, and exactly when.

Evans and Partners likes to highlight the specialist players in the local REITs sector, with the broker's Top Three Favourites post February being Arena REIT ((ARF)), Dexus Industria REIT ((DXI)), and Waypoint REIT ((WPR)).

Jarden

Put in a simplistic analogy, most REITs have been forced to play defense over the past three years, meaning all attention from management teams inside the sector (outside of Goodman Group) has gone out to keeping costs down, re-financing debt, revaluing assets (and divestments), managing empty offices, and making sure any damage done is absorbed without causing too much distress for shareholders.

Analysts at Jarden have tried to identify those REITs that might be ready to switch into offensive mode again, as these should see added growth and rising shareholder payouts, while others might still be forced to dig in heels and wait for better momentum to arrive.

On the positive spectrum, Jarden analysis suggests, we find National Storage ((NSR)), HMC Capital ((HMC)), Lifestyle Communities ((LIC)), Goodman Group, Ingenia Communities Group ((INA)), Arena REIT, and Stockland ((SGP)).

On the other side of the analysis, the likes of Charter Hall Long WALE REIT ((CLW)), Centuria Office REIT ((COF)), Charter Hall Social Infrastructure REIT ((CQE)) and Dexus ((DXS)) are still very much regarded as inside a forced upon defensive modus operandi.

When it comes to "valuing" the sector, analysts at Jarden believe it is imperative investors take into account the still mounting pressure on cash flows, be it through incentives offered (to attract tenants), capex, or other items that are not included in reported funds from operations (FFO) data.

On Jarden's data crunching, operating cash flows as a percentage of FFO fell in February, including for Lifestyle Communities, Stockland, Goodman Group, Dexus, Ingenia Communities Group, Mirvac Group ((MGR)), Region Group ((RGN)), BWP Trust ((BWP)), Scentre Group ((SCG)), and National Storage.

While this does not by default spell bad news ahead for all mentioned, the potential for further deterioration should still have investors' attention.

Jarden's analysis has identified those REITs that look positioned for above-average, strong growth in the years ahead (2024-28); Lifestyle Communities, Ingenia Communities Group, HMC Capital , Goodman Group, Charter Hall ((CHC)), and Stockland.

REITS for which achieving growth above inflation looks like a struggle include Charter Hall Retail REIT ((CQR)), Charter Hall Social Infrastructure REIT, Centuria Office REIT, BWP Trust, and Charter Hall Long WALE REIT.

Summing it all up, Jarden's sector favourites post-February are National Storage, Vicinity Centres ((VCX)), Scentre Group ((SCG)), Ingenia Communities Group -all Buy-rated- and Overweight-rated Goodman Group, Charter Hall, Region Group, Charter Hall Retail REIT, Arena REIT, HomeCo Daily Needs REIT ((HDN)), Centuria Industrial REIT ((CIP)), Stockland, and Lifestyle Communities.

The team at Jarden is not so keen on Mirvac Group, Centuria Capital Group ((CNI)), Centuria Office REIT, Charter Hall Social Infrastructure REIT, Charter Hall Long WALE REIT, GPT Group ((GPT)), Dexus, or BWP Trust.

In a separate analysis, Jarden analysts concentrated on REIT fund managers which enjoyed a fantastic five-years up until H1 FY23, but are now, as anticipated, struggling with falling asset prices and reduced sector activity overall.

Jarden believes the year ahead -H2 FY24 and H1 FY25- will likely still remain challenging for this particular part of the sector, but a robust recovery is anticipated for the subsequent years with current headwinds (bond yields, interest rates) to turn into tailwinds.

On Jarden's assessment, Goodman Group deserves its sector premium, also because the outlook for data centres demand is accelerating.

Charter Hall looks the most attractive, also because of its strong track record in the past.

HMC Capital remains full of promise but maybe too much has already been priced in and Centuria Capital is believed to be facing significant headwinds from its capital structure.

Morgan Stanley

Analysts at Morgan Stanley remain concerned about heavy capex plans for Dexus and Vicinity Centres, which raises balance sheet risks for in particular Dexus.

Most preferred exposures are Goodman Group, Stockland, and Charter Hall. Two other Overweight-rated REITs are Scentre Group and Centuria Capital Group.

In terms of asset devaluations, Morgan Stanley sees another round of devaluations happening by August this year.

Only then, the analysts surmise, will investors be able to assume the worst might have passed for the sector (in the current rate hike cycle).

Morgans

Stockbroker Morgans' preferred REITs are unchanged from pre-February: Dexus Industria REIT and HomeCo Daily Needs REIT. Both provide exposure to the industrial and convenience retail sub-sectors.

The likes of Goodman Group and HMC Capital were downgraded to Hold during reporting season as share prices rallied hard.

Morgans does see small cap opportunities in HealthCo Healthcare & Wellness REIT ((HCW)) and Hotel Property Investments ((HPI)) with both screening as undervalued.

Macquarie

Macquarie prefers Charter Hall, Mirvac and Goodman Group among the large caps, and Qualitas ((QAL)) and Centuria Industrial REIT ((CIP)) among the smaller players in the sector.

Industrial remains this broker's most preferred sub-sector, while Office remains least preferred.

Macquarie does not like Vicinity Centres, Scentre Group, or Charter Hall Long WALE REIT.

One scenario that is on the analysts' mind is that economic growth might well re-accelerate and this would have negative consequences through rising bond yields (yet again).

Macquarie's preference thus lays with quality and active names offering earnings growth that can help offset the negative valuation impact were bond yields to surprise on the upside.

Macquarie also points out most REITs have limited debt expiries over the coming 1-2 years, with a large contingent expiring in FY26.

This noticeable step-up in debt expiries applies in particular to Scentre Group, Dexus, Vicinity Centres, HomeCo Daily Needs REIT, Mirvac and Goodman Group.

Most REITs use bank facilities, while commercial paper is a significant source of liquidity for Scentre Group.

As bank facilities are more likely to be renewed, the average debt maturity for the sector has declined to 3.7 years. In June last year the average was 3.9 years. Twelve months earlier, the comparative average stood at 4.6 years.

If one were to assume more negative scenarios ahead for the sector, Macquarie believes Mirvac, Dexus, Vicinity Centres, and HomeCo Daily Needs REIT would be most at risk from a medium-term liquidity perspective.

Citi

Citi reports Australia continues to benefit at the macro level from high population growth, driven by immigration.

This has positive follow-through impact on retail activity and assets, housing prices and rental growth, demand for self-storage space, as well as logistics services.

The February results season highlighted artificial intelligence (AI) and strong demand for data centres as additional positives providing strong incentives for further investments.

Investors are all too aware, suggest Citi analysts, cap rates should become a tailwind for A-REITs over the next 12-24 months.

Echoing the cautiously optimistic mood that also dominated Citi's 29th annual Global Property CEO Conference, the broker's coverage of A-REITs includes many Buy ratings and only one Sell, carried by BWP Trust as the share price trades above the broker's $3.40 price target.

Buy ratings are for GPT Group, Stockland, Charter Hall Retail REIT, Abacus Group ((ABG)), Ingenia Communities, Goodman Group, Charter Hall Group, Growthpoint Properties Australia ((GOZ)), National Storage, Qualitas Real Estate Income Fund ((QRI)), and Abacus Storage King ((ASK)).

Citi analysts highlight underneath ongoing macro debates about investing in and the outlook for the sector generally, on-the-ground trends in many property sectors remain steady, with solid demand and leasing continuing in residential, retail, industrial, and data centres.

Risks remain, with Citi identifying supply (sunbelt apartments, life science, and industrial), office leasing, pressure from costs/expenses, select tenant health concerns, and a slow transaction market.

Conviction Calls & Best Buys

Macquarie's update on the energy sector, published on Monday morning, suggests share prices for many in the sector seem too low.

The in-house, Houston-based sector strategist has upgraded WTI oil price forecasts to US$80.34/bbl in 2024 and US$68.75/bbl in 2025. The flipside is that spot LNG prices have been downgraded.

Macquarie's key picks in the larger upstream segment are Santos ((STO)), Beach Energy ((BPT)) and Karoon Energy ((KAR)).

In the mining sector, updated simultaneously, Macquarie analysts expressed their positive view on aluminium, nickel, lithium, met coal, and copper (not so for iron ore and thermal coal).

Large-caps favourites are South32 ((S32)) and Rio Tinto ((RIO)). The preference is for Northern Star ((NST)) over Newmont Corp ((NEM)) and Evolution Mining ((EVN)). Arcadium Lithium ((LTR)) and Mineral Resources ((MIN)) are preferred over Pilbara Minerals ((PLS)) and IGO Ltd ((IGO)).

Among mid-caps, Macquarie likes Sandfire Resources ((SFR)), Nickel Industries ((NIC)), Patriot Battery Metals ((PMT)), Coronado Global Resources ((CRN)), and Westgold Resources ((WGX)).

Among contractors and engineers, Macquarie's Outperform ratings are reserved for Worley ((WOR)), Ventia Services Group ((VNT)), Monadelphous ((MND)), Service Stream ((SSM)), and Maas Group ((MGH)).

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The team of mining analysts at Morgan Stanley has equally expressed its sector preferences. The following seven companies are rated Buy:

-Rio Tinto
-29Metals ((29M))
-Alumina Ltd ((AWC))
-South32
-Whitehaven Coal ((WHC))
-Regis Resources ((RRL))
-Deterra Royalties ((DRR))

Two companies are rated Underweight; Pilbara Minerals and Fortescue Metals ((FMG)).

****

Morgan Stanley analysts continue to drip feed their post-February favourites among ASX-listed small and mid-cap companies. The number of Key Conviction Calls amounts to five so far:

-Accent Group ((AX1))
-Hub24 ((HUB))
-Johns Lyng Group ((JLG))
-Siteminder ((SDR))
-SG Fleet ((SGF))

****

Jarden's Key Picks, identified before the February results tsunami, delivered three winners and one disappointing outcome.

All of Temple & Webster ((TPW)), Lovisa Holdings ((LOV)) and Universal Store Holdings ((UNI)) saw their market updates rewarded through sharp share price increases, but Data#3 ((DTL)) failed to deliver.

Post season analysis has identified 16 Best Ideas from about 110 ex-ASX100 companies under the broker's coverage. Noteworthy: Temple & Webster, despite having experienced a 30% rally in the share price, remains the broker's Number One Favourite.

Other Key Picks include Lovisa, Siteminder, IDP Education ((IEL)) and Universal Store, as well as Inghams Group ((ING)), Light & Wonder ((LNW)) and NRW Holdings ((NWH)).

In the healthcare sector, Jarden likes Telix Pharmaceuticals ((TLX)) and Regis Healthcare ((REG)). Among REITs the Best Ideas have been identified as National Storage and Ingenia Communities Group. Energy & Mining delivers Karoon Energy and Capricorn Metals ((CMM)).

Other favourite picks are Domain Holdings Australia ((DHG)) and Pepper Money ((PPM)).

****

Jarden's team of healthcare analysts currently has one Buy rating, reserved for Telix Pharmaceuticals, with Overweight ratings for CSL ((CSL)), ResMed ((RMD)), Regis Healthcare, and Aroa Biosurgery ((ARX)).

Healius ((HLS)) is the only stock carrying a Sell rating.

****

Morgans has reviewed the financial services sector (financials ex-banks) which generated the following ranking (all are Add-rated, starting from the most preferred first):

QBE Insurance ((QBE)), Computershare ((CPU)), Suncorp Group ((SUN)), Generation Development ((GDG)), Challenger ((CGF)), Tyro Payments ((TYR)), MA Financial ((MAF)), and Kina Securities ((KSL)).

The broker's preferences inside Technology, Media & Gaming has seen a few changes post February. Technology favourites remain NextDC ((NXT)) and Objective Corp ((OCL)), with Ansarada ((AND)), currently under take-over interest, replaced with AI-Media Technologies ((AIM)).

Within the online and classifieds/media space, Seek ((SEK)) and Camplify Holdings ((CHL)) remain the broker's key picks. In gaming, Aristocrat Leisure ((ALL)) has been replaced with Jumbo Interactive ((JIN)).

In the consumer discretionary segment, Morgans' preference lays with Beacon Lighting Group ((BLX)), Lovisa, and Universal Store.

****

UBS's Buy ratings among consumer-oriented companies include Endeavour Group ((EDV)), Metcash ((MTS)), Treasury Wine Estates ((TWE)), and Universal Store.

The two Sell ratings are reserved for Premier Investments ((PMV)) and Super Retail ((SUL)).

****

Macquarie's number one technology stock on the ASX is Megaport ((MP1)).

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(This story was written on Monday, 18th March, 2024. It was published on the day in the form of an email to paying subscribers, and again on Wednesday as a story on the website).

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena's – see disclaimer on the website.

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