HMC Capital: More Upside Through Private Credit

This story features HMC CAPITAL LIMITED. For more info SHARE ANALYSIS: HMC

HMC Capital is an alternative real estate fund manager offering exposure to a rapidly growing segment of global investor interest; the private credit market.

-HMC Capital not you’re average REIT
-Private credit market is rapidly growing globally
-HMC has delivered impressive earnings growth
-Goldman Sachs initiates with a Buy rating

By Greg Peel

Australian-listed real estate investment trusts (REIT) have been making a comeback since late 2023. The RBA made its most recent rate hike to 4.35% in October as the pressures of the covid fallout begin to ease. As inflation falls, global central banks have begun cutting rates, and the Fed’s -50 point cut last month was the most significant.

While last week’s US jobs report has led Wall Street to rethink the speed at which the Fed will continue to cut, expectations remain the RBA will begin to cut some time in early 2025. And that is supportive of yield stocks such as REITs.

Morgan Stanley highlights over the past two years capitalisation rates for listed REITs have increased, but with the stabilisation of global interest rates and the potential for rates to move lower, the broker views risk to the upside for REIT valuations over the next 12-18 months.

A cap rate equates to net operating income divided by property value. As property values increase, cap rates fall. Morgan Stanley forecasts a -20-24bps fall in cap rates and the potential for REIT stock prices to trade nearer to net tangible asset valuations, if not above.

Last week, Ord Minnett upgraded earnings forecasts for REITs under coverage. The broker updated estimates as market interest rates ease in the commercial space and lenders relax their restrictions. It’s felt the sector will receive a boost from expected falls in official interest rates in 2025, if not sooner.

Ord Minnett has not specifically provided an updated view on alternative asset manager HMC Capital ((HMC)), other than to reiterate a Sell rating and $6.50 price target. Interestingly, of the 19 REITs and property developers/fund managers that Ord Minnett covers, HMC Capital is the only one to attract a Sell rating.

Ord Minnett’s $6.50 target is also well below those of other covering brokers. The other five brokers covering HMC and monitored daily by FNArena have between them an average target of $8.42.

Goldman Sachs is not monitored daily, but this week has set a target for HMC of $8.94, initiating coverage with a Buy rating.

The HMC Alternative

HMC Capital currently manages over $12.5bn of external assets under management (AUM) across real estate and private equity strategies. The group’s strategy is to become Australia’s leading diversified alternative asset manager with scalable growth platforms across real estate, private equity, energy transition, value-add infrastructure, and private credit.

Goldman Sachs is particularly interested in private credit.

The broker sees four key factors supporting growth in assets under management (AUM), including increased investor allocation to private markets, a positive skew in borrower preferences to private credit, a structural shift in the public markets to larger deal sizes, and an acceleration in commercial real estate credit due to Australia’s under-supply of housing stock.

Goldman Sachs believes there is currently a structural shift towards private markets, as investors increase allocations towards both private credit and private equity. The broker draws on analysis suggesting, globally, private markets’ AUM will reach US$17.8trn by 2026 (from US$13.5trn at the end of 2023) and that among asset classes, private credit is expected to see the strongest growth, and is forecast to reach US$1.21trn by 2026 to become the second largest private asset class behind private equity/venture capital.

HMC’s acquisition of Payton, a specialist commercial real estate private debt fund manager with $1.6bn of AUM (announced 24th May 2024) provided a strong entry into the private credit sector and a platform to build a more diversified credit business, Goldman notes. HMC now plans to scale the Payton platform funds under management to over $2-3bn and then to expand organically into larger and more complex areas of the private credit market including mezzanine finance, corporate loans, private equity/leveraged buy-outs, infrastructure/renewable and structured lending.

Growth Outperformance

When updating on HMC’s FY24 earnings result back in August, Macquarie (Outperform) noted the manager’s AUM have grown 80% in the last five years, underwriting a 44% compound average growth rate in earnings per share.

Goldman Sachs forecasts a 13% three-year earnings per share compound annual growth rate over FY25-27, driven primarily by revenue growth in annuity-style base management fees as HMC materially ramps up its funds under management to over $20bn in the medium term from $12.7bn currently, as is the group’s goal.

That implies more than a 20% funds under management compound annual growth rate over FY25-27.

Within this estimate, Goldman expects HMC’s private credit funds under management to increase from $1.6bn as at June 2024 to around $5bn by FY27, which is greater than a 40% compound annual growth rate, and reaching 30% of total fee revenue in FY27 from 0% in FY24.

HMC Capital’s share price has increased by 86% over the last twelve months. In so doing, the share price is now above or close to most broker price targets. Hence, all of Morgan Stanley, Bell Potter, UBS, Morgans and Jarden (the latter not monitored daily) currently have Hold or equivalent ratings.

The standout is Macquarie, with its Outperform rating and $9.01 target, exceeding Goldman Sachs’ target on initiation of $8.94.

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