If you're tired of volatility buy REITs!

Pat Barrett

UBS Asset Management

...sure, there's no +13% returns on results day like NIB Holdings, but there's also none of the wild swings we've seen with Worley Parsons, or the -36% MTD falls for software group CSG. The REIT results display reliable income growth due to the contractual nature of the rental income. REITs know what they're legally entitled to and they plan accordingly. That's why the sector is up +3% MTD. We attended a smorgasbord of results presentation, management meetings and a briefing from Eric Cantor last week. He's the former Republican congressional leader now Moelis employee. He said the Trump administration’s big job was to generate higher economic growth and more manufacturing jobs and that there will be significant tax reform. In theory, this means US GDP will pick up and the US dollar will be stronger. It also means Aussie assets will be comparatively good value, another tailwind for AREITs. Seventeen results last week included the following:

Arena REIT (ARF) – Kids are alright

Childcare landlord ARF has lifted its full-year distribution guidance on strong rental growth, development completions and lower debt costs. Their FY17 DPU guidance is now 12cps, which implies 10% growth on FY16 on top of a 6% dividend yield. They see industry conditions as supportive with “demand for high quality and well located early learning and healthcare property continues to be underpinned by growing community demand and supportive demographics trends.”

Charter Hall Group (CHC) – Records are made to be broken

The Charter Hall team delivered a fantastic result with lots of records broken in terms of equity inflows, returns and outlook. FY17 guidance is ~24% growth pre-tax and ~12% growth post-tax on FY16 operating earnings per security (compared to ~7% consensus growth). FUM growth has been 16% pa since 2010 and now stands at $19bn. CHC is the manager of CQR and CLW (see below).

Charter Hall Retail (CQR) – Flat

Supermarket sales picked up in this portfolio with Woolworths and Wesfarmers' Coles (50% of rental income), growing ~3% vs ~1% in the 1H16. However specialty sales growth has slipped from ~5% to ~2%, with big drops in South Australia and Western Australia. CQR has reiterated that FY17 operating earnings is expected to be flat on FY16, however the market assumed some growth given organic rental growth, contributions from FY16 acquisitions and lower debt costs. Further asset divestments were to blame. CQR has turned on their share buyback program as a means to return capital to unitholders.

Charter Hall Long WALE REIT (CLW) – Passes the first hurdle

The teams first result was solid, with FY17 EPS guidance upgraded by 1.2%. The upgrade was driven by the impact of the SUEZ portfolio and partially offset by greater funding costs from expanded debt facilities. The WALE of the REIT is ~12.2 years and occupancy remains at 100%. NTA increased by 4cps or 1% to $3.88ps compared to the share price of $3.98. This stock should form a core part of retirees portfolios.

Cromwell Property Group (CMW) – Funds management saves the day

CMW re-iterated their FY17 EPS guidance with look-through gearing at 45% (target of 33-55%) and NTA up 6.2% over the past 6 months to 86c. Rental income was below expectations while funds management was well above, aided by performance fees and transactional fees. Rental income was impacted by reduced rents and/or lower occupancy. The market awaits CMW's next move with the Investa Office proposal.

GDI Property Group (GDI) – Mill(stone) around the neck

GDI's guidance reflected the impact of recent asset sales in Adelaide and Brisbane, both at sizeable premiums to book value. GDI is targeting FY17 FFO ps of “not less than 8.2cps” (-10% vs pcp) and DPS of 7.75cps (flat on 2016). The result was hindered by a higher cost of debt than expected and higher corporate overheads, with a $0.65m provision for performance right bonuses. GDI intends to undertake a buy-back of up to 5% of its securities, should market conditions permit. The "problem child" asset at Mill St Perth remains empty for its 3rd year. It's now valued at $30m versus the $46m at IPO (-35%). Net gearing is ~9% post settlements and it's one of the only stocks trading below NTA with an attractive yield of ~8%.

Generation Health (GHC) – Fit as a fiddle

Medical property landlord Generation Healthcare reconfirmed FY17 DPS guidance of ~9c with rising property income and income from completed developments more than offsetting higher finance costs and management fees due to higher assets under management (AUM). The portfolio metrics remain solid underpinned by a long weighted average lease expiry (WALE) of ~12 years and the project pipeline remains on track and on budget with earnings set to contribute from FY18. The big projects to watch are the second stage of the Casey project and the Frankston Private Hospital expansion. Generation has won planning approval for the $72 million Clarendon Street project.

Growthpoint (GOZ) – Bets on office

GOZ reported operating EPS of 12.5c, 17% higher than pcp largely buoyed by the acquisition of the GPT Metro Fund (GMF). That purchase and sale of some industrial assets has moved GOZ's weightings to office markets to 66%. Management have reiterated its FY17 guidance of 20.5cps DPS and at least 23.3c EPS (6.4% above FY16). The group mentioned their aim to reduce gearing from ~42% at present to ~40% by June. This should be dilutive given higher property yields than debt costs.

Industria (IDR) – Willing and Abell

IDR re-affirmed FY17 guidance of 17.9cps-18.1cps. The turning point for this fund was the WesTrac acquisition in September which brought scale and WALE to the vehicle. The group leased ~3,600sqm of vacancy in the period but there remains some lease expiry risk with the Brisbane Technology Park (BTP) the major priority. The CEO (Alex Abell) and management are performing well and the dividend yield of ~7.6% appears attractive.

Ingenia Communities (INA) – Excitement builds

Management appeared quite excited on the call, and they are delivering on their strategy. The standout was the 90% growth in gross development profit to $9m following an increase in settlements, with the team lifting guidance for FY17 settlements from 170 to 190. Corporate costs where higher than expected due to some acquisition costs that did not proceed (due diligence / option costs). Cap rates compressed to 8.45% for the Lifestyle and Holiday Parks despite recent deals trading ~7.5%.

Investa Office (IOF) – Not being held to Ransom

IOF has a large exposure to the booming Sydney CBD office rental market and are well placed to capture some of this growth via large expiries such as IAG at 388 George St and ANZ at 347 Kent St in FY19. The team upgraded FY17 FFO guidance from 29.0¢ to 29.5¢ (from 3.0% to 3.1% growth). The good result was over-shadowed by the continuing saga of the Cromwell offer, with Investa executives effectively telling Cromwell to put up or move on. The new Fund Manager Penny Ransom is doing well and pro-actively communicating with the market.

ALE Property Group (LEP) – Closer to growth

LEP was effectively the first Long WALE REIT in 2003 with an average 12 year lease to ALH (Australia's largest pub operator). LEP are moving closer to the first rent review in November 2018 (FY19) capped and collared at +10/-10% with an open market review in 2028. The group reiterated the prospect for a lift in dividends post the first rent review (either one-off or over time). LEP highlighted progress on tenant-funded development at three hotels (Crows Nest, Gepps Cross and the Anglers Arms) and noted ALH has added 30,000m2 of buildings on LEP sites in the last 13 years. With buildings only occupying 25% of the land in the portfolio, a larger development opportunity with ALH is likely. A new Dan Murphy’s has opened at The Angler’s Arms (Gold Coast), with the new hotel ($8m ALH spend) to reopen in March.

Scentre Group (SCG) – Lowering the payout ratio

The full year result was in line with guidance, delivering FFO growth of +3.2%. This would have been +5% if we adjusted for dilutive asset sales. FY17 FFO guidance of +4.25% was provided and once again would be 5% if we adjusted for dilutive asset sales. DPS is expected to grow at ~2% which means SCG will pay a lower proportion of its earnings to investors. Management believe that the best use of their funds is to reinvest earnings back into development projects generating a yield on cost >7% and projected IRR of ~15%. All tenant types experienced a decline in comparable sales growth (specialty MAT) in the final quarter, with NSW the strongest state while WA remained the weakest market.

Stockland Group (SGP) – Stronger for longer

The company has tightened FY17 FFO guidance to 6-7% and recorded solid growth across all divisions. Of course most focused on the residential business which accounts for roughly 1/3 of EBIT and there they’ve lifted the expected residential profit margin to ~16% in FY17 (the highest in 5 years). Management believes that some modest price growth will continue in the residential market and are well placed given ~35% of its pre-sales are located in NSW and there's 8 projects finishing up in the next 2yrs, effectively capturing recent price growth. Retail sales moderated with the portfolio impacted by the Dick Smith closures, and gearing remains modest around 24%.

National Storage (NSR) – Heading in the right direction

NSR saw occupancy improve 4% to 79% and revenue rise ~3%. The result was impacted by the significant acquisition made during CY16, and the full year impact of elevated corporate costs. The trajectory of EPS is for a strong increase in 2H17 given an increase in rents and occupancy. The NTA per share increased from $1.12 at June to $1.23 at December.


Rural Funds Group (RFF) – Who pays first, the chicken or the egg?

We met with management who own land associated with a mix of uses covering cattle, vineyards, almond farms, cotton, macadamias and poultry. There's alot to cover with water rights and usage a key factor in the underlying value. The result was solid and management are doing a good job with investor education. Some related party transactions have some investors cautious but management are working on this issue.

Westfield Corp (WFD) – Are we there yet?

Westfield have one of the best management teams in the world because they focus on the medium to long term. They have a US$9.5bn+ development pipeline that will create significant value over the next 4 years, with the World Trade Centre's ~50% uplift vs cost one example of their skill. Unfortunately for investors though, we have to wait for this pipeline to finish before the growth kicks into gear. Despite solid operational metrics, this years result was impacted by lost rent from developments and adverse moves in the pound sterling. CY17 guidance was provided at FFO growth of <1%, which should be the trough year with very strong growth thereafter. When you think long term it's not that long to wait.

Written by Pat Barrett, Property Analyst at  UBS Australia























Pat Barrett
UBS Asset Management

Pat Barrett has twenty five years experience in the listed and direct property industries, most recently covering property securities, infrastructure and utilities analysis at UBS.

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