The major fund managers and developers – Goodman, Charter Hall and Lendlease – have the brightest prospects among the property stocks as asset values rise while retail conditions soften, according to Citi analysts.
In the wash-up from the earnings season for real estate investment trusts, one of the big themes to emerge was the way earnings metrics have become more influential than net asset values, according to Citi’s David Lloyd, Adrian Dark and Suraj Nebhani.
“Notably, the only AREITs experiencing negative earnings revisions are those with a dominant retail exposure, and we expect this to continue as both structural and cyclical headwinds intensify,” the analysts wrote in their summation of the season.
Headwinds in the retail sector are starting to bite, with income growth in mall portfolios lagging office and industrial as well as evidence of softer sales and pressure on shopping centre values.
BWP Trust, which owns Bunnings outlets, and Scentre, the owner and manager of Westfield, are among Citi’s least preferred stocks.
At the same time, the residential tide has turned, according to the Citi team, with lead indicators “consistently negative” and pointing to an uncertain 2020 financial year.
For fund managers though it is a different story, as they pick up a tailwind from momentum in assets under management.
Shift in focus
Goodman, Lendlease – a diversified player with a large funds management arm – and Charter Hall are likely to book uplifts in AUM of 10 per cent, 10 per cent and 7 per cent respectively, in Citi’s forecast.
There is some nuance to that though as the analysts note the cap rate cycle – which has been a big driver of book values – is now “well-seasoned”.
“Hence we have a preference for fund managers that can enhance assets under management growth via a proven acquisition strategy and or development pipeline,” they wrote.
The shift in focus towards earnings-based metrics was also observed by Macquarie analysts, who noted that traditional gearing measures were less relevant given booming asset values had suppressed net debt to asset ratios.
On that score, they noted that Scentre’s debt to pre-tax earnings ratio now sits around 6.75 times, while it has a covenant to maintain its existing credit rating of 7 times.
Scentre’s pre-tax earnings would only need to decline by around 3.5 per cent for the covenant ratio to be breached. Taking into account its development pipeline commitments Scentre could not then complete its planned $700 million buyback, the Macquarie team noted.
A similar situation exists for GPT as it approaches its credit covenant following its recent $278 million acquisition of Eclipse tower in Parramatta, putting pressure on its capacity to complete a 5 per cent share buyback.
Macquarie also favour the fund managers which are collecting strong performance and transaction fees – Goodman and Charter Hall – along with developers that are getting through apartment settlements with minimal defaults while rising land lot prices supplement their margins: Stockland, Mirvac and Lendlease.
“Coupled with Dexus benefiting from booming office conditions and likely supply delays in Sydney we think these stocks will outperform retail mall peers,” they wrote. “We think the retail space will remain challenging due to structural headwinds compounded with cyclical headwinds.”
Macquarie is neutral on Scentre and GPT and has research restrictions on Vicinity, which it is advising on a $1 billion sell-down in malls.