Income Report / Income Note: How much pain has been priced into property stocks?

By Market Matters 10 June 20

Income Note: How much pain has been priced into property stocks?

Market Matters Income Report 10th June 2020

The market has opened lower this morning however buyers stepped in early and pushed the index back up above par by lunchtime, US Futures helped (trading +0.60%) however the appetite to buy any semblance of weakness locally remains strong. While we continue to favour a shorter term pullback its important to understand that we’re bullish in the medium term as outlined in the AM note today, we’re merely trying to add some short term alpha, which is proving elusive!

The banks remain an influential sector locally we remain bullish on this sector and as a consequence this has more positive implications at an index level.

The ASX 200 is currently trading  up +22pts/0.37% to 6167, with reversion of yesterdays moves playing out, i.e. IT & Healthcare up, Energy & Financials down

ASX 200 Chart

The Income Portfolio performed well over the past week, continuing the recent trend by adding +4.87% in the shortened trading week. A few of the hybrids traded ex-distributions – AMPPB, NABPF and CBAPG. The banks were a big part of the rally, WBC topped that group by adding 15.58%, but Sydney Airports (SYD) was the best stock in the portfolio managing a gain of 19.29%. Financial year to date the portfolio has declined by -2.59% versus its absolute benchmark (RBA cash +4%) of +4.42%.  Since inception, the portfolio has added +12.82% vs. the benchmark of +15.34%.  

How much pain has been priced into property stocks?  

Many of our subscribers & clients are landlords and I’ve spoken to a number of you over the past few weeks about what’s actually transpiring in property, what sort of rental agreements are being negotiated and what impact this could have on values overall. My takeaways from these discussions are:

  1. Rental reductions are varying considerably and a number of clients leasing to ASX listed companies are getting nothing (companies have shunned paying rent entirely i.e. contracts are meaningless).
  2. Some are deferring rent however this is less common than I thought it would be i.e. 50% reduction now which is recouped by a set date in the future – the way to go in my view, similar to the banks approach on mortgages.
  3. Straight out rental reductions with a set date for review are the most common. Review periods generally quarterly.  
  4. Holding onto tenants has become the priority which implies any rent increases are off the table in the short term, which has a negative influence on property valuations.
  5. The balance of power has swung in favour of tenants.

In the residential market, its being reported that 1 in every 7 Sydney apartments are vacant. Harry, who contributes to these notes and often pens the afternoon missive is currently house hunting for a rental in the Eastern Suburbs of Sydney, in what he describes as the most ‘tenant friendly’ conditions in recent memory. Separately, my sister in law is doing a land development in Mackay (house and land packages) and they’ve enjoyed the strongest sales period in years as a result of Government stimulus, builders are busy again, activity is rolling ahead.

In my local area (northern beaches of Sydney) two properties sold recently for very strong prices in short time frames. A friend / client who is doing a large residential tower development in Western Sydney has continued to enjoy strong sales off the plan, although council approvals have remained sluggish at best. Mortgage brokers I speak with are complaining about the time for loans to be approved from the major lenders and this is having a big impact on the volume of loans being written, while my real-estate contacts are struggling for product given there is the perception that the market will improve, and in any case there is no reason to sell now given mortgage deferrals are in place from lenders.

In short, it seems like a very fickle market that is largely in a holding pattern, although I can’t help but think some pain is coming as stimulus rolls off and more stock comes onto the market.

So, what are the listed players saying and what sort of reduction in property values is currently being factored in?

Stockland (SGP) is a diversified property company and a good place to start in the sector with a mix of retail, residential, commercial, industrial along with retirement living. They are now trading at a 5% discount to the carrying value of their assets (NTA). At their low point, SGP were trading at a huge 56% discount to NTA. The share price has rallied recently for the same reasons as my sister in law is selling property in Mackay - the home builder stimulus package however their current price seems very optimistic to MM.

Using other retail focussed property companies as a guide (more on these below) we’d expect some revaluation down of SGP’s retail assets which would elevate gearing to the high end of their 20-30% target range implying they’re a high chance of needing to raise capital in our view.

MM are negative SGP after its aggressive rally

Stockland (SGP) Chart

Vicinity Centres (VCX) is one of Australia’s largest retail landlords holding around $23bn worth of retail assets like Chatswood Chase in Sydney and Chadstone in Victoria.

They recently raised $1.2bn to shore up their balance sheet after an independent valuation of their portfolio indicated a decline in asset values of 11-13%. The raise price in VCX was $1.48 versus the current share price of $1.77. At the time of the VCX raise they issued equity at around about a 30% discount to the pre-raise NTA showing how bearish the market had become on retail assets at that time.

Now VCX have raised equity, asset values would need to fall by another 30% for gearing to become an issue (currently 24%), however clearly VCX were concerned about this as a potential outcome. VCX currently trade at a 40% discount to NTA implying the market also sees downside risk to retail valuations.

While we would take up the SPP if we held stock given the large discount, the rally in share price is factoring in too much upside in our view for a sector that has structural headwinds.

MM are neutral / negative VCX

Vicinity (VCX) Chart

Scentre Group (SCG) operates Westfield in Australia & New Zealand and is trading at a 40% discount to the book value if its assets, highlighting the markets view around likely revaluations (down). If actual book values fell by 20-30%, which is possible, SCG’s gearing would increase from around 34% currently up to about 50%. They have banking covenants at 65% however at 50% we suspect the market would become concerned. While SCG have implied they don’t want to raise equity, asset sales in a depressed environment would be the other course of action.

SCG’s ~80% rally from the lows presents a selling opportunity.

MM are neutral / negative SCG

Conclusion (s)

Property stocks were clearly oversold at the lows as the ghosts of the GFC resurfaced, this difference this time around is the sector has substantially lower gearing.

However at MM we believe too much optimism is now priced into the retail focussed landlords, particularly Stockland (SGP).

At MM, we prefer specialised REITs with a skew towards self-storage and commercial

Have a great day!

James & the Market Matters Team

Disclosure

Market Matters may hold stocks mentioned in this report. Subscribers can view a full list of holdings on the website by clicking here. Positions are updated each Friday, or after the session when positions are traded.

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