Views at a Glance / Income Report; Is the unfranked yield in property stocks attractive? (VCX, SCG, ABP, MGR, BWP, CLW, CMA, VVR, PLG, SCP)

By Market Matters 03 October 18

Income Report; Is the unfranked yield in property stocks attractive? (VCX, SCG, ABP, MGR, BWP, CLW, CMA, VVR, PLG, SCP)

Market Matters Income Report 3rd October 2018

The market is trading higher this morning although the topic of this report – the Real Estate Sector is continuing the struggle – down around 0.5% and is the worst performing area of the market. Banks are bouncing – sort of, while the material stocks are remaining reasonably firm. Asian markets are up a touch although China is closed and US Futures are fairly subdued.

In terms of the MM Income Portfolio for the week, it was up  +0.13% against a backdrop of the ASX 200 down by -0.96%. Nick Scali (NCK) and Eclipx (ECX) both saw some solid buying up around 5% a piece while Suncorp (SUN) was a drag. The portfolio is now up +1.79% this financial year, and +7.90% from inception vs the benchmark which is tracking at +1.40% & +6.84% respectively. The expected yield on the portfolio is ~6.90% inclusive of franking.

Is the unfranked yield in property stocks attractive?

While the debate rages around the abolition of cash refunds from franking credits, property stocks are being thrown around as the obvious beneficiary if a change were to occur. Over the last month the property sector has underperformed the market on an accumulation basis (including dividends) and that’s been the theme this financial year to date. While it’s easy to be negative property at the moment given the headlines around prices – and we’ve certainly held that view for some time – we like to go ‘against the grain’ and right now the market seems to be collectively bearish the sector. Does that present an opportunity?

Firstly some stats to consider;

·         The sector is a trading on 15.5x funds from operations (FFO). We use the FFO multiple for Real Estate Investment Trusts (REITs) as it adds depreciation and amortization to earnings and then takes away any gain on sales – it’s essentially a cleaner metric

·         The forecasted dividend yield for the sector is 5.1% based on an estimated ~79% average payout ratio

·         The sector dividend yield spread over the 10 year bond yield is ~2.44% versus the longer term average of ~2.53%. 

·         REITs are trading at a 22.5% premium to net tangible assets (NTA),  which is down from the ~24% premium a month ago but above the long term average of ~20.7%.

·         Balance sheets are generally in good shape, with sector weighted average gearing of just 23.7%

Looking at the above we see the sector is shaping up okay in a general sense. Low debt, reasonable yield, it’s not glaringly cheap versus historical metrics however there’s not much out there that is. The main issue is dividend yield spread over bonds or more simply, how much ‘risk premium’ am I being paid to hold a property security over and above holding a very secure government bond?

At the moment, that ‘premium’ sits at 2.44% however, if bond yields go up, then property stocks must grow earnings by an equivalent rate + then pass them on in the form of dividends, otherwise share prices will retreat to maintain the spread. That makes interest rates a clear headwind for the sector in general – which is a fairly obvious conclusion. That said, there are some big variances across the universe of listed property stocks  in terms of yield, premium / discount to assets, balance sheet strength and importantly the outlook for earnings. For that reason, it makes sense to look at underlying exposures of particular stocks.

Retail exposed property companies

Last month, the main underperformers across the property sector were  Vicinity Centres (VCX) and Scentre Group (SCG) – both retail focused landlords. From the conversations I have with retailers in many parts of Australia, from the bigger picture retail sales data and importantly, from the performance of the retailers themselves and the growth in online shopping, this part of the market is under some pressure. This morning Vicinity came out with an interesting announcement with the sale of 10 assets to SCA Property Group (SCP) and one additional asset sale to a private investor for $631m in aggregate. The interesting component here was the sale price was at a ~5% discount to the 30th June book value for those assets.  A clear negative read through for the retail focussed players.

Vicinity Centres (VCX) 6.49% exp yield
VCX runs a direct investment portfolio owning a number of neighbourhood convenience based shopping centres, alongside an external FUM business that manages close to $10bil of assets for 3rd parties. While the portfolio is similar to SCA, the FUM business adds a reasonably secure income stream to VCX. VCX trades at a significant discount to its asset base, and todays deal with SCP confirms why. VCX had previously guided towards the sale of $1bn worth of non-core assets however the market was thinking these would be sold at book value. The first ~$600m hasn’t been.

·         MM are neutral VCX, although we would become interested below ~$2.40

Vicinity Group (VCX) Chart

Scentre Group (SCG)  5.61% exp yield

SCG is a retail developer and landlord born from the 2014 restructure of Westfield, managing over 11,500 retail outlets within the 39 Westfield shopping centres it owns in Australia and New Zealand. With another 7 developments in the pipeline, SCG is betting big on the longevity of instore retailing!  

·         We are neutral / bearish SCG at current levels

Scentre Group (SCG) Chart

Diversified Property Companies

A lot of the property companies on the ASX are by their very nature diversified. Developments often have a mix of residential, office and retail while some (such as the highly successful Goodman Group (GMG)) have assets both in Australia and abroad. If investing in property at this point in the cycle, we have a clear preference for the more diversified operators simply from a risk / reward perspective.  

Abacus Property (ABP) 5.34% exp yield

ABP has a diversified property portfolio across Australia’s office, retail, industrial/logistics and self-storage space. ABP is more focussed on the office and self-storage businesses with no new retail developments and around 25% of the current ABP portfolio in the retail space.

·         ABP is messy however a move to $3.00 would look interesting

Abacus Property (ABP) Chart

Mirvac (MGR) 4.90% exp yield

MGR is another diversified property group that manages assets in the major cities in Australia. Many of the Mirvac developments combine office, retail and residential space to help maintain occupancy – while supermarkets also have a place in this as well, however their exposure to residential development means we have little interest at this point in the cycle.

·         Technically a close above $2.50 is bullish

Mirvac Group (MGR) Chart

Property stocks – not an exciting bunch!

Overall, MM is still negative property which has been our position for some time. The MM Income Portfolio has held two property stocks over the past year, taking a ~20% profit on Centuria (CNI) and a small ~1.8% profit on Vicinity Centres (VCX).

Despite the reasonably attractive unfranked yield offered by the sector which would become more attractive under a Labor Govt, the obvious threat remains around higher interest rates. It’s therefore incredibly important that the underlying business can grow earnings and therefore dividends at a pace higher than the rate of interest rate hikes, clearly a difficult task in this sort of property environment. That said there are a number of property plays that look interesting from a technical standpoint and these are on our radar at the right levels…

BWP Trust (BWP); Ok buying around $3.20 with stops under $3.10.

Charter Hall (CLW); Ok buying ~$4, however neutral around current levels.

Centuria Metropolitan (CMA); Uptrend is intact but we would be considering stops under $2.48 – very tight.

Viva Energy (VVR); Bullish with an initial target around $2.40, should hold $2.05, not great from a risk / reward.

PropertyLink Group (PLG); Stay long / buy with tight stops under $1.08.

Shopping Centres (SCP); Is in a trading halt raising capital to fund the purchase of VCX assets discussed above – a move to ~$2.10 would start to look interesting  

Summary

We’re negative property overall however the market is gradually aligning themselves with that view
At some point, select property stocks will look interesting again from a yield perspective and at that time, we will likely add some exposure back into the MM Income portfolio

Have a great day!

James, Harry & 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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