Income Report / Income Report; One sell & two buys (VCX, ECX, IGL)

By Market Matters 06 June 18

Income Report; One sell & two buys (VCX, ECX, IGL)

Market Matters Income Report 6th June 2018

Last week we covered our thoughts around infrastructure stocks following a recent rally in the sector. This week we’ll focus on property and in particular our call to Sell Vicinity Centre (VCX) into strength, reallocating funds into two mid cap stocks with fewer macro  headwinds. US bond yields have ticked higher over the past week but remain below 3%. This is important - the cost of funds globally is dictated by the US 10 year bond yield and we simply feel the only direction over all for US interest rates is higher – a move back up above 3% is simply a matter of time with the next technical and psychological target at 3.5%.

US 10-year bond yields chart

In terms of the MM Income Portfolio over the past week,  the portfolio was down (-0.14%) while the ASX 200 was up by (0.14%). Overall,  the portfolio is up 4.62% since inception (5/7/17) versus it’s benchmark (RBA cash rate +4% - equates to 5.05%).  Cash for now sits at 5.5%, however assuming the removal of VCX (4%) and the addition of ECX (3%) and IGL (3%) as outlined below, cash will drop to 3.50%. To view all past activity on the Income Portfolio – click here 

Property

Key metrics for the property stocks show a sector once again ‘stretched’ after its recently rally. Forecasted Total Shareholder Return (TSR)  which looks at the difference between current share prices and consensus target prices + yield, shows a messily ~7%, 5% of that is income.

The sector trades at a big 23% premium to its net tangible assets which is skewed by some of the developers (LLC, GMG), but still high none-the-less, while gearing is low at just ~26%. With an overall trend of rising interest rates we are bearish property overall, and view recent strength in the sector as a selling opportunity. 

**Rising interest rates not only increase the cost of debt, they negatively influence the valuation of assets. As interest rates have fallen, property prices have increased obviously helping property stocks. When rates go higher, the cost of debt goes up (which is not the real issue here given low levels of gearing across the sector) – the main issue is around the negative revaluation of assets** 

ASX 200 Real Estate Index Chart

 

Recently we’ve seen more M & A activity in the sector with a bid for the Investa Office Fund from Blackstone. Before the bid IOF was trading at a 6% discount to NTA, which seems cheap relative to the sectors +23% premium to NTA however if we compare it to more “suitable” comparables with office exposure DXS (6% premium), MGR (6% premium), GPT (0% premium), it still looked cheap but not by as much. While we’re not keen on the overall sector we have held Vicinity (VCX) in the Income Portfolio on valuation grounds - simply we thought it was cheap relative to its assets and obviously it pays an attractive dividend. The position has been more volatile that we’d hoped.

At the end of last week we saw the company unveil plans to sell up to $1bn of sub regional and neighbourhood shopping centres, with proceeds used to fund VCX’s development pipeline. This has no real impact on FY18 earnings guidance, however they are guiding to a slight impact next year, largely around the lag between sales and the reinvestment of proceeds – not a big deal. The rationale for the sale of assets is sound. If the market is not ascribing value to them (shown through the SP trading below NTA) then a sale achieved at book value or better will be a positive result. The market is less likely to discount cash more than regional shopping centres!

So, we agree with this strategic decision, given (1) the point we are at in the real estate cycle and (2) the fact that VCX is trading at a 9% discount to NTA, despite having had a ~14% rally in the share price in the last few weeks. That positive take however is on the assumption that VCX executes this strategy and achieves at least book value on the sale of these assets in aggregate. They may not which would prove the markets assumptions around the quality of the assets is correct, or they may sell for more, which in turn would have a really positive impact on the VCX share price. In the last week or so we have had conversations with well-regarded property guys – they are finding it extremely difficult to source attractive investments, one fund we know is returning capital. This begs the question, assuming VCX sell assets for book value – which we think they will, reinvesting the proceeds (at attractive levels) could be more of a challenge. Holding cash for longer is a drag on earnings, but reinvesting at unattractive prices will hurt more over time.   

While we think further corporate activity will play out in the sector given there is still a wall of capital out there globally looking for a home  which rings especially true for Sovereign Wealth Funds, Public/Private Pension Funds and Real Estate Private Equity firms that have ongoing redemption obligations, the headwinds in the sector remain clear, with rising global interest rates the main concern. As we often say, we think selling into strength in areas that have headwinds make sense.  

For that reason, we will sell VCX from the Income Portfolio at a price of $2.70 or better. 

Vicinity Centres (VCX) Chart

From a relative valuation perspective, Stockland (SGP) looks most attractive trading on a forward PE of 11.9x, which is a -20% discount to its 5 year average while paying a yield of 6.26% fully franked. Technically, the developer looks neutral at best.

Stockland (SGP) Chart

Hybrids

A number of our hybrid holdings went ex-income last week (BENPG, WBCPC) while MCP (MXT) also paid a distribution. Today we have both CBA issues (CBAPF & CBAPG) going ex-dividend CBAPF pays $1.03 plus franking = $1.47 while CBAPG pay 73.03c plus franking = $1.04.

Looking at relative valuation across the hybrid space, and focussing on the 2-4 year maturity window, the CBA names are offering best ‘relative value’, specifically the CBAPF paying a grossed up yield of 6.37% while at the shorter end, the BENPE looks best value with 2.5 years to first call. Clearly the current dominance of CBA in the media (for the wrong reasons) is having an impact on their Hybrids.

Based on the below, for new money targeting financial hybrids, best value is currently showing in the 2-4 year window with CBAPE and BENPE screening cheapest.  

Portfolio changes

As discussed in the Income Report  two weeks ago we like vehicle leasing and finance business Eclipx Group (ECX) and advertising and marketing services company IVE Group (IGL) – click here to view the report. We are adding 3% of the MM Income Portfolio into ECX around $3.35 today. IVE Group (IGL) will be added to the portfolio around $2.23 with a 3% allocation if Vicinity Centres (VCX) trades at $2.70 or above and is therefore removed. Watch for alerts for further detail.

Eclipx Group (ECX) Chart

IVE Group (IGL) Chart

Conclusion (s)

We remain concerned about rising interest rates and the associated volatility that will likely cause for property stocks
We are adding ECX to the portfolio with a 3% weighting
We are cutting VCX above $2.70 for a small profit if it gets there, and allocating 3% into IGL

**Watch for alerts**

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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