Income Report / Income Report: Property stocks – are they worth another look? (VCX, NCK)

By Market Matters 30 January 19

Income Report: Property stocks – are they worth another look? (VCX, NCK)

Market Matters Income Report 30th January 2019

A choppy morning for stocks and the local market generally with a couple of stock / sector specific issues playing out. Some huge moves in the Iron Ore miners this morning following Vale’s dam issue over the weekend and subsequent rally in the Iron ore price  – early strength now getting met with some decent selling which implies that a degree of short covering was to blame. The China bears using Aussie Iron Ore stocks as their proxy have just had a tough few days! We sold FMG a day early in the Income Portfolio (yesterday at $5.10) however a 20% profit is hard to pass up in this market. This morning we sold RIO at $89 from the Platinum Portfolio which feels a good result with the stock now back at ~$85.  

G.U.D Holding (ASX:GUD) which manufactures consumer and industrial parts and is generally considered a good bell weather for the Aussie economy has released a poor set of results this morning and the stock is getting hit hard, trading down 11%. Hopefully not a sign of things to come this reporting season.

In terms of portfolio positioning, we’ve used recent strength in the market to increase cash and turn more defensive. The Income Portfolio is now carrying 24.5% cash, its highest level since inception while also holding 37.5% of the portfolio in more defensive income securities. That means we’ve got just a 20% exposure to equities going into this reporting season. Clearly room to move here.

Over the past week, the Income Portfolio added +0.71% while in the current financial year to date, it is up 0.28% vs the benchmark (RBA + 4%) of 3.19% while the ASX 200 accumulation (including dividends) is down by -3.07%.  Since inception, the portfolio is tracking at 4.22% p.a. vs the 6.5% p.a. benchmark. In the past week we saw opportunities to take profit in Fortescue (ASX: FMG), Nick Scali (ASX: NCK) and Suncorp (ASX: SUN), while we also sold Super Retail Group (ASX: SUL) for a loss.

Property stocks – are they worth another look?

Our job is to find good risk v reward opportunities in the market and as we kick off the new calendar year, we pose the question of whether or not we should be looking once again at property stocks in the MM Income Portfolio?

Some quick stats we keep track of in the sector on a regular basis;

·            The forecasted dividend yield for the sector is 5.1% based on an estimated ~77% average payout rate

·            The sector dividend yield spread over the 10 year bond yield is ~2.8% versus the longer term average of ~2.50%.

·            REITs are trading at a 24.1% premium to net tangible assets (NTA) which is above the long term average of ~20.7%.

·            Balance sheets are generally in good shape - gearing is low, just north of 20%

There were some stellar performances across the property sector last year while there was also some shockers. On the positive side of the ledger was Goodman Group (ASX:GMG) +34.5%, Charter Hall Group (ASX: CHC) +30.6%, Propertylink Group (ASX:PLG) +24.7%, National Storage (ASX:NSR) +24.1% and BWP Trust (ASX:BWP) +23.5% while on the negative side we saw  sector heavyweight Lendlease (ASX:LLC) -22.8%, Stockland (ASX:SGP) -11.6%, Centuria Capital (ASX: CNI) -3.5% and  Scentre Group (ASX:SCG) +0.9%.

Looking at the above we see the sector is shaping up okay in a general sense. Low debt, reasonable yield however it’s not glaringly cheap versus historical metrics. History shows that falls in property prices are generally pretty rare and according to recent analysis by Citi typically occur once every 8-10 years - but when they happen the underperformance of the REIT sector on the ASX is substantial – something around the 20% mark.  Clearly the A-REITS experienced significant pain through the GFC thanks to over geared balance sheets, and we’re now at the 10 year anniversary of that low, a theme that should not be lost on investors.

Last year while the equity market was weak and despite the negative sentiment towards property, property stocks actually eked out a positive return of around 6.5% including dividends  – not a bad result.  That’s the 6th time in the past 8 years that the sector has outperformed the broader market.

ASX 200 REITS – Chart

One of the main tailwinds for the sector at the end of calendar 2018 with a big decline in global bond yields (interest rates) which is generally supportive of property valuations and therefore supportive of property stocks themselves. That seemed to be the main reason property outperformed in 2018 - simply a result of weakness across the broader market in the December quarter as interest rates declined on recession fears.  

Australian 10 Year Bond Yield Chart

While we’ve written  about property stocks a number of times in this income note, ultimately we’ve only held two positions  over the past year or so, Centuria  (ASX:CNI) and Vicinity (ASX:VCX), both were sold for a profit however we haven’t gone back into the sector in recent times. The obvious superficial  tailwind for property stocks this year will be a change in Government  with Labor’s franking credit reforms a strong possibility. That makes  the high unfranked yield  in the sector more attractive, however ultimately, we think buying property stocks for this reason alone will prove a mistake.

One of the more obvious trends in the property space has been the weak performance from those with retail exposure. We’ve written about the headwinds facing the Australian consumer and ultimately that should flow onto weaker property values in that area of the market – and we’ve now started to see that play out.

Last week we saw Vicinity Centres  come out with a revaluation of assets booking an overall decline of 0.2% across their book – not bad considering the current environment however dig a little deeper and there were actually some more worrying trends that have implications for other retail exposed landlords, particularly those outside the major cities.  As a quick refresher, VCX runs a direct investment portfolio owning 60+ neighbourhood convenience based shopping centres, alongside an external FUM business that manages close to $10bil of assets for 3rd parties.

Vicinity Centres (ASX:VCX) Chart

Last week they published independent valuations on 38 of their directly owned properties with the balance subject to internal valuations. Below are the results as supplied by the company. Looking at the bottom 3 categories is a concern. Regional, subregional and neighbourhood centres have all gone backwards over the past 6 months. Is the Canary starting to chirp?  


While the concern about retail focussed property stocks is not new what’s interesting is the variance between the performance across the sector. While Retail exposed REITs such as VCX, SGP, SCG and MGR continue to trade at a discount to NTA – which we think is warranted, pure-play Retail REITs such as SCP and CQR are still trading a premium as shown in the table below – which we struggle to understand.


While the revaluation (down) of assets from Vicinity, mainly in regional areas is an extreme example, the trends should at least be a warning sign for the broader property sector. Just like equity fund managers are highly leveraged to the fate of equity markets in terms of both performance and FUM flow, property stocks are clearly very exposed to property prices. Rents generally go up and property prices follow suit which is supportive of share prices however there are signs emerging that it gets harder from here.

We remain neutral / negative property stocks at current levels

Nick Scali (ASX:NCK) – we cut it yesterday

NCK was in the MM income Portfolio from inception and it did well, trading up +20% in quick succession only to lose most of those gains in more recent times. We removed it yesterday for what turned out to be a disappointing +4% gain. NCK is a quality retailer and they’re doing a great job in a tough market, however given how strong their track record has been, analysts remain optimistic on their earnings, which concerns us leading into reporting.  Right now consensus for FY19 sits at EPS of 0.545 putting it in a forward PE of just 9.65x – it’s clearly cheap on expected earnings, as are a lot of retailers however we think there’s more pain to come from an earnings perspective, and ultimately local retails will put out downbeat guidance for the year ahead – and share prices will suffer.  As Matt Williams from Airlie funds mentioned recently, Australia seems intent on talking itself into recession – something we believe is a strong possibility.

Ultimately, I think retailers will bottom soon, but not yet, and the risk this earnings season is high, hence we cut the position.  

NCK Earnings Expectations

Conclusion (s)

Property stocks offer good yield however risk to capital now seems obvious.  

We are negative property stocks & consumer discretionary  stocks at this point in the cycle

There will be a time to buy these, but just not yet.  

Have a great day!

James / Harry & the Market Matters Team


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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