Views at a Glance / Income Report; Should we own property stocks for income?

By Market Matters 25 October 17

Income Report; Should we own property stocks for income?

Market Matters Income Update 25th October 2017

The MM Income Portfolio tracked the ASX 200 broadly this week with the portfolio up ever so slightly versus the market which was down –0.06%. - overall, the portfolio has gained 5.038 % since inception. Cash now sits at 16.57% however we are allocating 7.5% of that into the new Bendigo Hybrid which is being issued shortly. That will leave ~11% cash in the portfolio and we are looking for opportunities as they present themselves…potentially in the property sector?

Should we own property stocks for income?

Back in August we penned an Income Report titled - Are the supermarkets a better bet than their landlords? CLICK HERE to view with the conclusion at the time being; Neither supermarkets or their landlords are attractive from a thematic standpoint. Rising interest rates will hurt property stocks and rising competition and reduced spending power will clearly hurt the supermarkets.

At that stage, we owned Wesfarmers however we subsequently sold after picking up the dividend and a small capital gain, seeing more risk of downside than potential upside in the stock / sector. Today they’ve come up with a weak sales update which we’ll cover in more detail in today’s afternoon report, however we remain comfortable with our avoid call at this stage.

Thinking about the other side of that report, being the landlords and expanding our horizons to include all property plays following the positive move we have experienced from our holding in Centuria (CNI) which accounts for 8.4%  of the MM Income Portfolio. Broadly some interesting stats on the sector below;

-          The sector forecast DPS yield is 5.01% on a weighted average basis, based on an ~83% average payout ratio. 

-          The sector DPS yield spread over bonds is 2.16%, having narrowed significantly from ~2.53% as at 31 Aug 2017.  This is a function of both higher bond yields (2.85% vs. 2.63% one month ago) and surprisingly, concurrent pricing growth in the sector.

-          REITs are trading at a 21.2% premium to NTA, which is in line with the sector’s long term average.  However, at an individual stock level, there is a wide variance.

-          Balance sheets generally in good shape, with sector weighted average gearing of 26.3%.

-          Cheap long term debt issuances in the bond market.  We note that during the month, large cap REITs GMG, GPT and MGR all issued long term debt via the bond market at (what we see) as attractive rates. Any concerns over REITs held by equity holders do not appear to be shared by the bond market for good quality, well capitalised large cap REITs. 

Source; Shaw and Partners

So, a few key takeout’s for us.

The sector has a good yield, mostly unfranked however a 5% yield with the hope of some capital growth seems reasonable versus the cash rate of 1.5% and typical borrowing costs of ~4%. The listed Real Estate Investment Trusts are trading at a premium to their net tangible assets – which we should be conscious of, however that’s because an individual can’t replicate their suit of assets, therefore you pay a premium for diversification, expertise, buying power etc.

So when someone says that you can get 10% by holding one asset in one area with 5 tenants versus holding 150 different assets across states and even countries getting 5%, then we’re not comparing similar risk profiles relative to the return being generated. It’s a similar scenario with MCP (MXT) we hold in the portfolio. They invest in corporate loans, lots of them, and the risk profile here is lower than simply being an unsecured creditor to one particular corporate.

Anyway, I’m digressing after a busy day...  

Back to the topic at hand – should we be putting more money in the property stocks?

No would be my first thought in a general sense however we could be enticed on a specific event driven scenario. The main issue right now is not about gearing or their balance sheets which are fine, it’s not about dividends which are ok, it’s not even about the premium versus NTA the sector trades on, which is +20% but aligned with historical averages. 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 2.16% however, if bond yield 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 so there needs to be a compelling ‘stocks specific’ reason to buy something in the sector. We have that with Centuria (CNI) which we own, and there is also corporate appeal bubbling away with PropertyLink Group (PLG) underpinned by a strong asset base & yield, however outside of those areas, we’re struggling to find reasons to go more heavily into the sector.

Centuria (CNI) Daily Chart

For those looking for opportunities, we do rate the property analyst at Shaw Peter Zuk, and the below is an outline of his current picks. Total Shareholder Return (TSR) represents capital growth to 12 month price target + projected income.

The sector first…

Specific stock calls…we own Centuria and have previously spoken favourably about Vicinity (VCX). Incidentally, Lend Lease (LLC) has been upgraded to a buy after recent weakness.  

Vicinity (VCX) Daily Chart

Summary

The property sector has performed well given the clear headwinds around interest rates
That said, we find it hard to justify a bigger weighting towards the sector over and above our current exposure
We are looking for opportunities outside the property space at this point in time

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 Wednesday.

Disclaimer

All figures contained from sources believed to be accurate.  Market Matters does not make any representation of warranty as to the accuracy of the figures and disclaims any liability resulting from any inaccuracy.  Prices as at 25/10/2017.  10.00am

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