PORTFOLIO POINT: After a disastrous run through the GFC, listed property trusts are back. They’re paying decent dividend yields, and their share prices are rising.
Call it fashion. Call it a trend. But the world moves in cycles and, sooner or later, the discarded and unattractive remnants of a previous era reinvent themselves and once again become desirable.
It is not a fool proof theory. Bellbottoms surely will prove to be the exception.
But Australia’s listed property companies, or Real Estate Investment Trusts, suddenly are back in the spotlight. And this time, it is for all the right reasons.
Having spent almost four years at the bottom of the heap, as they battled to unshackle themselves from the baggage of the financial crisis, 2012 has seen them clawing their way back to respectability.
Admittedly, they have come off a very low base. Back in August, after some serious capital gains since mid-year, many were trading well below net asset value, suggesting investors feared write-downs. Even today, after further gains since then, the bulk of our listed property trusts are trading at a discount.
But these once over-geared and over-loved enterprises, which fell spectacularly out of favour in the wake of the Centro Properties debacle, have now found themselves front and centre of the intense and increasingly desperate hunt for yield among local investors.
Collectively, Australian REITs fundamentally have a great deal more merit as a yield play than almost any other sector in the market. For it is about the only sector where dividend growth is being funded by earnings growth.
According to some worrying research from Macquarie Private Wealth, dividend growth among industrials has outstripped earnings growth for the past three years. The situation is only marginally better among resources companies, where dividend growth has remained steady in the face of increasingly volatile commodity prices. And, post financial crisis, even the banks are increasing dividends faster than their earnings ordinarily would allow.
There are two mutually agreeable forces at work here. Investors want yield. And corporations, mindful of the need to keep the shareholders happy, are more than willing to deliver in an effort to drive share prices higher.
In the process, many have been forced to raise their payout ratios. That wouldn’t be a problem if there was broad consensus that earnings were likely to take off next year. But all the signs point to a looming slowdown in the global economy along with domestic fears that there is nothing to fill the breach when investment in the resource sector begins to tail off. At best, the future is uncertain.
Dividends, excluding resources, have risen throughout the past year, with yields now above the long-term average. That has pushed the payout ratio to 75%, well above the long-term average of 60%.
There are limits as to how much further and how much longer this can continue. Longer term, it clearly is unsustainable. It is also worth noting that much of the capital growth in our market from mid-year until the US election a fortnight ago was based on yield hunting.
It is a rally that has become a self-fulfilling phenomenon as corporates shell out bigger dividends to attract yield hunters, resulting in healthy capital gains. The only missing ingredient in this magic equation is earnings.
REITs are the exception.
“Listed property trusts show the strongest and most positive trends – positive and stable dividend per share growth with earnings per share and dividend per share delivered broadly equal, thus leaving the payout ratio that has trended lower over the last three years largely unchanged,” says Macquarie.
Back in 2006, REITs were paying out an average 103.1% of earnings, which explains just why they hit the skids when global stock and credit markets tanked. They now pay out a more sustainable 81.7% of their earnings.
There’s a curious parallel between what is happening locally and in markets abroad right now.
In the ongoing quest for yield, which in normal times is considered a flight to safety, investors inadvertently are pushing into dangerous territory.
The insatiable demand for US treasuries that since has spilled over into corporate bonds has raised concerns of a potential bubble forming in credit markets, in the same manner that cheap credit midway through the noughties caused an investor stampede into high-yielding synthetic instruments over US real estate.
With US and European rates likely to remain low for the next two years at least, as their economies struggle, there’s little chance of bubble trouble just yet.
For local investors, the key danger for those hunting yield in our market is that the obvious targets – the banks and infrastructure stocks like Telstra – have been on the radar for months, which decreases the scope for further capital gains and increases the risk of falls.
Even the banks, which have attracted yield hunters like bees to a hive for most of this year, may struggle to maintain the momentum. Credit growth has stalled, unemployment is edging higher and business confidence remains depressed despite a recent improvement in consumer sentiment.
That has forced the banks to look for improved margins through cost cutting in an attempt to maintain the earnings momentum.
Deutsche recently joined that call, advising clients that bank stocks could become vulnerable to investors reweighting their portfolios and arguing that listed property trusts were a better option.
The forced restructuring of Australian REITs in the wake of the financial crisis has returned them to their roots, to the days when they concentrated their efforts and their assets largely in Australia with ample equity and conservative gearing with a clear focus on property development and management rather than financial engineering.
It clearly is paying off. Consider the performance of Australian REITs in the market rout following the US presidential election, when Wall Street suddenly noticed it was racing towards a fiscal cliff.
The Australian market held up reasonably well, dropping 2.8% in the week that followed. But Australian REITs fell by just 1.1%, clearly showing their resilience.
As a group, they still largely trade at a discount to net tangible assets. If you eliminate Westfield Group from the pack, given it trades at an enormous premium, the average discount is 7.2%, according to research by Bank of America Merrill Lynch.
Within the broad grouping, they can be categorised into retail, office, industrial and managers and developers. There also are a large group of diversified trusts.
While none of the trusts recommended by brokers as a buy are cheap (price earnings ratios range from 6.1 to 17.9, with many sitting around 12) the dividend yields are attractive, ranging from just under 5% for some of the most popular trusts to as much as 8.8%.
This week, a new trust was formed as Woolworths spun off its Shopping Centre Australia. With a yield of 8.3%, it stacks up favourably against its rivals, although Macquarie points out that this is based on rental guarantees from Woolworths until 2015. Still, those guarantees minimise the potential for short-term earnings downgrades.
The broker also points out that the spin-off follows Woolworths’ failure to sell the portfolio. Of the 32 centres it put up for sale in 2010, it managed to offload just 12 to Charter Hall Retail and Telstra Super. The remaining 20 are included in the portfolio in the proposed SCA listing, which all up will hold 69 retail assets, 55 of them in Australia and the remainder in New Zealand.
Deutsche analysts like Charter Hall Retail, which is in the throes of exiting Europe with the sale of its Polish portfolio and rationalising its American operations. As mentioned, Charter Hall has snapped up some of the Woolworths portfolio and recently spent more than $200 million buying Bunnings centres. It yielded 8.1% on 2012 earnings with prospect to deliver 7.6% this year.
They are also keen on Westfield Group, the giant of the sector, Dexus and Stockland. JP Morgan analysts like Dexus as well. The group is offloading its American assets to concentrate solely on its Australian portfolio and the $625 million it will receive for the sale next month should put it in a strong position to pick up quality local properties. The US exit, they argue, will reduce management and head office costs, resulting in a leaner operation.
Bank of America Merrill Lynch recommends 11 trusts as a buy, five as a hold and five to underperform. The laggards include Lend Lease, GPT Group, FKP Property, CommonW Prop and Goodman.
No stock highlights the dramatic rehabilitation of the sector like Centro. In late 2007, it was the first Australian company to feel the wrath of investors when the value of its US portfolio plummeted, leaving the company horribly exposed to its massive debts.
In December last year, the group underwent a complex reorganisation that involved a massive debt restructure. And now, many analysts rate it a buy. Trading at a modest 3.6% discount to net tangible assets with a dividend yield of 5.9%, it tops Bank of America Merrill Lynch’s recommended buys. If it is yield you are hunting, then Cromwell Property Group tops the list at 8.8% while Stockland delivers a healthy 7.2%.
There is always a trade-off between risk and reward. At least that’s the theory. But when the herd goes hunting in one direction, there are usually a few bargains left in the bin.