BWP Trust: Interim result 2015

The share price of BWP Trust (BWP) has increased 32% since we upgraded it in Bunnings upgraded to Buy for a total return of 42% in barely a year. That's a ridiculous return for such a predictable and widely covered business, and shows the power of low interest rates on share prices.

A listed security is never a substitute for a term deposit, particularly those protected by a government guarantee. But we'd much rather own BWP than have our money tied up in a term deposit, as we're expecting interest rates to fall further and its rents are protected against inflation. That's why we're bumping up the Sell price in the recommendation guide by 10%, but you must be mindful of the risks.

With 81 of its 84 properties leased to Wesfarmers's Bunnings Warehouse, the continued success of the hardware chain is the major attraction – and the major risk – for investors in BWP. While the share prices of most retailers have been crushed lately, hardware retailer Bunnings produced a remarkable 9.1% growth in same-store sales. Clearly Masters isn't providing much competition just yet.

It's important to remember that Bunnings Warehouse is virtually the trust's sole tenant, so if the business crumbled for some reason rents and distributions would dry up. That's a highly unlikely scenario in our view, but you should still consider taking profits as the company's share price increases to control your portfolio limit in case something changes.

The trust's like-for-like rental growth was 2.7% for the 2014 calendar year, down from 3.8% in 2013, which included many more rent reviews. Although the 13 rent reviews concluded recently produced average rent increases of 8.8%, only 10% of its properties are subject to rent reviews in each of the next four years. Rental growth, unlike Bunnings' own sales growth, should be modest.

New Competition

With Wesfarmers planning to open 20 Bunnings Warehouses in 2015 the trust will have plenty of acquisition targets, but because it distributes most of its profits as dividends you must be prepared for intermittent capital raisings. For the right property, that isn't a problem. More concerning is that competition for sites is increasing, potentially raising prices for new purchases.

The success of BWP, and low interest rates, is attracting competitors. Charter Hall recently raised $235m to help add to its current portfolio of six Bunnings stores. Management highlighted that rival purchasers recently paid cap rates of around 6.5% for several properties in Melbourne and Sydney, which is higher than the average value of the trust's properties despite their inferior quality.

Furthermore, Bunnings has recently vacated four poor performing stores. Although it's required to pay rent until the leases expire – which means we don't expect a significant reduction in BWP's 99.4% occupancy level in the medium term – BWP must eventually find new tenants. If they pay lower rent, asset values could fall.

Net tangible assets (NTA) has been increasing in recent years but mainly because capitalisation rates have been falling; they declined again from 7.71% to 7.41%, suggesting investors are simply bidding up prices as interest rates fall. The trust now trades at a 32% premium to NTA.

An estimated second half distribution of 8.1 cents will bring the 2015 total to 15.77 cents per share, for an unfranked 5.5% yield. We're getting closer to selling, but for now we're sticking with HOLD.

Note: The model Income Portfolio owns shares in BWP.