ALE Property has been a top performer for us, returning 96% (plus some healthy distributions) since we first recommended it almost four years ago, at $2.08 in ALE Property: Down in one.
The stock recently reached an all-time high of $4.20 and, with our Sell price set at $4.30, members have been asking through our Q&A feature whether we might be about to call last drinks and say goodbye to our old friend.
That was the approach we took with BWP Trust last year, when its price got too high – and its yield too low – for comfort. But ALE has a few more kegs in its cellar and we’re keen to stay at the party for a while longer.
Rent reviews in 2018 and 2028
Increasing price guide
‘Substantially under rented’
As we explained in ALE Property: Down in one, ALE has a lot of similarities to an inflation-linked bond.
That’s because, as owner rather than operator, ALE does nothing more than collect rent from its only tenant ALH Group, 75% owned by Woolworths, with the rent rising annually at the rate of inflation.
Considering its leases are on a triple-net basis, ALE only has to cover Queensland land tax and other management expenses. ALH Group picks up the tab for all rates, insurance and maintenance.
This means that ALE has very low costs and any increase in rent will largely be paid out through increased distributions.
However, the bad side of these leases is that it has left ALE’s portfolio of 86 pubs being rented at levels much lower than what they could achieve on the open market.
Independent experts believe that market rent would be between 35% and 40% of a property operator’s earnings before interest, taxes, depreciation, amortisation and rent (EBITDAR).
In FY2015, ALH Group reported EBITDAR of $773m and ALE owns 26% of ALH’s licensed venues. So, if ALH was paying typical market rates, it would have to fork out $70m–80m, rather than the $56m reported by ALE.
Calling in the bar tab
This under-renting is why ALE consistently trades at a premium to its reported net tangible assets per share (of $2.49 as at 31 December 2015).
ALE’s properties are valued by dividing net rent by a capitalisation rate. As its pubs are receiving less rent than they would on the open market, the property values on its balance sheet and by association its net tangible assets are also understated.
The extra kegs in ALE’s cellar, then, are two scheduled rent reviews which should significantly boost the rents. The first, in November 2018, is capped at total rental growth of 10%, which will likely be achieved. The second, in 2028, is unrestricted and should bring rents up to market levels.
Raising the bar
A further positive is that ALH has itself been renovating and extending the properties, increasing the rents they might ultimately achieve. It has a commercial incentive to do this while the market rent review is relatively distant. This has helped it increase its EBITDAR at rates far higher than inflation, so the gap that will eventually be filled by the 2028 rent review is getting bigger.
These factors, along with interest rates that look likely to stay low for a while longer, are enough to justify an increase in our price guide, with our Buy price rising from $3 to $3.50 and our Sell price rising from $4.30 to $5.
ALE expects to pay total distributions of 20 cents a share in 2016, which puts it on a forward dividend yield of 4.9%. HOLD.
Note: The Intelligent Investor Equity Income portfolio owns shares in ALE Property Group. You can find out about investing directly in Intelligent Investor and InvestSMART portfolios by clicking here.