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2 top-tier property-linked income stocks

Glenn Freeman  |  04 Aug 2017Text size  Decrease  Increase  |  

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These two companies from Morningstar's latest Best Stock Ideas each occupy quite different areas of listed property, but both provide strong prospective dividend yields.

 

Each hold considerable competitive advantages in their specific fields, or narrow moats, in Morningstar terminology. They also have only medium levels of fair value uncertainty, with stable operating margins and high-quality retail tenants, respectively.

Pubs and clubs

Hotel Property Investments (ASX: HPI) is one of Morningstar's preferred picks in the Australian real estate investment trust (REIT) sector, and it has a forecast dividend yield of 6.6 per cent. It operates a portfolio of more than 40 pub properties, primarily in Queensland and South Australia, which provide secure earnings within a business that has reasonable gearing--both of which underpin Morningstar's medium uncertainty rating.

The rents are highly predictable: leases have either initial terms of 15 years, or an initial term of 20 years, with tenant options to extend for a further two 10-year terms.

"The rental growth outlook is very attractive compared with that of other Australian REITs. More than 80 per cent of the portfolio's rents grow at the lower of two times the average five-year consumer price index, or at 4 per cent per year," says Johannes Faul, a Morningstar equity analyst.

The underlying pubs are leased almost exclusively to subsidiaries of supermarket giant Coles, which, along with rent security, is a key underpinning of the REIT's moat rating.

However, the company is not without risks, including potential changes to Queensland gambling and liquor regulation, which according to Faul, "could negatively affect pub profitability and therefore rents as leases roll over".

"Considering the distribution yield, relatively secure medium-term earnings, and solid growth, we consider Hotel Property Investments an attractive income stock," he says.

Global retail giant

With a forecast income yield of 4.3 per cent, Westfield Corporation (ASX: WFD) is a well-known operator of shopping malls. While having launched in Australia and New Zealand, a series of restructures means Westfield is now a stand-alone internationally-focused entity that holds a strong portfolio of premium malls in the US and UK.

"In our view, Westfield is, and will remain, a market leader in mall development, reflecting its substantial in-house expertise, strong balance sheet, and options to redevelop existing malls," says Morningstar equity analyst Tony Sherlock.

He believes the combination of an attractive tenant mix and the higher household income of inner city locations will see Westfield's sales and rental performance outperform the broader market, particularly among its larger centrally-located malls.

"Our medium-term earnings forecasts are premised on approximately 96 per cent occupancy for the portfolio. Our longer-term earnings forecast is for base rents to grow annually by about 3 per cent," he says.

Westfield's narrow moat rating is ascribed because of its efficient scale, network effect, and high customer switching costs.

In terms of challenges, Sherlock believes the escalation in the number of struggling US apparel brands and the prospect of rising interest rates are the two factors weighing on the share price of Westfield. While both risks are real, he believes there has been a share price over-reaction and Westfield now screens as attractively priced.

"We believe brick and mortar will face further challenges from a higher proportion of sales occurring through online channels, but Westfield has the option to reallocate space currently occupied by struggling fashion brands to alternative uses such as dining and services," he says.

Sherlock expects incoming tenants to have "marginally lower rent-paying capacity" and he accounts for this in his forecasts.

"As has already occurred in major Asian cities, we see Westfield's retail malls evolving to become de facto town centres, rich with entertainment, dining, and essential services, but also extended trading hours."

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Glenn Freeman is a Morningstar senior editor.

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