Two undervalued REITs report earnings
These two real estate investment trusts are trading at a discount to our fair value.
Investors continue to be wary of listed property but there are some undervalued opportunities for investors that are seeking income. Two undervalued REITs recently reported earnings.
Charter Hall Long Wale REIT (ASX: CLW)
Charter Hall Long Wale REIT’s portfolio is high-quality and consists of assets of with long lease terms. Liquor retailer and pub operator Endeavour Group is the largest tenant at 19% of passing income. At least four fifths of passing income comes from tenants we view as unlikely to miss a rent payment, including Endeavour Group, government agencies, Telstra, BP, Inghams, Coles, Metcash, Arnotts, Bunnings, and Westpac.
External fund manager Charter Hall has a strong record and good relationships with tenants. Continued acquisitions may have diluted CLW’s portfolio, particularly as long-WALE assets have been in high demand and thereby came with a hefty price tag. CLW has been acquisitive, buying properties and other REITs by using debt and issuing new equity.
It issued about $386 million of new equity in fiscal 2019 to fund acquisitions, including various offices, a bus terminal in Eagle Farm, Brisbane, and several agricultural logistics properties from Inghams on a sale-and-leaseback arrangement. In fiscal 2020, it issued $850 million of equity to purchase telco exchanges, a Brisbane office building, Telstra’s Melbourne headquarters, and BP service stations in Australia. In fiscal 2021, it issued $626 million of equity, using the proceeds to purchase Telstra exchanges, a portfolio of offices, and BP sites in New Zealand, taking its BP portfolio to about $500 million in Australia and New Zealand. CLW issued substantial new equity every year since its 2016 listing, with the number of securities on issue tripling from about 208 million in June 2017 to 720 million at March 2022. Higher interest rates are likely to slow the group’s expansion and weigh on earnings, given the group’s relatively high gearing.
We keep our fair value estimate unchanged at $5.10 per security after no-moat Charter Hall Long Wale REIT released half-year earnings that were broadly in line with our expectations. The REIT delivered operating earnings and distributions of $0.13 per security in the first half of fiscal 2024 and reaffirmed the full-year distribution guidance of $0.26 per security. This is in line with our unchanged estimate and equates to a 6.7% yield at the current security price.
For the first half of fiscal 2024, the REIT’s net property income rose 4% from the previous corresponding period to $167 million, helped by 52% of the leases being inflation-linked. Operating expenses remained contained. However, the revenue gains were overshadowed by a 33% jump in finance costs inflicted by rising interest rates. We expect higher finance costs to be a headwind until debt costs peak around fiscal 2026 at our estimated long-term cost of debt of 5.8%, compared with the current prevailing rate of 3.9%.
At December 2023, the total portfolio was valued at $6.5 billion, reflecting a 5% decline since the end of last fiscal year. During the first half of fiscal 2024, the REIT sold $146 million of assets across industrial and logistics, office, and convenience retail categories.
Benchmarked against the valuation as of June 2023, the assets were mostly sold at modest discounts, broadly consistent with the changes of valuation in the total portfolio. The weighted average capitalization rate, which is negatively correlated with property values, inched higher to 5.08%, while net tangible assets fell 8.7% to $5.14 per security.
This contributed to a rise in gearing to 34.5%, slightly higher than the 32.9% six months ago, with a weighted average debt maturity of 4.7 years and 82% of look-through debt hedged.
The securities are currently trading at a 25% discount to our fair value.
Mirvac (ASX: MGR)
Mirvac trades as a stapled security, comprising one share in the corporation and one unit in Mirvac Property Trust. Stapled securities refer to an arrangement under which different classes of securities are listed and traded as one security. About 80% of earnings come from a passive commercial property portfolio housed within Mirvac Property Trust.
Earnings from the rent-collecting business are relatively stable and predictable, while most of the remainder comes from a residential development business that can be lucrative but volatile. Mirvac’s REIT status results in low company tax because trusts pass income and tax liabilities through to the end investor. Mirvac pays slightly more tax than some passive real estate investment trusts, because of the development business within the Mirvac corporation.
Mirvac is gradually reweighting its business in several ways. It is allocating most of its capital toward passive rent collecting. Within that, it is allocating more to industrial and mixed-use commercial, trimming retail exposure, and refocusing its retail portfolio on urban areas. The residential development side has been weighted to houses and land lots recently, but we expect a recovery in apartment demand in coming years.
Mirvac is rolling out build-to-rent residential projects, though this is only a small portion of the portfolio at present. Initial projects have seen strong take-up from residents. Mirvac’s current crop of projects completed or in development look well placed because of an acute shortage of housing and rising rents in inner urban areas. Mirvac's first project, LIV Indigo in Sydney, was 98% leased by June 2022. LIV Munro in Melbourne completed in November 2022 and was 91% leased in January 31, 2024. LIV Aston in Melbourne is expected to commence pre-leasing in the second half of 2024. Other projects are scheduled to complete in 2024 and beyond.
No-moat Mirvac posted first-half fiscal 2024 operating earnings per security of 6.4 cents and a distribution of 4.5 cents. Management reaffirmed full-year guidance for operating earnings (“OEPS”) of 14.0-14.3 cents per security (“CPS”) and distributions (“DPS”) totaling 10.5 cps. Our forecasts remain in line with guidance with OEPS of 14.2 cps and DPS of 10.5 cps. We reaffirm our fair value estimate of $3.10, and Mirvac securities screen as significantly undervalued.
Investment earnings before interest and taxes (“EBIT”) fell 3% compared with the first half of fiscal 2023. Underlying property income growth was more than offset by asset disposals, including 60 Margaret St and MetCentre in Sydney’s CBD and Stanhope Gardens in western Sydney, as well as Mirvac shutting down Toombul Shopping Centre in Brisbane after severe flooding. Development EBIT fell 9% with fewer office or mixed-use projects, partly offset by higher residential development earnings and lower costs. Funds EBIT grew 7% as lower costs and increased funds under management more than offset lower valuations, which affected base management fees and an absence of performance fees in the half. Mirvac has gathered $8.8 billion of new third-party inflows over the past 18 months, more than half its $16.4 billion of FUM.
Group EBIT was down 4%, and operating profit after tax was down 17% due mainly to higher interest costs. Mirvac’s debt costs averaged 5.4% over the half, up from 4.5% in the previous corresponding period. Rising debt costs will remain a headwind as hedges expire. But we think much of the pain has been taken, given debt costs aren’t far below our estimated long-term cost of debt of 5.8%.
The securities are currently trading at a 27% discount to our fair value.