Is the unfranked yield in property stocks attractive?
While the debate rages around the abolition of cash refunds from franking credits, property stocks are being thrown around as the obvious beneficiary if a change were to occur. Over the last month the property sector has underperformed the market on an accumulation basis (including dividends) and that’s been the theme this financial year to date. While it’s easy to be negative property at the moment given the headlines around prices – and we’ve certainly held that view for some time – we like to go ‘against the grain’ and right now the market seems to be collectively bearish the sector. Does that present an opportunity? Firstly some stats to consider; · The sector is a trading on 15.5x funds from operations (FFO). We use the FFO multiple for Real Estate Investment Trusts (REITs) as it adds depreciation and amortization to earnings and then takes away any gain on sales – it’s essentially a cleaner metric · The forecasted dividend yield for the sector is 5.1% based on an estimated ~79% average payout ratio · The sector dividend yield spread over the 10 year bond yield is ~2.44% versus the longer term average of ~2.53%. · REITs are trading at a 22.5% premium to net tangible assets (NTA), which is down from the ~24% premium a month ago but above the long term average of ~20.7%. · Balance sheets are generally in good shape, with sector weighted average gearing of just 23.7% Looking at the above we see the sector is shaping up okay in a general sense. Low debt, reasonable yield, it’s not glaringly cheap versus historical metrics however there’s not much out there that is. The main issue is dividend yield spread over bonds or more simply, how much ‘risk premium’ am I being paid to hold a property security over and above holding a very secure government bond? At the moment, that ‘premium’ sits at 2.44% however, if bond yields go up, then property stocks must grow earnings by an equivalent rate + then pass them on in the form of dividends, otherwise share prices will retreat to maintain the spread. That makes interest rates a clear headwind for the sector in general – which is a fairly obvious conclusion. That said, there are some big variances across the universe of listed property stocks in terms of yield, premium / discount to assets, balance sheet strength and importantly the outlook for earnings. For that reason, it makes sense to look at underlying exposures of particular stocks. A lot of the property companies on the ASX are by their very nature diversified. Developments often have a mix of residential, office and retail while some (such as the highly successful Goodman Group (GMG)) have assets both in Australia and abroad. If investing in property at this point in the cycle, we have a clear preference for the more diversified operators simply from a risk / reward perspective. Overall, MM is still negative property which has been our position for some time. The MM Income Portfolio has held two property stocks over the past year, taking a ~20% profit on Centuria (CNI) and a small ~1.8% profit on Vicinity Centres (VCX). Despite the reasonably attractive unfranked yield offered by the sector which would become more attractive under a Labor Govt, the obvious threat remains around higher interest rates. It’s therefore incredibly important that the underlying business can grow earnings and therefore dividends at a pace higher than the rate of interest rate hikes, clearly a difficult task in this sort of property environment.
