By Tony Featherstone
Opportunity is emerging in yield stocks as the market stampede towards cyclical growth companies tramples valuations in interest-rate-sensitive sectors.
Investors could not get enough of the big mining stocks and other cyclicals after Donald Trump’s surprise win in the United States election sparked hopes of a stronger US economy and higher commodity demand. It unleashed the bulls.
The flipside was firming expectations for US interest-rate increases and a higher US dollar. The market has baked in a US rate hike in December and expects further increases in 2017. That’s bad for the so-called “bond proxies”, such as infrastructure stocks and listed property.
Sector rotation from overvalued defensive yield stocks to undervalued cyclical growth stocks was well overdue. I went cold on pricey infrastructure stocks, such as Sydney Airport and Transurban Group, in July, just before their price pullbacks.
But I underestimated the strength of commodity prices and gains in BHP Billiton, Rio Tinto and Fortescue Metals Group. As I outlined in November, the resource sector had rallied too far, too fast, and was being driven more by sentiment than fundamentals.
This rapid portfolio tilt has pushed several mining stocks to 52-week highs, and key infrastructure stocks and listed property trusts to near 52-week lows – a trend that should put yield stocks back on the radar of value investors.
Yes, rising bond yields are bad for interest-rate-sensitive stocks. They make equity yields look less attractive and hurt companies with higher debt. But the market has quickly priced in expectations of higher bond yields in equity valuations – and then some.
Commentators are warning against buying the big defensive yield stocks. They might be right in the next few months as momentum towards growth stocks lingers. Blanket views, however, overlook improving valuations in yield stocks for long-term investors.
Consider the Australian Real Estate Investment Trust (A-REIT) sector. It leapt in the first half of 2016 as bond yields fell and investors sought defensive sectors. The S&P ASX 200 A-REIT index rallied almost 20% in the first half of 2016, in a flat market.
Then it tumbled by almost as much from July as prices became overvalued, the 10-year bond yield rose and the August profit-reporting season for A-REITs disappointed. At its peak, the A-REIT sector traded 29% above its Net Tangible Assets (NTA) in July on Macquarie Group numbers – a valuation premium that was unsustainable.
The A-REIT index has given back most of its gains in 2016. This index is up 5.9% this calendar year (on a total-return basis, including distributions). That compares with a 7.1% return for the S&P/ASX 200 index.
Chart 1: S&P ASX 200 A-REIT Index
Source: Yahoo Finance
This is a rare period of underperformance for the A-REIT sector against the broader share market over the past three years. The ASX 200 A-REIT index’s annualised total return of 15% compares with a 5.3% return for the ASX 200.
That does not mean the A-REIT sector is undervalued or that investors should load up portfolios with listed property trusts. The sector is still trading around 7% above NTA on Macquarie numbers (although care is needed with aggregate NTAs because of the high weighting of Westfield Group and other large A-REITs in the index).
That suggests value is improving in select A-REITs.
Niche A-REITs appeal
I had a positive view on several niche A-REITs and outlined that view for The Switzer Super Report in 2015 (some examples here). Favoured ideas included National Storage REIT, Asia Pacific Data Centre Group, Arena REIT, Galileo Japan Trust and the US Masters Residential Property Fund.
Shopping Centres Australasia Property Group, BWP Trust and Charter Hall Retail were other small- and mid-cap A-REITs covered favourably for this report in 2014.
For the most part, these A-REITs performed well in 2015 and in the first half of 2016. But like the broader listed property sector, they sold off sharply in the past few months.
Storage provider National Storage REIT has fallen from a 52-week high of $1.94 to $1.43. Data centre operator Asia Pacific Data Centre Group is down from $1.67 to $1.47. Education and childcare property owner Arena REIT has eased from $2.44 to $1.79.
Shopping Centres Australasia is 13% off its 52-week high, BWP is off 26% and Charter Hall Retail REIT is down 15%. Two other A-REITs I covered for this report this year, Aventus Retail Property Fund and Folkestone Education, are also well off their 52-week highs after strong earlier gains.
Several of these A-REITs traded at substantial premiums to the NTA at their price peaks and needed a share-price pullback. None look overwhelmingly cheap now, even after 15-20% falls, but they are heading towards value territory.
Three A-REITs to watch
National Storage REIT looks interesting after recent price falls. The star REIT is well placed to make acquisitions in the highly fragmented self-storage industry and, longer term, is a play on capital-city densification, smaller apartments and demand for extra storage space.
National Storage reaffirmed its FY17 earnings-per-share guidance at its Annual General Meeting in Brisbane in November. An increase in occupancy rates from 75% to 79% impressed, but it came with a lower rate per square metre. National Storage is discounting to attract tenants and betting it can lift rental rates over time.
I like the long-term thematic of consolidation in the self-storage sector as bigger players snap up small independents. At $1.43, National Storage trades below a median price target of $1.69, based on a small consensus of five brokers that cover the REIT.
National Storage trades well above its latest net tangible asset (NTA) of $1.14 a security, but deserves a reasonable premium given its higher growth prospects and its self-storage management operations. It looks about fair value – something that has been rare for National Storage since it listed at 98 cents a unit in December 2013.
Chart 2: National Storage REIT
Source: Yahoo Finance
Aventus Retail Property Fund is another worth watching. I included it in a story on five top small-caps for this report in September when it traded at $2.37. The owner of big-box retail centres rallied to $2.55, then eased to $2.26 as the A-REIT sector sold off. It has held up relatively well and still trades above its $2 issue price from its October float.
Like National Storage, Aventus has an interesting market position in a property niche that is poorly represented by REITs. These properties have good prospects as big-name electrical, homeware and other specialty retailers are grouped together in “super centres”. Big-box retailing, and the REITs that own these properties, are much more common in the US than in Australia – a reason why Aventus was initially overlooked upon listing.
Aventus beat several prospectus forecasts in its maiden full-year result in August and lifted its guidance. The current price ($2.26) is above the latest stated NTA of $2.02, but Aventus’s portfolio had almost double-digit gains in property valuations.
Aventus, too, has good opportunities to consolidate a fragmented property niche and grow through acquisitions and organically. It is one of the more interesting niche A-REITs to emerge on ASX in the past few years.
Chart 3: Aventus Retail Property Fund
Asia Pacific Data Centre Group (AJD), a favourite of this column over the past few years, also stands out at the current prices. The NEXTDC spin-off owns three data centres and is a lower-risk play on the cloud-computing boom. It is benefiting as NEXTDC attracts more companies to its state-of-the-art data centres, in turn reducing tenancy risk.
NEXTDC’s strong operating performance creates more confidence in AJD. The REIT’s single-tenancy risks through NEXTDC have been the market’s main concern. AJD’s $1.46 security price compares with its latest stated NTA of $1.43 (which increased 15% over the year).
AJD’s leverage to the fast-growing cloud-computing trend, and its ownership of a property portfolio that is hard to replicate, arguably demand a premium to NTA – something the REIT had for most of this year until the broader A-REIT sell-off.
The long-term thematic for data-storage centres appeals as companies store more data and increasingly outsource that service to specialist providers. AJD’s trailing 6.5 per cent distribution yield is another attraction.
Chart 4: Asia Pacific Data Centre Group
Content provided by Switzer Super Report.
By Tony Featherstone