In an inflationary environment with rising interest rates, our focus has turned to which stocks and sub-sectors are best placed to maintain their pricing power and grow earnings.
Fund managers such as Goodman Group (GMG), Charter Hall Group (CHC), and Centuria Group (CNI) remain our top picks for a number of reasons:
1) After a rebasing in share prices, where most fund managers have fallen as much as 20%, we see this as buying opportunity. CHC is now trading on a ~16x earnings multiple, below the average for the AREIT sector. We believe CHC and GMG are candidates to upgrade FY22 guidance at the upcoming results. We forecast CHC’s earnings growth to be 15% through to FY24, underpinned by AUM growth and margin expansion as incremental FUM is being added at a very high margin.
2) Tailwinds continue for the logistics sector driven by global e-commerce demand. GMG, with a development book of $12.7bn combined with very high and growing margins (~60% on developments given the 250bps spread between yield-on-cost and market cap rates) should drive significant growth in development earnings as the projects are delivered. This flows through to AUM growth and performance fees providing us with confidence and visibility of future earnings growth.
3) The structural shift into alternative assets will benefit CNI. Having grown AUM to over $20bn through the acquisitions of Heathley Healthcare (2019), Augusta Capital (2020), and Primewest (2021), CNI now has one of the highest exposures to alternative sectors. In Australia, alternative assets only represent 6% of the AREIT index compared to more established markets such as the US and UK where they represent more than 50%. We believe as the structural headwinds remain for discretionary retail from online retailing and the work from home (WFH) thematics for office, alternative assets – being driven by secular trends, and hence less cyclical – will provide both earnings certainty and capital growth for investors.
4) On a macro view, with the anticipated economic slowdown underway and the risk of moving towards a downturn, we expect this will result in a flight to defensive asset classes such as REITs. This is likely to be supportive of real asset values and deployment of capital into the sector, which will aid fund managers. The risk is another shift higher in yields, although the current spread between asset yields (average at 4.5%-5.5%) and the cost of debt (average of 2%) is generally attractive and supports asset valuations and further M&A in the sector.
Based on valuation, the sector is trading on a forecast FY23 distribution yield of 4%, providing a 200 basis points gap to 10-year bonds, and an attractive three-year EPS growth of 6%.
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