With annual reporting season now in full swing, we look at the latest movements in the domestic REITs and infrastructure space, providing a glimpse into what lies ahead for shareholders.
Asset valuations across all categories continue to increase. This is being driven by capitilisation rate compression in most asset classes as well as income growth across all sectors, particularly within office. Balance sheets remain in good shape, which is a stark contrast to the GFC. Companies are generally paying out no more than their free cash flow – a positive we like to see.
Indeed, office markets have delivered very strong effective rental growth with a lack of supply (particularly in Sydney) seeing effective rents currently circa 30% above their previous peak in real terms. We expect this to continue over the next 2 years given the lack of new supply in that time. This is particularly evident in Dexus Property Group (DXS) which reported significant valuation gains across Sydney and Melbourne portfolios with very strong effective rental growth. FY19 guidance is +5% earnings mainly sourced from like-for-like net operating income and lower operating capital expenditure. We’re overweight DXS with office currently the bright spot within listed property.
Residential continues to raise eyebrows for investors and consumers alike with settlements slowing. This should not be a surprise. Mirvac Group (MGR) typically trades as a proxy to the residential market, illuminating the fact that we are now in an environment of lower price and volume growth. Group capital in the Trust will increase to 85-90% (from the previous 80% target) as passive rent collecting plays a bigger part in Group earnings. This should attract a higher valuation multiple through reduced risk, in our view. Whilst growth in FY19 is forecast to be between +2% to +4% this comes off 11% growth in FY17 and 8% in FY18. FY20 growth will kick in driven by a record year for residential with record apartment settlements at high margin and continued Master Planned Communities strength.
Retail continues to face headwinds with sales growth anemic across most specialty categories. Our Fund remains underweight retail, as we expect the structural changes occurring within the space will continue to remain a headwind for the sector going forward. Rents continue to increase at much faster rates than underlying sales. In our view this remains unsustainable and is why we are seeing incentives for retailers increase in the current market.
The childcare narrative continues its positive trajectory as evidenced by Folkstone Education (FET). With strong +6% growth, guiding into another +6% in FY19, the stock sees the benefit of triple net leases supplemented by development completions. Accelerating things further, the new government Child Care Subsidy will assist the majority of low to middle income families.
Transurban Group (TCL) continues to perform well operationally. Traffic growth, toll escalation and trip mix contributed to +9% EBITDA. TCL has guided earnings to slow to +5% growth in FY19. This is due to the ramp up of several development projects. The balance sheet sits comfortably above ratings agency hurdles and capital releases, which are difficult to forecast, playing a greater part in the Group’s earnings composition moving forward. However, it really is about the upcoming WestConnex bid which would secure Transurban’s next decade of growth opportunities. The ACCC is currently deliberating on Transurban’s eligibility to bid for WestConnex, which has been delayed until 6 September 2018.
We’re only half way through earnings season, so all eyes will be on major events which shape the year ahead.