EUR 850.00 For Business Accounts Only

Morningstar | ALE Group’s FVE Unchanged Following Broadly In Line 1H19 Results

Our fair value estimate of no-moat ALE Property Group is unchanged at AUD 4.60 per security following in line first-half fiscal 2019 results. Unfortunately, the earnings update did not provide any meaningful guidance on potential changes in market rents on the 45 properties that remain subject to the ongoing 2018 market rent reviews. The 34 properties that have already had their rents increased by 10% as part of the market rent reviews led to overall passing rents increasing by 4.26% from June 30, 2018. These rental increases were backdated to Nov. 4, 2018 and therefore the first-half fiscal 2019 results only captured circa 2 months of the increase, leading to a circa 2.4% increase in rents in first-half fiscal 2019 compared with first-half fiscal 2018. We continue to expect rents in fiscal 2019 to increase by 7%, with the second half of fiscal 2019 capturing the full rental increases of all 34 properties that have already had their rents increased as well as the 45 properties we expect will eventually have their overall rents increased on completion of the rent reviews. However, we believe the REIT is overvalued and are concerned about the lack of valuation uplift to its property portfolio in the half-year results.

We continue to expect the ongoing 2018 rent reviews will result in an overall 8.5% increase in rents on the 79 properties subject to the review. Management now indicate that the results of the remaining 45 properties are due after June 30, 2019. The delay stems from the 45 properties being in different Australian States and requiring separate valuations. One consequence of the delay is it may impact the timing on when investors may benefit from the rent reviews in the form of higher distributions. Notwithstanding, we continue to forecast distributions to increase by 6% in fiscal 2019 based on the expected increase in rents from the rent reviews. At our fair value estimate, the REIT has a fiscal 2019 dividend yield of 4.8%.

There is some uncertainty to both the timing and amount of the fiscal 2019 distribution because it will depend on when the ongoing rent reviews are completed and the board's view on appropriate gearing levels after they are aware of the full impact of the rent reviews. As at Dec. 31, 2018, gearing (net debt/total assets less cash) remained at a historically low 41.6% and management reiterated their strategy to review appropriate gearing levels following completion of the market rent reviews. Gearing levels have been managed by paying part of the REIT’s distribution out of capital, with AUD 3.29 cents of the AUD 10.45 cents interim distribution again funded out of capital. Our forecast of a 6% increase in distributions in fiscal 2019 assumes the board will maintain gearing at current levels and that they will receive results on the rent reviews on the 45 outstanding properties in time to be able to upgrade the final 2019 distribution.

Somewhat of a concern is the fact the REIT's property valuations remained unchanged at AUD 1.136 billion, which impacted on statutory profits. Statutory profit for the first half of fiscal 2019 was AUD 5.6 million compared with AUD 29.8 million in the first half of fiscal 2018 (which benefited from an AUD 20.4 million valuation uplift). However, management indicate the general view of independent valuers is that pub properties, pub rents and underlying capitalisation rates for comparable properties remain substantially unchanged. We expect cap rates to stabilise and gradually increase from fiscal 2018 levels. We forecast the weighted average cap rate on its portfolio of properties to increase to 5.31% by fiscal 2023, from 4.98% in fiscal 2018. However, we think the market rent reviews and ongoing CPI rent increase and strong locations of its properties should result in future modest valuation uplifts, with cumulative valuation uplifts forecast to total AUD 145 million in the next five years, compared with AUD 352 million in the previous five years. As property values had not increased and passing rents increased by 4.26% as a result of the part-completion of the rental reviews, the weighted average yields on its properties increased to 5.19% from 4.98%.