EUR 850.00 For Business Accounts Only

Morningstar | ALE Group’s FVE Unchanged Following Distribution Update

We maintain no-moat ALE Property Group’s fair value estimate at AUD 4.60 per unit following its announced AUD 10.45 cents per unit distribution for the second half of fiscal 2019. This results in a fiscal 2019 distribution of AUD 20.90 cents per unit, moderately lower than our forecast of AUD 22.10 cents. The difference is due to timing on when unitholders capture the benefit of expected rent uplifts from the ongoing 2018 market rent reviews. We continue to estimate the rent reviews will result in an overall 8.5% increase in the rents of the 79 properties subject to them. At our fair value estimate, ALE will have a distribution yield of 4.6% in fiscal 2019 and 4.9% in fiscal 2020. However, we think Ale is moderately overvalued at current prices.

We now forecast total rental income to increase by 5% in fiscal 2019 and about 6% in fiscal 2020, compared with our previous forecasts of 7% and 4.6%, respectively. A combination of the market rent review delays and moderately lower CPI-linked rental increases are the primary reasons for the change. On a more positive note, tenant ALH Group has now agreed to the maximum 10% rental uplift on 36 properties, with the remaining 43 disputed properties expected to have their rent reviews completed by the end of calendar 2019. Our rent forecast captures the fact rental changes from the reviews are backdated to Nov. 4, 2018.

We estimate that about AUD 5.5 cents per unit of the fiscal 2019 distribution will be a return of capital. Over the last few years, distributions have included a return of capital, with the board using distributions to manage gearing (borrowing less cash/total assets less cash). This policy is also designed to allow existing unitholders to benefit from the expected rental increases from the 2018 and 2028 market rent reviews and the capital appreciation of its properties. Gearing was at a historically low 41.6% at Dec. 31, 2018 and we expect gearing to remain at about 42% at the end of fiscal 2019.

Based on an update from the company, we understand there has been no material change in the market for hotel properties and that capitalisation rates have remained relatively flat. This is despite interest rates falling precipitously to historically low levels, with the Australian 10-year government bond currently yielding less than 1.3%. We expect the lack of cap rate tightening is because there is usually a time lag between when valuers incorporate factors like lower interest rates into their valuation. However, if interest rates remain at these historically low levels, we would expect a further tightening in cap rates and valuation uplifts, which may positively impact both gearing and distributions. Nevertheless, the board indicates it will determine longer-term through-the-cycle gearing targets once the 2018 rental reviews are completed and a better understanding is gained on market rents. The ongoing rent reviews continue to be a major risk factor, both on the upside and downside, for ALE’s distributions and fundamental value. However, lower interest rates should not result in lower interest payments as ALE’s debt is 100% hedged until November 2025.