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Morningstar | ALE Property Group to Pay Higher Land Tax in Queensland, But Impact on Our AUD 5.10 FVE Immaterial

Narrow-moat-rated ALE Property Group reported property rental income of AUD 58.1 million in fiscal 2018, up 1.9%, in line with inflation, and in line with our estimate. However, distributable income of AUD 29.0 million was 1% below our AUD 29.4 million estimate, and down on the AUD 29.1 million generated in fiscal 2017 with higher costs outweighing the increase in rental income. The cause is management expenses relating to one-off rent review negotiations, which we estimate at around AUD 0.4 million.

We have reduced our distributable income forecasts by AUD 0.7 million from fiscal 2019, to reflect an increase in land tax in Queensland. However, the impact on our intrinsic valuation is negligible and our AUD 5.10 fair value estimate stands. The more material near-term earnings consideration is market rent reviews, capped at 10% on the up- and downside, coming up in the first half of fiscal 2019. We expect these reviews to result in rental income growth of 7% and 5%, in fiscal years 2019 and 2020, respectively, before growth moderates to 2.5% from fiscal 2022.

Securities in ALE Group are screening as slightly overvalued, equating to a distribution yield of 3.9%. We forecast distributions growing by 2.5% to AUD 21.3 cents in fiscal 2019, with any shortfall in distributable income to be supplemented from cash balances. In fiscal 2018, only 73% of declared distribution was underpinned distributable income of AUD 14.83 cents per security, with capital and surplus cash providing for the balance, presenting AUD 11.7 million in overdistributions.

Management intends to increase annual distributions by CPI at a minimum, but will revisit this policy after the market rent reviews in late 2018. We forecast CPI at 2.5% per year, representing the midpoint of the RBA's inflation target range of 2.0%-3.0%.

Fiscal 2018 year-end gearing of 41.6% was in line with our 41.5% estimate, and below the 42.7% as at June 2017, mainly driven by an AUD 54.3 million increase in property values. This is well below management's target gearing range of 50%-55%. We expect gearing to peak at 48.0% in fiscal 2029, as the group continues to supplement distributions with debt, overdistributing income in the lead-up to expected material rent reviews in fiscal 2029.