EUR 850.00 For Business Accounts Only

Morningstar | Arena REIT Remains Undervalued Despite Oversupply Concerns. See Updated Analyst Note from 19 Jul 2018

A combination of a lack of announcements by no-moat-rated Arena since its interim financial result in February and a lack of movement in the Australian 10-year government bond yield have caused the price of Arena's securities to go nowhere this year. The key concern overhanging the company has been the oversupply of child care centres in Australia. This may limit Arena's growth prospects but could also undermine child care centres' operators viability and result in vacant properties for child care REITs.

However, child care centre operators and REIT’s have unanimously claimed that the oversupply issue is abating as lenders are increasingly reluctant to fund speculative child care centre construction. In addition, we expect the introduction of the Child Care Subsidy, or CCS, on July 2, 2018, to stimulate demand for child care services, offset oversupply pressures, and enable child care centres to increase their fees. We expect this to provide support for child care REITs via more creditworthy tenants and more opportunity to expand portfolios.

Arena has several attractive qualities including high occupancy rates of around 100%, high tenant renewal rates, and a relatively long-weighted average lease expiry of 13 years. Tenant leases are "triple net" which means tenants pay virtually all property-related costs. Our earnings forecasts assume Arena will generate a distributable income per security CAGR of 3.9% over the next decade with portfolio growth comprising only the existing development pipeline. The current market price of AUD 2.16 implies a fiscal 2019 dividend yield of 5.2% and we continue to believe Arena is undervalued relative to our AUD 2.50 fair value estimate.

It is also worth bearing in mind that Arena has a high exposure to Goodstart Early Learning, which comprises 40% of the portfolio by income, which we consider to be a particularly strong tenant. Goodstart is owned by a consortium of charities, is very conservatively managed, and is the largest child care centre operator in Australia. We expect these attributes would likely mean Goodstart would be supported by the government should it ever experience material financial issues. We also continue to believe the child care sector benefits from positive long-term tailwinds including a growing population of 0- to 5-year-olds, an increasing proportion of children using child care, an increasing female workforce participation rate, an increasing time spent by children in care each day, and increasing child care fees.