EUR 850.00 For Business Accounts Only

Morningstar | BWP Trust a Net Seller, Not a Buyer in This Market; FVE Unchanged at AUD 2.85

Narrow-moat-rated BWP Trust made great strides in addressing the existing and upcoming vacancies in the first month of fiscal 2019. Besides the sale of the Dandenong site, which was concluded in fiscal 2018, four more properties are expected to be sold in fiscal 2019. The trust’s portfolio will shrink to 75 properties, down from 79 in June 2018. However, we expect a further four properties to be sold in fiscal 2019, reducing the portfolio to only 71 properties.

Management is continuously assessing opportunities to expand the trust’s property portfolio, but these remain scarce in the current market environment. Capitalisation rates for Bunnings sites have stabilised at very low levels of 5.0%-5.5%, and next to valuations, location remains another key attribute underpinning the long-term rental growth potential of properties. Although attractive assets, in terms of valuation and location, haven’t presented themselves to management since fiscal 2015, the trust’s balance sheet is strong and positions BWP Trust to take advantage, should the market turn.

Distributable income from operations, excluding capital profits, of AUD 113.2 million in fiscal 2018 was 0.7% ahead of our estimate of AUD 112.4 million, due to lower-than-expected management fees and higher rental income. Distributions of AUD 17.81 cents per unit met guidance and our estimates. We maintain our fair value estimate of AUD 2.85, with units screening as overvalued at the current price of AUD 3.25. Management guided to fiscal 2019 distribution growth similar to the 1.7% in fiscal 2018, and we expect distributions to increase by 2% to AUD 18.17 cents per unit. Our fair value estimate implies a yield of 6.3%, and at current prices, units yield 5.6%.

The key short-term risk to our rental income estimates is lower-than-expected occupancy, if it takes longer to release or sell vacant properties. We expect an average occupancy rate of 97.5% in fiscal 2019, compared with an occupancy rate of 98.8% as at June 2018. From fiscal 2020, we forecast occupancy to return to 100%, as most upcoming vacancies will be addressed by then.

In the long term, repositioning more Bunnings warehouses to other large-format retail could introduce more tenancy risk. We consider physical hardware retail sales, such as Bunnings’, to be relatively sheltered from the continuing migration of retail sales to the online channel. Over the medium to long term, we expect many domestic retailers to rationalise their existing store networks, especially in highly consolidated markets with high online penetration, such as department stores. We expect this transition to put downward pressure on rents, and therefore property valuations and occupancy rates. For instance, the Mentone property in Victoria is being repositioned instead of sold, development is due to be completed in February 2019, and two new leases have been signed with big-box retailers.

In 2018, like-for-like rental increases of 2.4% across the portfolio were slightly lower than our 2.7% estimate. However, the trust negotiated much better-than-expected increases on market rent reviews, averaging 4.6% on seven properties, versus our previous estimate of 2.5% and the 2.1% average increase on market rent reviews achieved in fiscal 2017. We expect like-for-like rental growth of 2.7% in fiscal 2019, but rental income to decline nevertheless by 2.6% to AUD 148.5 million, following the divestment of Dandenong and eight other properties.

BWP Trust’s balance sheet remains strong. Gearing of 19.3% at year-end fiscal 2018 was slightly higher than our 18.3% estimate, but still lower than the 20.4% in the previous year and below management’s target range of 20%-30%. Despite a shrinking property portfolio and declining rental income, distributions can be maintained with any shortfall topped up by capital profits. Also, the balance sheet provides firepower in the event that any external growth opportunities arise.