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Morningstar | Charter Hall Education Sensibly Capitalises on Positive Investor Sentiment

Charter Hall Education Trust’s decision to raise AUD 100 million to buy 13 childcare centres is a sensible move which capitalises on positive sentiment towards the childcare sector and yield stocks. Investor sentiment was particularly negative in mid-2018 due to concerns about an oversupply of childcare centres. However, the introduction of the childcare subsidy in July 2018 improved the affordability of childcare services, and childcare centre occupancy rates have improved in recent months. This has boosted the share prices of childcare centre operators, like G8 Education, and childcare real estate investment trusts Charter Hall Education and Arena. The decline in the 10-year Australian government bond rate to record lows has also boosted REITs' unit prices.

We’ve long thought the market was undervaluing childcare REITs, but their strong unit price performance in recent months means both Charter Hall Education and Arena are now fairly valued. We have maintained our fair value estimate for Charter Hall Education at AUD 3.34 following the capital raising, which implies it’s acquiring the new centres at a fair price. Our distribution forecasts are in line with management guidance and, at the equity placement price of AUD 3.35, imply an unfranked distribution yield of 4.8%. We also forecast a distribution compound annual growth rate of 4.3% over the next decade.

We are pleased that management opted for a AUD 5 million unit purchase plan, or UPP, in addition to the AUD 100 million institutional placement. Although relatively small, the UPP equitably enables small shareholders to participate in the raising on equal terms with institutions. The UPP offer will open on 2 April 2019 and close on 16 April 2019. At this stage, we expect to recommend unitholders to subscribe to the UPP as the offer price is close to our fair value estimate and below the most recent market price. However, we will provide our formal guidance closer to the offer close date.

The acquisition of 13 centres is not particularly material for Charter Hall, with the AUD 76 million portfolio cost increasing the book value of real estate by around 8%. The childcare portfolio will increase by just 3% to 426 and is around double the size of Arena’s portfolio of 211 centres. The remaining funds raised will mainly be used to reduce debt, which will help reduce pro forma gearing as at 31 December 2018 to 27.0% from 29.9%. This is comfortably below the target gearing range of 30%-40%. The increase in the debt facility, by AUD 50 million to AUD 397 million, implies around AUD 90 million in undrawn debt facilities. Charter Hall will remain the largest owner of childcare centres in Australia, but with just 6% of the market, further acquisitions are likely but not incorporated into our model.

The acquisitions have a lot of positive attributes including a weighted average yield of 6.5%, versus the existing portfolio’s yield of 6.2%, and the average market yield for east coast childcare centres of 5.9%. The acquisition yield also compares favourably with Charter Hall's and Arena’s distribution yield of 4.8%. The weighted average lease expiry of 18 years is also much better than the 9.5 years of the existing portfolio, and the weighted average annual rent review of 3.1% is better than the existing portfolio at 2.6%.

Generally speaking, we are very comfortable with the capital raising and acquisitions. If we have any concerns, it is that Charter Hall may have compromised asset quality to boost assets under management and management fees. In this regard, we note that the acquisitions will decrease the proportional exposure to high-quality tenant Goodstart Early Learning to 45% from 49%, and increase exposure to "other" childcare operators to 28% from 25%. We expect "other" means relatively small childcare centre operators, which may also have greater vacancy risk.