EUR 850.00 For Business Accounts Only

Morningstar | Transferring Coverage of Narrow-Moat Charter Hall Group, AUD 6.80 FVE Maintained

We have maintained our narrow-moat, Standard stewardship, and medium fair value uncertainty ratings for Charter Hall Group following the transfer of coverage to a new analyst. We have also maintained our AUD 6.80 fair value estimate and, at the current market price of AUD 10.57, continue to believe the shares are overvalued. Our fair value implies a fiscal 2019 P/E ratio of 16 and a dividend yield of 4.9%, or 6.2% with franking, versus a market price-based P/E ratio of 20 and yield of 3.8%, or 4.8% with franking. Our forecasts assume a negative EPS CAGR of 1.7% over the next decade which mainly reflects a reversion of performance related fees towards long term trends.

We applaud Charter Hall's decision to substantially expand its internal property development capabilities and become a vertically integrated property firm spanning ownership, management, and development. This provides a competitive advantage over pure-play REITs and enables Charter Hall to source product cheaper than buying on market and provides a greater range of investment options for prospective investors. An intangible benefit is greater insight into conditions across the office and industrial markets.

Our earnings forecasts assume Charter Hall will encounter a two-year period of slowing assets under management, or AUM, growth from June 2020, followed by a two-year period where asset values decline by 15% on the expectation that credit risk will be repriced. We expect this to weigh on the values of all property assets and cause wholesale investors to reduce property exposures and increase bond exposure. Further, we are seeing evidence of increased competition in property funds management, diluting the expected growth rate of incumbents. The timing of these factors is uncertain, but we believe it’s prudent for our long-term forecasts to incorporate a removal of the prevailing monetary stimulus, which we expect to eventually cause interest rates to rise and asset values to fall.

We suspect the main reason for our valuation discount to the current share price is more conservative assumptions around the long-term growth rate in AUM and outer-year performance fees. Recent growth in AUM has been outstanding, but we see many impediments to this being sustained and after recent strong growth, there is increased risk of retracement that we don't believe is appropriately priced by the market.

Aside from the AUD 205 million acquisition of Folkestone and its AUD 1.6 billion of funds under management, or FUM, Charter Hall’s satellite funds appear to be widening their investment remit to more esoteric property. In this regard, Charter Hall’s Long WALE REIT in December invested AUD 224 million to buy a series of chicken-rearing properties at a high yield--around 7.5%--on a 16-year lease to Inghams Group. This portfolio comprises 27 rural properties, a mix of hatcheries, feed mills, and breeder farms all on triple-netlease structures, with the tenant responsible for all repairs, maintenance, and capital replacement.

In recent months, there has been very strong appreciation in the shares of listed "aggregators," being firms who manage income-generating assets on behalf of third parties and generate a series of annuity-style and high-margin fees in the process. As with Charter Hall, most of these firms have reported very strong growth in FUM of late and also exceptionally high performance fees. We think this level of growth and the corresponding spike in performance fees are unsustainable and have been driven by asset revaluations as global bond yields have retraced.