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Morningstar | Charter Hall's Supermarket Sales Comb Over Softness in Specialty Sales. FVE Raised to AUD 4.00

Charter Hall Retail reported first-half fiscal 2019 operating earnings of AUD 15.61 cents per security, or cps, up 2% on the previous corresponding period. A solid first half plus organic rental growth and earnings accretion from AUD 132 million of acquisitions versus AUD 76 million of divestments and the delivery of a AUD 60 million expansion at Lake Macquarie Square puts Charter Hall firmly on track to hit reiterated fiscal 2019 guidance for earnings growth in excess of 2%. We’ve slightly raised rental growth expectations for supermarket tenants and our fair value estimate for no-moat Charter Hall Retail increases to AUD 4.00 from AUD 3.90. The firm continues to screen as overvalued, currently trading around AUD 4.55.

Based on major performance metrics, Charter Hall Retail’s portfolio appears to be performing ahead of peers. In contrast to peers who have suffered from weakening performance, Charter Hall saw a modest improvement in the trailing 12-month net property income, or NPI, up to 2.1% from 1.8%. Blended rents for new and renewed specialty leases were up by 1.9%, when peers mostly saw rents fall on letting. Digging into the numbers reveals nearly all of the outperformance is due to the high weighting towards nondiscretionary retail categories of supermarkets and liquor. Charter Hall’s specialty tenants only achieve sales growth of 0.9%. Further, the figures would have been flattered by Charter Hall recently offloading AUD 309 million of its "lower growth assets," which are now excluded from the comparable bucket.

Even though Charter Hall's sales and leasing metrics are positive relative to peers, it is not enough to compensate for softening industry fundamentals. The portfolio sales growth rate was a meagre 1.5% (2.2% for supermarkets and 0.9% for specialties), well below historical averages. Given specialty sales are only growing 1.5%, continuation of the fixed annual rental escalators of around 4% will slowly eat into the profit margins of all but the strongest specialty tenants. Industrywide pressures are changing consumer spending patterns, with more products purchased online, but this is less of an issue for Charter Hall that is focused on nondiscretionary retail.

One of the main outer year risks for Charter Hall is the periodic opening of stand-alone supermarkets near its existing assets, which dilute sales and hence the rent growth trajectory. The high level of competition among the major supermarkets looks set to persist, weighing on the rate at which the landlord will be able to grow these rents. We also think the firm needs to do something to lift the sales of its specialty tenants. There were few bright spots, with discretionary categories of jewellery and fashion down 2.9% and 2.8%, respectively. As these represent 14% of special sales, the remixing away from these to other categories could dilute rental income.