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Morningstar | Corporate Action: Cromwell Taps Market at Opportune Time. FVE Increased 5% to AUD 1.05.

No-moat Cromwell Property Group has placed AUD 375 million of new securities with institutions and is attaching a non-underwritten security purchase plan, or SPP, to raise up to a further AUD 30 million. We don’t recommend subscribing to the SPP given the issue price is above our 5% upgraded AUD 1.05 fair value estimate. The AUD 1.15 issue price is at a 7.0% discount to the distribution-adjusted closing price of AUD 1.24 on June 25, but is at a 15% premium to our previous fair value, driving the upgrade. Cromwell has sensibly tapped the market at an opportune moment, and proceeds along with recycled capital from asset sales, will be put towards more than AUD 1.0 billion of development opportunities across the existing Australian Core+ and Active real estate portfolios.

Cromwell reaffirms fiscal 2019 operating profit guidance of not less than AUD 8.0 cents and distributions of AUD 7.25 cents. We slightly reduce our operating profit estimate to AUD 8.2 cents though maintain distributions at the guidance-equalling AUD 7.25 cents. New operating profit guidance for fiscal 2020 is set at AUD 8.1-8.3 cents, with distributions of not less than AUD 7.5 cents. We retain our guidance high-end fiscal 2020 operating profit forecast of AUD 8.3 cents, but increase distributions to AUD 7.5 cents from AUD 7.0 cents, in line with the new guidance.

We support Cromwell’s strategy, and the raising of equity at a premium. However, at AUD 1.25 we view the shares as somewhat over-valued. The implied 6.0% fiscal 2020 yield is insufficiently enticing given the growth outlook. We assume flat to declining operating profit to AUD 8.1 cents by fiscal 2023. Our fair value estimate implies a fiscal 2023 price/earnings multiple of 14.3 and EV/EBITDA of 15.1. We assume only modest rental growth on existing leases (underpinned by a substantial proportion of fixed reviews), but rising vacancies in outer years, given the effective rents have fallen in Brisbane and other secondary markets.

Weakening tenant demand and delivery of new supply will hurt rents on expiring leases and market reviews.

Cromwell has identified a number of strategic growth opportunities as part of its "Invest to Manage" strategy. The equity raising will provide certainty of funding to pursue these opportunities and strengthen the balance sheet. Cromwell is higher-risk than most major Australian REIT peers. The small Australian portfolio of (mostly office) properties drives the vast majority of earnings, though the management and development divisions could add upside as property markets improve in the longer-term. The SPP offer is open from July 3 to July 24 to shareholders as at June 25. New securities will not be entitled to the quarterly distribution for June 30, 2019.