Morningstar | Transferring Coverage of No-Moat Cromwell Property Group; AUD 1.00 FVE Unchanged. See Updated Analyst Note from 22 May 2019
We confirm our AUD 1.00 fair value for Australian REIT Cromwell Property Group as we transition coverage to a new analyst. Our no-moat, medium fair value uncertainty and Standard stewardship ratings are unchanged. At current prices, the stock is trading 18% above our valuation.Our fair value estimate implies a fiscal 2019 price/earnings multiple of 11.7 and a fiscal 2019 EV/EBITDA of 14.5. Our valuation is broadly consistent with the net tangible asset backing of AUD 0.99 as at December 2018. 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 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. Management's strategy is to use higher gearing over a lower-grade portfolio to maximise returns, while mitigating risks by locking solid tenants into long-term leases. Unfortunately, many long-term leases are expiring in coming years, and are likely to see rents fall to market levels upon renewal.
Gearing has decreased more recently to just below the group’s 35% to 55% target range, but at 33.7% at December 2018 (or 40.4% on a look-through basis) is still more aggressive than many peers. We’d prefer more conservative settings as much of the gearing decline reflects asset revaluations which could quickly reverse in the event of a credit crisis. Cromwell’s properties are generally located in fringe central business district and suburban locations in Brisbane and Canberra where entry barriers are lower. These markets experience more volatile tenant demand than core-CBD ones.
Cromwell Property Group has five operating segments: property investment, which owns investment properties located throughout Australia; property/internal funds management, which includes property and facility management, leasing and project management for the trust and all of Co.'s managed investment schemes; external funds management - retail, which at June 30 2016, included nine Co.-managed external retail funds with combined assets under management of A$1.70 billion; external funds management - wholesale, which had combined assets under management of A$5.60 billion as at June 30 2016; and property development.
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