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Morningstar | Good Times Roll for Growthpoint But Little Value at Current Levels. FVE Increases to AUD 3.30

Growthpoint reported first-half fiscal 2019 earnings on a funds from operations, or FFO, basis of AUD 12.5 cents per security, or cps, unchanged on the previous corresponding period. Guidance was retained for fiscal 2019 FFO of at least AUD 24.8 cps and distributions of AUD 23 cps. Factoring outgoings for tenant incentives and maintenance capital expenditure (that hit the cashflow statement but not the income statement) gives us adjusted funds from operations, or AFFO, a proxy for the underlying cash generated by the operating business. We forecast fiscal 2019 AFFO of AUD 19.4 cps, roughly 18% below distributions, which will see Growthpoint continuing to borrow to pay distributions for the year. Growthpoint is one of a few remaining Australian REITs that pay distribution above AFFO, and we’d prefer distributions around 100% of AFFO. Low borrowing costs, high occupancy and rising asset values are all conducive to paying distributions above AFFO. However, the strong economic tailwinds and supportive monetary and fiscal policies shouldn’t be banked on to persist forever.

We’ve increased our fair value estimate to AUD 3.30, with most of the upside coming from recently announced developments in Richmond, Melbourne and expansion of a Woolworths distribution centre in South Australia. Our fair value estimate represents a discount of 2% to December 2018 net tangible assets per security of AUD 3.36. With securities in no-moat-rated Growthpoint trading around AUD 4.10, the firm continues to screen as overvalued.

The core portfolio is performing solidly, with net property income up 2.7% for the office assets and 3.9% for the industrial assets, or 3.1% on a blended basis. These metrics don’t tell the full story as rents across the industrial portfolio are 6.3% above market rates, pointing to a moderation in rent growth in outer years or the need to pay significant tenant incentives. Rents for the office portfolio are similarly 6.8% above market rates, but management attribute most of this to the New South Wales Police Headquarters in Parramatta, where the lease has a further six years to run. With strong organic rent growth occurring in Parramatta, its likely this under-renting will further narrow going forward.

The major upcoming change in the portfolio is Growthpoint’s AUD 57 million investment to expand its distribution centre in Gepps Cross, South Australia leased to Woolworths. A new 15-year lease will be put in place post the redevelopment works, with a yield on incremental cost of 6.75%. The new lease will contain fixed annual rental increases of 2.5%, below that of the broader industrial portfolio. As part of this transaction Growthpoint has agreed to an early surrender of the Woolworths lease at its Broadmeadows distribution centre on the city fringe of Melbourne. If Woolworths depart 1.5 years early as indicated, rental income foregone will approximate AUD 7.5 million. The Broadmeadows site at 120 Northcorp Boulevard is a large asset, representing AUD 73 million or 1.9% of Growthpoint’s AUD 3.8 billion office and industrial portfolio. The Broadmeadows site is extremely large and close to major transport links which provide plenty of repositioning opportunities. However, land availability is high in the area, pointing to a lengthy period of downtime between departure of Woolworths and securing a new tenant or potentially a sale. In a worst-case scenario, we estimate the valuation loss from departure of Woolworths at AUD 10 million, which is immaterial in the scheme of the broader business.