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Morningstar | Corporate Action: Decent Acquisition but Don’t Subscribe to GPT’s SPP. See Updated Analyst Note from 19 Jun 2019

Narrow-moat GPT Group is raising equity to buy stakes in office and retail assets in Sydney’s Cockle Bay. The equity that is being raised comprises an AUD 800 million underwritten institutional placement, in addition to a non-underwritten security purchase plan for retail investors capped at AUD 50 million. The placement is priced at AUD 6.07 per security, a 4% discount to the prior closing price. The SPP, which closes on July 15, is priced 2.2% lower at AUD 5.94, because SPP securities won’t be issued in time to receive the midyear distribution. The SPP price is 10% above our unchanged AUD 5.40 fair value estimate and we don't recommend subscribing.

GPT is performing well and management estimates the firm is tracking toward growth in funds from operations per security of 4.5% in 2019, slightly ahead of 4% guidance. However, dilution from the equity that is being raised, sees growth guidance fall to 2.5%. Regardless, management has opted to maintain 4% growth in distributions per security in 2019. FFO will pick up as the proceeds from excess equity, that has been raised, are redeployed into the AUD 1.5 billion developments. We adjust our forecasts for the equity raising and acquisition but the effect on our fair value estimate is immaterial. At current prices, GPT is overvalued.

After GPT exercised pre-emptive rights, it appears to have secured a good deal by buying a 25% stake in the Darling Park 1 and 2 office towers and Cockle Bay Wharf retail and dining complex for AUD 531 million. The assets were bought on a capitalisation rate of 5.04%, comparing favourably with the recent sale of the firm’s 50% stake in the MLC office tower at a cap rate of 4.7%. The Darling Park office towers are almost fully leased, have a weighted average lease of five years and two months, and attractive fixed rental increases of 4% per year.

GPT, including its Wholesale Office Fund’s 50% stake, now controls 75% of Darling Park 1 and 2, and Cockle Bay Wharf. GWOF also owns the Darling Park 3 office tower. This gives the firm considerable influence over the area. Via the acquisition, GPT also gains a 25% stake in a proposed new office tower and retail/dining precinct in Cockle Bay, which could complete around 2025. The development addresses the main issue with Cockle Bay by sitting astride the busy Western Distributor to allow improved pedestrian access between the bay and the CBD.

The equity raising is considerably larger than the acquisition. The balance will reduce net debt initially, and will then be used to move the firm’s mostly office and industrial property development pipeline. Combined with the recent sale of the MLC tower, GPT’s gearing will fall to 21.7% after the equity raising and acquisition, from an already conservative 26.3% in December 2018. We believe the oversized equity raising is a case of management taking advantage of GPT’s strong security price, which has risen more than 30% from lows earlier in the year. Unless another large acquisition is made, GPT shouldn’t need more equity for a few years. We like the firm’s focus on maintaining a strong investment-grade credit rating.

Since December 2018, 71% of GPT’s portfolio has been revalued, resulting in asset values rising 0.7% on average. Retail values decreased because of soft operating conditions while office and industrial values rose. Following the equity raise, net tangible assets per security remains flat at AUD 5.60 versus six months ago.