EUR 850.00 For Business Accounts Only

Morningstar | GPT Group’s Retail Sales Strong but Not Across the Board. FVE Unchanged at AUD 5.10. See Updated Analyst Note from 29 Oct 2018

GPT issued a minor upgrade to guided growth for 2018 distributions and funds from operations, or FFO, to 3.5% from 3.0% previously. The upgrade was mostly due to incremental income from the purchase of the Eclipse office tower in Paramatta (acquired for AUD 288 million in September) and stronger-than-anticipated income from the office and industrial portfolio. Following minor forecast revisions, we retain our AUD 5.10 fair value estimate, with narrow-moat-rated GPT Group screening as fairly valued, currently trading around AUD 5.20.

The AUD 6.3 billion of retail shopping centres at 47% of property assets are performing slightly ahead of expectations at a headline level, with comparable specialty retail sales up 5.4% over the 12 months to end September. The strongest contributor was technology and appliances category, with sales up 16.8%. Total centre sales growth was weaker at 3.4% dragged down by the 0.3% sales growth for supermarkets, 2.4% decline for discount department stores and 2.3% decline by department stores. Specialty sales data illustrates a massive evolution in consumer spending patterns is underway. Traditional stalwarts of apparel, jewelery stores were both weak, with sales down 0.4% and 7.8%, respectively. The retail services category that grew by 10.7% over 2017 was surprisingly weak, comparable sales down 4% over the 12 months to end September.

A second evolution in malls is the shift in sales towards larger specialty retailers, many of which are international brands. Sales for all specialties were up 4.4% in the year to June 2018, but the heavy lifting was done by the larger specialties (stores over 400 square metres) where sales rose 12.8% rather than the smaller specialty retailers whose sales grew just 1.7%. The problem with this evolution is the larger stores reason their strong customer pulling power can negotiate lower average rents, which will weigh on the longer-term rent growth trajectory.

We continue to remain cautious on the outlook for retail rents as we think Australian households will struggle to increase their spending on discretionary items. Major pressure points that loom large are rising mortgage rates, higher fuel prices and slowing wages growth. The fact the Australian household savings rate is now around 1%--a 10-year low--points to limited capacity to loosen the purse strings. The higher quality of GPT Group’s retail portfolio means sales and rents are likely to outperform the broader retail market, but we still see economic pressures leading to a slowdown in retail sales and rents. Our central scenario is for retail rents growth to average 2.3% over the coming decade, materially below the 4.7% fixed escalation implicit in many specialty leases.

The AUD 5.4 billion office portfolio at 40% of rent generating assets continues to perform solidly, with 97.5% occupancy and high weighting to Sydney and Melbourne at 60% and 30%, respectively. Barring a major economic shock, rental growth prospects look very strong in these two markets over the coming two years reflecting low levels of vacancy and solid demand. That said, we think rents are consistent with peak market conditions and market rental growth to slow significantly from 2021 when new building complete. However, as most office leases contain fixed annual rental increases of 3% to 4%, overall rents should continue to rise, albeit at a slow rate.

Separately, we remain very cautious around the resilience and quality of tenancies, as an increasing portion of the rental role is composed of smaller startup businesses. We have heard many landlords trumpet the benefit of numerous smaller tenancies who pay higher average rents and provide greater income diversity. We do not share this view as many smaller tenancies, particularly technology startups, are higher rental risk reflecting their weak balance sheets and negligible operating cash flow. When the next economic downturn comes around, we foresee a high proportion of these smaller tenancies will face financial stress and by extension office market occupancy and rents could suffer more than in previous periods of economic contraction. It would seem the next recession (when it comes), will be particularly severe given the elevated indebtedness across households and government.