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Morningstar | GPT Yet to Solve Headache of Downward Pressure on Retail Rents. FVE Unchanged at AUD 5.40

GPT Group’s first-quarter operational update confirms our view of a challenged environment for retail property landlords. Total sales for tenants in the shopping centre portfolio were up only 1.3% in the year to end March, pointing to a significant slowing on the 2.4% growth for the year to December 2018. For the high rent-paying specialty tenants, operating performance was similarly weak. Trailing 12-month specialty sales growth was 1.9% at end March, versus 3.6% at end December 2018. Prepared comments from GPT that retail conditions remain subdued is quite an understatement, as it appears Australian households have significantly tightened the purse strings over the past three months. Against this backdrop of slowing sales, we don’t see GPT or other landlords orchestrating a rebound in rent growth. We’ve been factoring a soft outlook for retail rents in our forecasts for some time and continue to forecast rents rising by 2.3% over the longer term. This is roughly half the average fixed increase of 4.7% GPT has been negotiating on recently finalised retail leases. However, having a swag of leases with high fixed annual increases doesn’t tell the full story as to achieve this GPT needs to separately pay large inducements, or tenant incentives. In 2018, tenant incentives across the office, retail and industrial portfolio were AUD 61 million, equivalent to 10.6% of net rental EBIT.

We’ve left our fair value estimate for narrow-moat GPT unchanged at AUD 5.40 with the firm screening as overvalued, currently trading around AUD 5.85. GPT reiterated 2019 guidance for 4% growth in funds from operations and dividends per security. Our forecasts are unchanged and align with company guidance.

Retail sales performance was mixed across categories, the standouts were food retail and technology where comparable sales rose by over 8%. The specialty categories posting the weakest sales were jewelery, down 10.5% and fashion, down 3.7%. These categories have undoubtedly been impacted by the rotation in consumer spending to online retailers. The trouble for GPT and peers is these legacy categories have traditionally paid high rents per square metre, and any new replacement tenants are likely to have lower rent-paying capability. The rotation in tenant mix away from traditional high rent-paying categories to categories paying lower rents is a major reason why we forecast a significant moderation in long-term growth in retail rents.

The portfolio of warehouse or logistics assets is performing in line with expectations with March occupancy at 94.4% down slightly on the 97.2% at December 2018. Logistics as an asset class has delivered exceptionally strong performance over the past two years as asset values have been buoyed by falling long-term bond yields and a surge in rents, mostly driven by strong demand for tenants for modern and technologically enabled storage facilities. We view the broader logistics market as overvalued with Australian assets trading on yields around 5% an all-time low. Given the majority of logistics assets are in city fringe areas where land is reasonably plentiful, we foresee valuation multiples for these assets easing in the coming few years as new supply comes to market and Australian economic conditions weaken.