EUR 850.00 For Business Accounts Only

Morningstar | Hotel Property Investments Takes Advantage of Strong Pub Market With Sale of Wickham Hotel

Narrow-moat-rated Hotel Property Investments reported distributable income of AUD 28.6 million, 10% higher than our AUD 26.0 million forecast, despite slightly lower than expected average rental growth across the group’s pub portfolio. We had forecast higher maintenance costs and greater interest expenses in fiscal 2018. We expect maintenance expenditures to tick up again, and the hike in Queensland property tax is a AUD 0.5 million headwind from fiscal 2019 onwards.

We maintain our fair value estimate of AUD 3.40, with the increase in land tax largely offset by the time value of money, with securities screening as undervalued. Hotel Property Investment agreed to sell its Wickham Hotel, with the deal expected to close in September 2019, shaving AUD 0.5 million off rental income in the year. The price tag of AUD 14 million is AUD 2 million, or 16%, above book value and equates to a capitalisation rate of 5.6%. The transaction highlights the unabated demand for pubs and similar relatively small commercial properties. Net tangible assets were AUD 2.79 per security as of June 30, 2018, with our fair value estimate representing a premium of 22%.

The group’s key tenant, Coles, is rumoured to be considering a restructure of its pub operations, which could potentially see it continue operating the liquor stores linked to the pubs’ licences required by Queensland law, but handing over the operatorship of the pubs themselves to a third party. We expect Coles would remain the tenant of the pubs owned by Hotel Property Investment, if a restructure were to be implemented. We estimate Coles’ liquor business accounts for a high-single-digit percentage of its sales and EBIT, and we expect the grocer will remain committed to its liquor business after its demerger from Wesfarmers. Therefore, we expect Coles to exercise its options when leases expire, and we forecast occupancy to remain at 100% in the long term.

We understand the current lease agreements don’t have rent reviews embedded when options are exercised. However, we continue to implicitly account for the risk of a potential restructuring and reset of rents in our base case by assuming all properties are released at market rents when their initial lease expires. We forecast rents are adjusted to around 40% of our estimate of the pub's earnings before interest, tax, depreciation, and rent.

Potential change is not all bad though. A new operator could embark on an investment spree, upgrading the pub network, with the intent of increasing returns. We generally expect more profitable operating businesses to result in better rental outcomes for the landlord over time, in this case Hotel Property Investment.

Near term, we forecast fiscal 2019 distributions of AUD 19.7 cents per security, in line with management’s guidance, and virtually flat on the AUD 19.6 cents distribution paid in fiscal 2018.