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Date : 05/07/2023

Charter Hall Long WALE REIT

ASX :

CLW

Market Cap : $2.92 Billion

Dividend Per Share : $0.28

Dividend Yield : 6.85 %

Buy

52 Week Range : $3.840 - $4.775

Share Price : $4.09

In addition to the lucrative dividends, CLW is trading ~38% off its NTA value. We recommend a 'Buy.'

Company Analysis

REITs are one of the simplest business models to understand. In this case, Charter Hall owns and manages a diversified portfolio of real estate properties. These properties generate rental income and a steady stream of cashflows – allowing investors to passively invest in real estate without being directly involved in property management.

Charter Hall Long WALE REIT (ASX: CLW) is Australia’s largest diversified Long WALE REIT and is one of the top 10 Australian real estate investment trusts listed on the ASX. It has a diverse portfolio of high-quality properties across core sectors – Office, Industrial & Logistics, Retail and Social Infrastructure. It is actively managed to grow the portfolio through investments across multiple real estate sectors. CLW has a history of outperformance against relative benchmarks and, in the five years ending 30 June 2022, has delivered an annualised total security holder return of 7.3% per annum. This compares favourably to the 4.4% annualised return from the S&P ASX200 (GICS) Property Accumulation index over the same period.

As of June 2023, CLW’s portfolio comprised 549 properties valued at $6.8 billion. The recent valuations have resulted in a decrease in the value of its portfolio by $419 million or 5.8% – a consequence of the interest rate hikes on the real estate market. These valuations have also resulted in an estimated (unaudited) decrease in the NTA (Net Tangible Asset) per security from $6.23 on 31 December 2022 to $5.65, reflecting a $0.58 or 9.3% decrease.

REITs have been sold off in the past year, primarily because they have an inverse relationship with interest rates. CLW shares are down by ~9% in 2023. However, given the sell-off, the strength and diversity of its portfolio, and the dividends on offer, we think this is the time to get back into REITs. Regarding monetary policy, we are approaching closer to the end of the interest rate hiking cycle. As such, we think current prices are attractive for long-term investors.


Source: Tradingview.com

What makes CLW High Quality?

Certain characterises of CLW stand out and de-risk the investment, such as a deliberate focus on resilience through long leases to high-quality tenants operating in predominantly non-discretionary industries.

  • CLW has a Long WALE (Weighted Average Lease Expiry) of 11.8 years. It represents the average length of time remaining until the leases on the properties in the portfolio expire. The long Wale reduces risk and provides income security.
  • 99% of CLW’s tenants are Governments and blue-chip companies that are ASX-listed multinationals, such as Telstra, Endeavour Group. In fact, CLW says that 6.1% of their distribution yield is generated from these blue-chip clients – indicating low-risk distributions despite the challenging operating environment.
  • CLW can drive income growth through annual rent increases across all its leases. 50% of the leases are linked to CPI, with a 7.2% weighted average increase in FY23; the other 50% have an average fixed increase of 3.1%. This blend of exposure to CPI-linked and fixed annual rental increases provides a growing rental stream for investors and resilience in both low and high-inflation scenarios.
  • The investment strategy of this REIT focuses on tenants from defensive industries. Government, Pubs & Bottle Shops, Telecom, Fuel & Convenience, Grocery, Food Manufacturing, and Waste Management make up the bulk of the portfolio of up to 82%.


Source: CLW

Charter Hall’s Active Management is a Strength

Portfolio curation remains a key strength of the Charter Hall platform. During 1H FY23, CLW completed $112 million of divestments and $105 million of income-enhancing property acquisitions, which contributed to improving portfolio quality, sector diversification and lengthening the portfolio WALE. Recent portfolio movements include:

Acquisitions:

$90.9 million acquisition of Geosciences Australia headquarters, a life sciences complex comprising an office, specialised laboratory, storage, and warehousing for the Commonwealth Government’s technical adviser on all geoscience, geographical and geological matters. Geosciences was acquired in October 2022 on a 7.4% initial yield with a 9.6-year WALE at acquisition and 3% annual rent increases, and a net lease structure where the tenant is responsible for all property outgoings.

$14 million acquisition of two Endeavour Group leased pubs; the Emu Hotel, SA and the Horse & Jockey, QLD. Acquired on a blended 4.8% cap rate, both pubs have new 15-year, CPI-linked leases, further extending CLW’s relationship with Endeavour Group.

Divestments:

$74 million divestment of Woolworths Distribution Centre, Hoppers Crossing, VIC, at the prevailing book value with a 4.50% cap rate and a 3-year lease term remaining.

$38.3 million divestment of Toll Distribution Facility, Altona North, VIC, at the prevailing book value with a 4.75% cap rate and a 2.9-year lease term remaining.

1H FY23 property valuations resulted in a net uplift of $65 million over initial book values. The valuation uplift was predominantly driven by properties with uncapped CPI-linked annual rent reviews in the Long WALE Retail, and Industrial & Logistics sectors. However, as stated earlier, valuations have decreased as of June 2023 by $419 million or 5.8%. As we approach what looks to be the tail end of the rate hiking cycle, we can start to see these valuations stabilise and once again begin their ascendency as the operating environment improves in 2024.

Investment Thesis

Despite the interest rate hikes and challenging operating environment, CLW’s 1H23 results were in line with market expectations.

Net property income increased by 16.9%, driven by like-for-like rental growth of 4.1%, with the balance driven by acquisition activity. Operating expenses increased by 20% due to portfolio growth and new acquisitions. Higher interest rates predominantly drove the increase in finance costs. We can expect these high finance costs to remain in full-year FY23 earnings and start to decrease once interest rates begin to come down in 2024.

Operating Earnings increased 3.5% to $101.2 million. Ultimately, CLW delivered an Operating EPS of 14 cents per security, down 8.6% but in line with guidance. The reason for the decline in EPS is the interest expense going up from $24m to $41m as interest rate hikes took effect. CLW paid out 100% of its Operating EPS as dividends during 1H23, 8.1% lower than the pcp.


Source: CLW

Gearing is well within Target Range

The Balance Sheet of CLW is fairly strong. While the gearing level may raise eyebrows at first glance, it is synonymous with REIT business models. It is a capital-intensive industry and by using debt, REITs can increase their purchasing power and accelerate their growth. This is also one of the contributing factors to REITs being inversely proportional to interest rates.

CLW’s gearing is 30.2%, at the mid-point of its 25-35% target range. Just like 1H23, we can expect interest rate hikes to further dent earnings and distributions as CLW operates through a period of high-interest rates. However, this is well known and has been priced into the share price.

During 1H FY23, CLW refinanced and extended the syndicated debt facility for the bp Australia portfolio by four years. CLW’s share of this facility is $225 million. CLW has a weighted average debt maturity of 5.0 years with staggered maturities over a nine-year period from FY24 to FY32. With the exception of an $85 million capital-indexed bond maturing in FY24, CLW has no other debt expiries until FY27.

CLW’s drawn debt is 74% hedged with a weighted average hedge maturity of 2.6 years. The firm also has $349 million of cash and undrawn debt as of 31 December 2022, shoring up its balance sheet.

Outlook – Dividends to Remain High

CLW’s 30% gearing means it is susceptible to the effects of rising interest rates. The market appears to have accounted for this risk, as the stock is currently trading well below its NTA value of $5.65 per share.

The primary risk we currently observe is the potential increase in interest rates. This can affect dividends by raising the debt cost and impacting property values. In a rising interest rate environment, we would typically exercise caution when considering a REIT with high gearing levels. However, in the case of CLW, we find reassurance in its long weighted average lease expiry of 12 years, its significant government and large corporate tenant base, and the robust management track record that Charter Hall has demonstrated. The lucrative dividends also make for a compelling case.

It is worth noting that across the 5 sectors that CLW’s clients come from, 4 boast a 100% occupancy rate, while the Office sector sits at 99.7%. This takes the weighted average occupancy to 99.9%.

CLW’s management has reaffirmed its operating EPS and dividend guidance for FY23 at 28 cents per share, representing an 8% decrease compared to FY22 (30.5 cents per share) due to the impact of rising interest rates. At current prices, the 28 cents dividend means an FY23 forward dividend yield of 6.8%. CLW pays dividends 4 times a year, with the next expected to be another 7 cents which will be announced during FY23 full-year results.


Source: asx.com.au

CLW Trades at a Discount to its NTA Value

About 50% of CLW’s leases are linked to Consumer Price Index (CPI) reviews, which should contribute to a growth of approximately 7% in FY23 due to high inflation. This growth is expected to partially offset the high-interest costs. While the primary risk remains the high-interest rates, impacting dividends and property values, we believe the market has already priced these risks into CLW’s stock.

CLW had an NTA per security of $6.23, reflecting an increase of 1.0% from $6.17 in June 2022. The movement was primarily driven by a net property valuation uplift of $65 million during the period. However, since then, the new unaudited valuations have had an impact on the NTA – bringing it down by 9.3% to $5.62. At current prices, CLW still trades at a considerable discount of more than 38% to its NTA.

Why does this matter? It indicates that the market is valuing the REIT at a discount to the underlying value of its assets. The NTA per security represents the estimated net value of the REIT’s assets, such as properties minus liabilities, divided by the number of outstanding securities. We think this discount accounts for the risks ahead and offers long-term investors a significant value proposition. Additionally, CLW’s dividend yield of 6.8% is highly attractive.

To summarise, while CLW may face challenges due to rising interest rates, its favourable characteristics, such as a long weighted average lease expiry, high occupancy rate, and strong management by Charter Hall, position the company well to navigate the current environment and maintain an attractive and sustainable dividend yield of over 6%.

For FY24, market expectations are for revenues to increase by 4% and Operating EPS to return to growth by growing around 1.8%. The consensus is pricing in an EPS of 28.50 cents a share for FY24, which would mean that dividends will remain around the 28 cents per share range – bringing the FY24 implied dividend yield to 6.9% based on the current stock price of around $4.09.

As we move away from the interest rate hikes and an eventual lowering of interest rates in 2024 and beyond (based on market expectations), we can expect property valuations to turn positive once again and the NTA to increase. This will reduce CLW’s interest expenses and boost operating earnings and, as a result, dividends. Easing operating conditions will also boost share price performance, given its relationship with interest rates. With this bigger picture in mind, we think CLW offers fantastic value at current prices, and its lucrative dividends are the icing on the cake, even in the short term.

Recommendation

REITs have experienced a decline in value over the past year due to their inverse relationship with interest rates. However, amidst this market turbulence, Charter Hall Long Wale REIT stands out as a high-quality REIT with strong characteristics. The company has secured blue-chip tenants who have committed to long lease agreements, resulting in a remarkable occupancy rate of 99.9% and a promising outlook for income growth.

Notably, 50% of CLW’s leases are linked to CPI, which is anticipated to generate approximately 7% income growth. The remaining leases have a solid average fixed increase of 3.1%. This combination of CPI linkage and fixed increases ensures stability in earnings and dividends despite the cycle. With four dividends paid annually, CLW currently offers an attractive yield of 6.8%.

Furthermore, CLW’s gearing is within the target range, indicating a prudent approach to leverage. According to consensus estimates, the stock is trading with an implied dividend yield of approximately 6.9% for FY24. CLW is currently trading at a substantial discount of ~38% compared to its Net Tangible Asset (NTA) per security. This suggests that the market has factored in the associated risks from interest rate hikes. As the operating environment gradually improves, we anticipate a potential rebound in CLW’s share price towards its NTA. Considering these factors, we believe that current prices present a compelling opportunity for long-term investors. As such, we recommend a ‘Buy.’

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