Dexus (ASX: DXS) is one of the largest real estate property managers in Australia. They have a property portfolio that is valued at $32 billion and that spans across the country. The portfolio consists of Office and Industrial property worth $16.5 billion that Dexus owns outright. Dexus also manages $15.5 billion of Office, Retail, Industrial, and Healthcare properties for third party clients.
There are 3 revenue streams for Dexus. This diversifies them compared to most real estate companies that are listed on the ASX. The revenue streams are:
- Rent & Lease payments from their property portfolio.
- Funds Under Management fee from property management and development for third parties.
- Trading of properties.
Out of the $16.5 billion property portfolio that Dexus owns, $14.2 billion consists of Office properties and only $2.2 billion of Industrial properties. This translates into 86% weightage for Office and 14% towards Industrial. This has raised a red flag during the pandemic as we are witnessing the decline in demand for office properties. Quite a few existing companies have moved to working offline permanently, and new businesses are discouraging office spaces and promoting the work from home culture.
The lease expiry profile of Dexus’ office segment is well below the threshold 13% that the company strives to manage, FY2021 however, has a few key properties that are due to have their leases expire. While there are no red flags in the short-term, the long-term dynamics in terms of growth are restricted in the office segment.
- The occupancy of the Office segment is 96.5% and the weighted average lease expiry is 4.2 years. There has been a decrease in occupancy by 1.5% compared to FY2019. The office portfolio of Dexus has been marginally outperforming the MSCI office index over the past 5 years.
- The occupancy of the Industrial segment is 95.6%, after declining by 1.5% from FY2019. The weighted average lease expiry sits at 4.1 years. Just as the office segment, the industrial segment has also very marginally outperformed the MSCI Industrial Index over the past 5 years.
Dexus has a well-diversified funds management business that provides an annuity style income. The funds under management portfolio consists of:
- $9.1 billion in Office
- $3.3 billion in Retail
- $2.7 billion in Industrial
- $0.4 billion in Healthcare
The segmented revenue that can be seen in the above image shows that the funds management business plays a very small role in the overall revenues that is earned by the group. The Dexus Wholesale Property Fund (DWPF) is the largest fund that Dexus operates with an FUM of $10.3 billion. It is again weighted heavily towards Office by as much as 56%. The remaining is made up of Retail and Industrial to the extent of 33% and 11%, respectively.
The trading segment has delivered profits of $369 million as of FY2020. Dexus has sold interests in 2 properties already in FY2021, despite the real estate asset valuations being low.
- The property on 60 Miller Street, North Sydney was sold in November 2020. The property fetched $273 million in proceeds before transaction costs. The price as announced by Dexus, represents a 3% premium over the book value of the property. The premium of 3% can be attributed towards the property being 97% occupied with a weighted average lease expiry of 3.5 years.
- November 2020 saw Dexus sell another property. Dexus sold 50% interest in Grosvenor Place, Sydney. The net proceeds from the sale are a huge $925 million for just the 50%. The sale price was 5% below the book value of the property and it is attributed to the property being currently vacant and experiencing short-term leasing risk in the asset.
The net proceeds from both these properties are being used to repay the debt that Dexus holds on its balance sheet.
The Covid19 crash in March 2020 came as a very harsh reality check for the property segment. Since then, Dexus has failed to recover and the performance has lagged behind the broader ASX-200 index (orange line) and even the ASX 200 Property Fund (blue line) – which consists of the top real estate firms listed on the ASX. The massive underperformance is due to the heavy reliance that Dexus places on the office segment. Compared to the other real estate segments, the office segment faces a rockier and longer road to recovery, as the structural dynamics following the pandemic has changed. Office space demand is set to decline. While it may take longer for brick-and-mortar firms to completely shift to work from home, the growth in demand for office real estate is often led by new firms/start-ups that pop-up. There has been a rising trend in work from home adoption among start-ups and it is estimated to continue as investors are weary of the increased costs that can be avoided.
Financially, Dexus has looked stable right up until now. Despite the impacts of the pandemic, Dexus has collected 98% of their cash collections. Revenues in FY2020 grew 11% in FY2020 after a few flat years with negative growth in revenues. EBITDA, however, has declined. The EBITDA margins have dropped from 75.4% to 65.1% – a worrying sign for a firm that has just 3 main costs – property management, funds management and corporate costs.
The decline in EBITDA in FY2020 is due to the 90% hike in property expenses. New funds, acquisitions and development completions have played a role in the increase in costs. Finance costs have also increased due to the cessation of capitalising interest at Dexus’ development projects.
As of FY2020, Dexus had $31.8 million in cash on their balance sheet. The total debt the firm has was $4.9 billion. The high level of debt is a common theme that can be seen among firms in the real estate segment. The long-term financial health of Dexus is secure though. The total assets come in at over $17.5 billion and it exceeds the total liabilities by 3.2x, which comes in at $5.5 billion. Most of the asset value is coming from the long-term properties that the firm owns, and with short-term liquidity being in question, the markets have punished Dexus. The capital structure of the firm as of 30th June 2020 shows – 71% equity capitalisation and 29% debt capitalisation.
The debt maturity profile snapshot that is seen in the below image is as of FY2020. With the new proceeds from the sale of a couple of assets we mentioned earlier, and the 98% collection in rent offsets the short-term risk for the next couple of years.
Trading profits are already in place for FY2021 and FY2022. Dexus has already entered into agreements for the sale of a few assets in the next couple of years, and the expectation is that Dexus will generate about $85 million over the course of the next two years.
The development pipeline of Dexus group is fairly large. They have $10.6 billion in the pipeline, however, only $1 billion has been committed as of now, out of which Dexus share is believed to be $500 million. The remaining spend for the fulfillment of these projects is $180 million. These committed properties consist of 3 city projects and an industrial property in Ravenhall. The uncommitted projects all look to be in the city – spread across Brisbane, Sydney, Melbourne, and Perth.
Dividends have been a big part of why investors hold Dexus shares. The payout ratio in FY2020 was 55%, as the firm maintained its 50 cents annual dividend even though their EPS declined. The dividends in FY2021 were in question given the impact of the pandemic. However, the firm has announced that they expect to continue with their current dividend policy with an aim to payout 50 cents over the course of the year. The most recent dividend was 28.8 cents on the record date was the 31st of December.
Dexus has trailed the performance of the index and its segment. Its reliance on the office real estate vertical has headwinds coming its way in the medium to long-term. The financial health of the firm is secure, but their revenue growth will decline over the next few years. The stock looks rightly priced and we expect it to underperform both – the index and segment going forward. We issue a “Hold” recommendation to members who already have positions in Dexus, given its high dividend yield.