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Charter Hall Group (ASX: CHC)

1H24 Earnings Analysis – 23rd February 2024

Charter Hall Group (ASX: CHC) delivered 1H24 results largely in line with expectations. There was more evidence that the property devaluation cycle has bottomed out. At the end of the period, the Property Investment portfolio value was $2.8 billion, which is 4% of the Group’s property platform of approximately $68 billion.

The earnings resilience and diversification of the Property Investment portfolio continue to remain a key strength for CHC, combined with a high-quality tenant covenant profile. No single asset represents more than 4% of portfolio investments. Government covenants are the largest tenant exposure and makeup 24% of portfolio income, whilst 20% of net income is derived from leases with CPI-linked rent reviews complementing market rent reviews, fixed annual rent escalations, and turnover growth-driven rental increases.

Portfolio occupancy remains healthy with a 97.0% occupancy rate, Weighted Average Lease Expiry (WALE) of 7.3 years, and the Weighted Average Rent Review (WARR) is an attractive 3.5%, whilst the cap rate has risen 65 bps to 5.24% over the past 12 months.

Charter Hall reported operating earnings post-tax of $195.1 million, compared to $239.9 million in the previous corresponding period, a decrease of 18.7%. Operating earnings is a financial measure that represents statutory profit after tax adjusted for accounting items. Operating earnings are used by the Board to make strategic decisions and to pay out dividends. Operating earnings per security (OEPS) post-tax was 41.2 cents per security (cps). Statutory earnings came in at -$190.0 million, compared to a profit of $226.5 million for the half year ended 31st December 2022.

Based on operating earnings, Charter Hall has a Return on Contributed Equity of 21.4%. Distributions per security was 22.1 cps, which was conveyed earlier. There has been consistent DPS growth of 6.0% from FY19 to FY24. Based on the OEPS of 41.2 cents and the 22.1 cps dividends, CHC is paying out 53% of it as dividends. The ex-dividend date for the dividend was 28th December 2023, and it will be paid out on 29th February 2024.


Source: CHC

Property Investment Segment

Property investment provides the Charter Hall Group with yields from its co-investments in Group funds. During the half year, property investment contributed $71.2 million (31st December 2022: $66.5 million) in segment earnings to the Group. CHC’s property investments are classified into the following real estate sectors:

  • Industrial & Logistics
  • Convenience Net Lease Retail
  • Office
  • Social Infrastructure
  • Shopping Centre Retail and
  • Diversified (such as the Long WALE REIT)

The property investment portfolio was valued at $2.8 billion as of 31st December 2023. CHC has 1637 properties with a combined WALE of 7.3 years and a 97% occupancy rate. Most of their properties are located in NSW (39%) and Victoria (23%), followed by Queensland (18%). The other states make up single digits each.

There have been net investments of $108m since June 2023. The entire investment portfolio has a 4.5-year CAGR of ~9.0% per annum. In an effort to not pile on more debt, retained earnings are driving co-investments and supporting new fund creations.

Earnings from this segment are extremely resilient given Charter Hall’s tenant strength, which we touched on earlier and in extensively in past coverage. EBITDA increased by 7% as a result of increased investment activity.

Funds Management

Group FUM reduced by $4.8 billion to $82.6 billion, consisting of $67.7 billion of Property FUM and $14.9 billion of Paradice Investment Management (PIM) FUM. Property FUM contracted by $4.2 billion, driven by net divestments of $0.4 billion, devaluations of $3.5 billion, capex spend of $0.6 billion, and development commitment re-classifications of $0.8 billion.


Source: CHC

Charter Hall said that its $0.9 billion of gross equity inflows during the period comprised inflows of $249 million in Wholesale Pooled Funds, $552 million in Wholesale Partnerships, $6 million in Listed Funds and $65 million in Direct managed funds. Outflows impacting net inflows were predominantly driven by secondary unit sales in pooled funds, where selling demand was met by inflows from existing and new investors.

Unlike a typical fund management business, with Charter Hall, investors cannot pull out their money as they desire. There are redemption terms that are set in place to align investors with the fact that real estate is large and illiquid. Investors typically have redemption windows every 5-7 years, depending on the fund, and this makes Charter Hall’s FUMs sticky. Sticky FUMs mean more predictable management fees and higher chances of performance fees.

On the earnings front, funds management revenue increased 2%. However, transaction and performance revenue declined 83%, resulting in an EBITDA of $159.3m from the segment. This was already priced in. Property, facilities, and project management revenue increased by 25.6%, reflecting increased development activity. The development revenue uplift reflects strong activity levels and is a positive sign.

Operating expenses were reduced, reflecting strong cost control, albeit CHC has said that they are expected to increase in 2H24. EBITDA margin (excluding transaction and performance revenue) expanded to 68.2%, driven by operational efficiencies.

Property Sector Outlook by Segment

As for what lies ahead, the overall property market outlook is positive. The Australian real estate market is expected to see continued growth in 2024, albeit at a slower pace than the previous year. This is supported by factors like easing inflation, increased buyer confidence, and potential interest rate cuts. However, it’s important to note that the market is fragmented, with different segments experiencing varying performance.

Industrial & Logistics has the strongest outlook. This segment is likely to be the strongest performer due to continued e-commerce growth, rising demand for warehouse space, and limited supply. Rental growth is expected to remain strong, attracting investors.

Convenience Net Lease Retail is positioned to benefit from essential services and a defensive nature, providing stable income streams. With rate cuts on the horizon, tenant affordability will rise, and therefore, it has a positive outlook.

The office is the most under pressure. The outlook is mixed as the future of office space is uncertain due to hybrid work models. While some cities like Brisbane and Melbourne show positive signs, others like Perth and Adelaide might face challenges. But Charter Hall is best positioned among its peers in the office segment. The national average for office space occupancy is just 84.5%. However, Charter Hall’s office space occupancy sits at 95.6%. Their buildings are also well-located, newer, and environmentally friendly. Thus, the company has been able to retain its tenants and wrap up new leases with ease. The negative sentiment on CHC’s office segment is quite overblown as more than two-thirds of Charter Hall’s FUM sits outside the office segment.

Social Infrastructure has the highest WALE among CHC’s portfolio. In the medium to long term, government investment in infrastructure projects is expected to drive growth in this segment. Healthcare and education facilities are likely to see strong demand.

Shopping Centre Retail is facing some challenges. Traditional shopping centres face competition from online retail and changing consumer preferences. However, well-located centres with mixed-use offerings are still attracting investment. Our shopping centre traffic has held up better than most developed countries. We expect it to be flat in 2024.

Development activity and pipeline

Development activity drives modern asset creation, enhancing returns, which continues to attract new capital to CHC’s funds. This is the business model. Development completions totalled $3.0 billion in the last 12 months. Notwithstanding completions, the pipeline continues to be re-stocked and is currently $12.8 billion with $5.0 billion in committed development project value.

The Group continues to use its cross-sector tenant relationships and the scale of its portfolio to create development opportunities. During the period, CHC successfully completed the 480 Swan St, Melbourne office development, predominantly leased on completion to Australia Post. Development activity is predominantly undertaken by funds/partnerships, with the majority of committed projects being de-risked through pre-leases and fixed-price building contracts. 91% of Industrial committed projects and 66% of Office committed projects are pre-leased. This ensures revenue certainty.

The office segment is where Charter Hall’s competitive advantage lies. In a segment that is shrinking and under pressure, CHC stands to dominate a reduced market with new buildings that are well located. Charter Hall is investing in that outlook, and they announced that it had commenced main works construction at its new $1.8 billion Chifley South development in the core business precinct of Sydney CBD. When the tide in the office segment turns, older buildings will get left behind, and the newer, higher-quality buildings will see heightened demand, boosting rents.

During the period, the Group completed $9.2 billion in new and refinanced debt facilities across the Platform. Platform facility limits exceed $29.6 billion, with circa $6.0 billion of available liquidity with additional committed and uncalled equity. The Group balance sheet is strong, with $401 million of cash as of 31st December 2023 and low balance sheet gearing of 2.4%. CHC has an investment capacity of $701 million available for fund creation and growth opportunities.

Outlook

Based on no material adverse change in current market conditions, Charter Hall reconfirms that FY24 earnings guidance is for post-tax operating earnings per security of approximately 75cps. FY24 distribution per security guidance is for 6% growth over FY23. This means the expected FY24 final dividend is around 23.05 cps. At current prices of ~$11.80, this is an implied dividend yield of 3.8%.

As for the share price, it remains under pressure due to the high-interest rate environment. REITs and, by extension, REIT fund managers have been sold off in the past year, primarily because they have an inverse relationship with interest rates.

When interest rates skyrocketed, so did bond yields. The Australian 10-year Government Bond currently has a yield of 4.5%. This has made CHC unattractive by reducing the value of the assets that it manages and charges fees on. As such, it has put the share price under pressure. Investors also hit the brakes on buying and selling in this sector, hesitant to lock their money into long-term investments that they might not easily sell if asset prices drop soon. This posed a challenge for Charter Hall, which relies on this activity to grow their investment portfolio (FUM) and, ultimately, its profits.

But with interest rates having peaked and rate cuts now in sight, the pressure will be relieved. We are likely to see transaction activity return in 2024 and allow CHC to reduce devaluations in its FUM. Ultimately, it should take the lid off the share price. In order to catch this wave, investors need to be already positioned.

Recommendation

Charter Hall announced a 1H24 result that was largely in line with expectations. FY24 guidance has been maintained, which will see another 6% growth in dividends. We can expect a final dividend of 23.05 cps in addition to the 22.1 interim dividend.

During the period, funds under management fell by $4.8 billion to $82.6 billion. Within that total, its pool of property funds contracted by $4.2 billion to $67.7 billion, mostly due to devaluations of $3.5 billion. As interest rates are cut in 2024, the pressure on valuations should start to ease, and it will also support a busier real estate market, benefitting Charter Hall. It should also support a recovery in sentiment in the sector, which will eventually lead to a significant Operating EPS recovery and re-rating of the share price.

Thus, with reliable dividends and potential share price gains on the table, we maintain a ‘Buy’ recommendation.

Technical Analysis

When we recommended CHC previously, it was looking weak just below the level at $11.80. However, it never had a proper sell down, and it has now regained the $11.80 level.

The short-term downside risk seems to have abated, but without a clear catalyst there’s no reason for it to shoot the lights out in the very short-term either. But we are in this one as a dividend play, not for massive growth.

If a bullish catalyst does emerge the stock has room to run up to the strong resistance at $15.30

CHC is a good pick for the long term. Think 5-10 years or longer. We’re looking for the long hold here. It’s a safer income play, and we’re not expecting a 10X return. Buy up to $11.65 and sell above $14.50.

Source: TradingView / Shares in Value

 

 

Charter Hall Group (ASX: CHC) – Initiation – High Conviction Buys – 21st January 2024

Who is Charter Hall Group?

Charter Hall Group is a diversified property fund manager and developer managing a suite of institutional, wholesale and retail unlisted property funds in which it holds investments. The funds are diversified across the office, retail, industrial and residential sectors. They generate revenue through their fund management business by way of application and performance fees and through their investments in the properties themselves.

REITs and, by extension, REIT fund managers have been sold off in the past year, primarily because they have an inverse relationship with interest rates. CHC shares are down -15% in the past 1 year. 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, with inflation coming down, rate cuts are expected to begin in the first half of 2024. This will lift the lid on property valuations, and as such, we think current prices are attractive for long-term investors.

Charter Hall, being a high-quality property manager, has historically exhibited strong fund growth and an ability to attract large sums of capital inflow from investors such as superannuation funds and sovereign funds that are looking to gain exposure to the arguably bulletproof Australian property sector.

Good Properties, great Funds Management

Charter Hall boasts occupancy rates of 97%, an 89% leasing retention rate, and a high-quality tenant base such as the Australian Government and blue-chip companies. The top 20 tenants represent more than half of the total income. This makes their income stream highly reliable.

No single asset represents more than 4% of portfolio investments. Government covenants are the largest tenant exposure and makeup 23% of portfolio income, while 18% of net income is derived from leases with CPI-linked rent reviews – guarding against inflation and ensuring slow but steady rent revisions. CHC’s Weighted Average Lease Expiry (WALE) is healthy at 7.4 years, and the Weighted Average Rent Review (WARR) is 3.6% per annum.

Even the office segment, which has been under pressure globally due to the adoption of work-from-home, is better placed than its peers. The national average for office space occupancy is just 85%. However, Charter Hall’s office space occupancy sits at 96.3%. Their buildings are well-located, newer, and environmentally friendly. Thus, the company has been able to retain its tenants and wrap up new leases with ease.

In FY23, Group FUM grew by $7.5 billion to $87.4 billion. Unlike a typical fund management business, with Charter Hall, investors cannot pull out their money as they desire. There are redemption terms that are set in place to align investors with the fact that real estate is large and illiquid. Investors typically have redemption windows every 5-7 years, depending on the fund, and this makes Charter Hall’s FUMs sticky. Sticky FUMs mean more predictable management fees and higher chances of performance fees.

How to play Charter Hall?

Charter Hall has $3.0 billion co-invested in its own funds. So, its property Investment portfolio provides a strong alignment of interest with its investor customers. This is a similar trait to the management holding high equity stakes in a business.

FY24 guidance is for post-tax Operating EPS of approximately 75 cents. FY24 distribution per security guidance is for 6% growth over FY23. This means we can expect ~46.3 cps in dividends in FY24 – translating into a forward dividend yield of 4.13% at current price levels.

In addition to the dividends on offer, we believe Charter Hall is undervalued. The company has kept a lid on its costs and managed to increase its EBIT margins. FUMs continue to grow, and so will management fees. Interest rates are forecasted to begin coming down this year, which will certainly boost property valuations and the overall value of Charter Hall’s portfolio. The company’s balance sheet is exceptionally strong, and it maintains the lowest balance sheet gearing in the AREIT sector at 2.2% and has $600 million of liquidity available.

The overall sentiment on REITs is low due to the macroeconomic backdrop. However, with interest rate cuts now on the horizon, Charter Hall Group’s 14x FY24 P/E looks modest. CHC’s occupancy rates give it resilience, its office segment is much better positioned than its peers, and the funds management business continues to attract inflows. We can expect a re-rating to transpire as property valuations are boosted and interest rates fall in 2024.

The CHC share price is seeing short-term weakness and may see opportunities closer to the support at $10.49. Below that, we should see strong buying above the support at $8.63. Any weakness in the first quarter of 2024 could provide a great entry.

CHC is a good pick for the long term. Think 5-10 years or longer. We’re looking for the long hold here. It’s a safer income play, and we’re not expecting a 10X return. Buy up to $11.65 and sell above $14.50.

Source: TradingView / Shares in Value

 

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