The week saw markets continually challenged on the impacts of the coronavirus. While the human side is not good, the WHO’s global count is 75,748 confirmed cases and 2,129 deaths so far, corporates and hence financial markets are becoming concerned as to the economic impact that is evolving due to China’s ability to deliver on contractual obligations through the supply chain. A couple of examples were warnings from Lendlease and other developers on the risk around building product supply chain from China impacting their construction waypoints, and Vicinity cautioned on the negative impact from tourism on their Mall retail sales and downgraded 2H19 guidance citing MAT’s had been impacted in the 1st 4-6weeks of 2020 trading. Another example was Apple announcing it would not be able to meet Q2/20 guidance due to worker shortages, stating “Work is starting to resume around the country, but we are experiencing a slower return to normal conditions than we had anticipated.” Approx 15% of Apple’s revenue comes from China and many of its products including the iPhone are manufactured there.

What eventuated were somewhat volatile financial markets, but remaining strong hitting new all-time highs, supported by better than expected earnings reports and reiterated low for longer interest rate policies from the world’s central banks. In support of their economy, China announced stimulatory policies where they cut their 1yr lending rate 10bp to 3.15% and said it was planning tax cuts in an effort to boost economic activity as the coronavirus continues to bite. Japan on the other hand reported Q4/19 GDP contracting -6.3% due to the impact from typhoons, trade tensions and slumped consumer spending as a result of a tax hike in the quarter. This technical downturn is now feared to turn into recession exacerbated by the spread of the coronavirus, impacting further negative retail sentiment and spending.

In Australia we saw weakening economic data, despite the interest rate regime and comments on low for longer for years, “perhaps decades”, from the RBA. This is highlighting a two speed economy where low rates are supporting strong corporate earnings, a revitalised Resi market closing in on all time high prices and asset price inflation via the stock market and property, yet an underperforming employment market and consumer confidence and spending. As a result, is the dilemma of a falling AUD to the US dollar, but also to our trading partners via the TWI. This dilemma is that economic evidence could point to further easing rates, however they are already at next to zero levels at 0.75% and are not working despite the time lag of up to 18-24 months (we are almost 12 months in to the latest easing cycle).  

My belief is if rates at 0.75% are not working, why would they work at 0.5%? More constructively the Federal Government should be using these all-time low interest rate levels to ramp up borrowing and invest into much wider and required infrastructure projects such as water security, education and health that will support the positive immigration policy currently in place. The following graphs highlight a weakening AUD and a yield curve that is enabling the cheapest Government debt creation in generations. These factors will only encourage foreign capital to invest into Australian initiatives that will provide Next-Gen infrastructure to our growing population.

RBA Governor Philip Lowe says low interest rates may be the norm "for decades" ... Property will continue to win

The comments from RBA Governor Lowe haven’t been widely reported despite there being a slight change in rhetoric. RBA Governor Philip Lowe says "It's quite likely we're going to be in this world of low interest rates for years, perhaps decades, because it's driven by structural factors in the global economy." 

This statement is not new news from Lowe statements over the last few months, however the reference to rates low for longer for “perhaps decades” is. This is a far more bearish view on the economy and its ability to reflate economic growth, reduce unemployment closer to 4.5%, increase inflation to a more expansionary 2.5% and promote business and consumer sentiment and hence investment, than we have seen from Lowe and hence the RBA.

The unintended consequence is that house prices are rising and with it mortgage debt and as a consequence the increasing risk dynamics from higher interest rates. This in turn will limit what the RBA can do if it has to tighten rates if inflation kicks up and GDP and employment doesn’t…

So what does this mean for asset prices?

• Further cap rate compression particularly in Office and to a lesser extent Industrial/Logistics.
• The rising tide will lift all boats from a relative yield perspective (yield compression in this instance), meaning lesser grade properties and Retail will not get sold off too hard. Indeed we are seeing Retail assets transact particularly in the private and syndicate owners segment, despite retail conditions being challenging.
• Longer term a low AUD relative to major trading currencies. This is a positive for the Resources sector in particular, but also for asset prices. Note USREIT Public Storage’s bid for AREIT National Storage at a trailing dividend yield of 3.9%.
• -Foreign capital will continue to focus on Australia. Relative yields in Australia are still meaningfully higher than global alternatives.
• Development capital will become bolder and we will see more spec development particularly in Sydney and Melbourne CBD Office. The trickle down will be to the fringe markets of North Sydney, Parramatta, South Sydney to Green Square and St Kilda Rd/Cremorne/Southbank. 
• Juries out on Brisbane Office, but it is a developer’s paradise, so opportunity will arise and offshore buyers will focus at a yield discount to Syd/Melb.  
• Perth is showing signs of regeneration as the Resources Industry reflates and space gets absorbed (Office and Industrial). Again Perth CBD Office will trade at a discount to Syd/Melb, but owners/investors know this and accept it. Again this is opportunity.
• Sydney Industrial will be interesting with the price that can be achieved for Moorebank’s Logistics Park (850,000sq m warehouse space potential)…talk is $2-$2.5bn.

Property will be the winner from low for longer rates as we have seen in 2019 and underlies my still bullish view, however quality over quantity will prevail and spec dev will be on the rise. I expect to see greater spec development with structured sale while in the construction phase to help developers move to the next project. The trick will be to manage the risk of over supply… an issue but not yet a problem.

Low for Longer interest rates continue to stimulate Residential

Auction clearance rates continued to firm, with Sydney reporting 80.3% on 578 auctions and Melbourne 79.2% from 717 auctions. The lower interest rate environment and relaxation of lending rules by APRA and the banks has boosted housing market turnover, but has also boosted home prices meaningfully. Indeed I would argue this is all the 3 rate cuts in 2019 have achieved in the economy. The ABS reported Dec 2019 housing finance increased +4.4%sa, the highest monthly growth rate in 3yrs and up +20.7% since the May 2019 lows. The main growth was from owner occupier, up +22.8% since May 2019.

Foreign capital still finds Aussie assets viable

It is reported that USREIT Public Storage (PSA) has made an unsolicited and non-binding indicative cash proposal to acquire 100% of AREIT National Storage (NSR) for AUD$2.40 (AUD$1.891bn). This cash bid (generally a minimum requirement, versus cash plus scrip, for AREIT shareholders to contemplate the economics of a bids success) represents a 47.2% premium to NTA of $1.63 (as at June 2019) and a trailing dividend yield of circa 3.92% (FY20 div of circa 9.4cps/$2.40). As at June 2019, the portfolio had a 81.4% occupancy rate and a WACR of 6.85%, meaning this bid is very aggressive and highlights the opportunities foreign capital have with the AUD valued at US$0.6719. 

NSR has 2 potential suiters chasing, with Hong Kong based Gaw Capital also interested, however according to NSR, PSA’s bid is superior at this point. NSR has granted PSA access to due diligence. Public Storage is the world’s largest owner operator and developer of self-storage facilities across the US and UK/Europe, with over 170m square feet NLA. NSR is due to report its 1H20 financials on 26 Feb.

Wages Price Index rises only marginally

The ABS reported Dec quarter WPI rising +0.5%sa and +2.2%sa yoy. This is not enough to be a concern for inflation and not enough to stimulate positive consumer sentiment and retail sales growth. Positively, private sector wages have started to outgrow public sector. Victoria recorded the highest rise of +2.7%yoy and WA the lowest of +1.7% (has remained below 2% since June 2016). The largest rises by industry were healthcare and social assistance +3.1%yoy and electricity, gas, water and waste services +2.9%yoy. Information, media and telco was the lowest at +1.6%yoy, retail 1.8% and construction 1.8%. The following graph highlights the decline in growth rates since the GFC and how since mid-2013 growth has been below the 20yr average of +3.1%pa.

Employment grows, but the unemployment rate rises to 5.3%sa as participation rate grows 

There are more people looking for work, which is meaning the unemployment rate has moved out from 5.1% to 5.3% and more importantly the underemployment has expanded from 8.3%sa in Dec 19 to 8.6%sa in Jan 20. The participation rate is to blame in that more are looking to work, perhaps highlighting household finances remain under pressure. The participation rate has moved from 66% Dec 19 to 66.1% in Jan 20 and up from 65.7% a year ago. Employment increased by 13,500 with full time up 46,200 and part time down 32,700 people. The AUD was sold off as markets again worried about future policy and how to kick start the economy if interest rates are still not working at 0.75%.

The graph highlights how the unemployment rate is stubbornly around the 20yr average of 5.5% while the underemployment rate is above its 20yr average of 7.3% despite all time low interest rate policy. It is evident that alternative policies need to be adopted such as tax reductions which will enable households to spend. Not all households are impacted by monetary policy such as renters and mortgage free’s which equate to approx 2/3rds of households, meaning MP isn’t working other than for corporate earnings (low debt costs passed back to shareholders) and highlights an all-time high stock market.

Scentre Group FY19 Earnings beats, yet the markets maintain expectations that conditions will worsen

Please note: Commentary on Scentre Group does not constitute an investment recommendation.

Scentre Group reported a relatively good FY19 earnings report, beating analyst FFO expectations of AUD$0.2530 vs AUD$0.2542 actual.  The expected fall in NOI didn’t happen, however negative releasing spreads on new leases were somewhat higher at -5.5% (comparable) and -6.4% (all) vs -3.5% in FY18. The stock price was down -1.6% to $3.72 on this wider fall in releasing spreads, future negative releasing spreads expectations and the unknown effect on FY20 sales turnover on the spread of the coronavirus.

Major reveals over the 12 months were:

• Burwood compressed 25bp to 4.75%
• Hurstville compressed 12bp to 5.13%
• Carindale compressed 25bp to 4.75%
• Doncaster compressed 25bp to 4.25%
• Innaloo compressed 50bp to 5.75%
• Marion expanded 12bp to 5.25%
• NZ saw meaningful compression from 6.23% FY18 to 5.92% FY19.

Rent releasing (specialties):

• Existing +4.0%
• New -5.5% (new releasing spreads for all centres -6.4%)
• Incentives 7.2%
• Comparable sales growth by type and State:

• Comparable NOI +2.0% for FY19
• Total sales +1.5% for 4Q19 and +1.9% FY19
• Specialty Sales MAT $11,303sq m
• Specialty Occ costs 18% (flat on FY18)
• Specialty sales +2.8% for 4Q19 and +2.2 for FY19
• Majors sales -0.9% for 4Q19 and +0.7% for FY19
• Occupancy 99.3% for 6.0yrs average
• WACR 4.72%, Economic Yield 5.19% (WACR adjusted for internal and external management, so includes management rights)
• Cost of Debt 4.2% for 4.2yrs average
• Gearing 33.0%

LLC is selling its share of Carindale, with SCG valuing their component at 4.75% cap rate and economic yield of 5.41% (includes management rights).

Comment: The stock price sell-off is an overreaction given FY20 company guidance has been given as a dividend yield of $0.2328/$3.71=6.27% on a FFO cash earnings of $0.2530/3.71=6.82%. This is in contrast to the current tabled takeover for National Storage at a trailing dividend yield of 3.92% as mentioned in my daily yesterday. I would prefer to own Scentre Group given its fortress and irreplaceable assets. From a comparable perspective, in the US, Simon Property Group has a friendly takeover bid underway for similar Mall owner Taubman at a cap rate yield of circa 6.2%. I would argue Scentre (4.72% WACR) is better located to densification, improving demographics and socio-economic wealth than Taubman.

National Storage (NSR) now has 3 interested parties

Please note: Commentary on National Storage REIT does not constitute an investment recommendation.

It is reported that Warburg Pincus has bid $2.20 all cash, USREIT Public Storage (PSA) has bid $2.40 all cash and Gaw Capital has bid $2.20. The PSA bid represents a 47% premium to $1.63 NTA, and a trailing dividend yield of 3.92% on a reported weighted average cap rate of 6.85% and occupancy rate of 81.4%.

ISPT buys the $950m Martin Place Station Tower (the old Tiffany’s site)

The AFR is reporting that ISPT has won the race for 30,000sq m 39 Martin Place, beating Investa, CBUS Dexus and Charter Hall. The AFR is reporting rents are expected to be circa $1,500sq m and that it will transact at 4.25%-4.50% yield. This is a further example of scarcity of product in the Sydney CBD and supports our view that Office yields will continue to compress in 2020, and is likely to be the best performing Office market in Australia this year.

Further reading: AFR article: ISPT seals the deal on $950m Martin Place Station Tower

Coles reports stronger 1H20 results

Please note: Commentary on Coles Group does not constitute an investment recommendation.

Coles reported good like for like supermarkets sales growth, up +2% and headline sales revenue growth of +3.3% in 1H20 to $18.8bn and +4.8% in 2Q20. Supermarket sales density increased +1.6% to $16,800sq m and liquor sales density increased by +1.5% to $14,370sq m. Coles Online sales increased +23.8% (Supermarkets) and +28.2% (Liquor) on pcp. Coles noted that their net property divestments will be $130m-$180m in FY20, up $30m-80m on previously announced.

This is a good result although does highlight continuing competition in the Supermarkets space and perhaps gives greater reasoning as to why Kaufland pulled the pin on Australia. Revenue sales growth highlights a positive for landlords, in particular with exposure to turnover rents. The Coles earnings report highlights our preference towards Neighbourhood Shopping Centres with high exposure to supermarkets and day-to-day living consumer requirements.

As an aside, online retailer Kogan missed consensus expectations, which is the direct opposite to JB HiFi that beat and is strengthening its market share.

Outside the square

Burger King has launched an advertising campaign that focuses on an “image of a mould-infested Whopper” as its differentiating component to the burger market. In this instance Burger King is highlighting its artificial preservative free Whoppers. BK has released a time-lapsed video on Twitter showing the Whoppers’ degradation over a 34 day period, wilting, collapsing then turning blue. Apparently the preservative free Whopper will be sold in France, Sweden, Spain and circa 400 of BK’s 7,346 locations in the US. In Australia, according to the company, “Hungry Jack’s famous flame-grilled 100 percent Australian beef patty is preservative free,” and “Whopper comes with fresh Australian grown lettuce, tomato and onion.”

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