Tuesday, July 28, 2009

Australand - buy into rights issue?

It was the former managing director of Australand, Brendan Crotty, that told me that property was all about demographics. It's true for investing generally, but has special resonance for property.

Australia has an immigration regime that underwrites our continued population growth - over 200,000 new mouths in 2008 (that's both permanent and non-permanent residents). Even when times get tough, Australia is captive to its immigrant legacy. The demographics of Australia support the builder.

This is not the say the property owner will always have it their way. They won't. We have had easy credit for so long, it is going to take a while for excessive valuations to unwind. But that's property ownership - there is a distinction.

So to Australand's half year results. They are a builder and an owner in equal measure. The question I'm asking myself is - are they value at 40 cents?

Let's try to break it down...

Property portfolio - investment and development ownership

Let's look first at property ownership - the questions here are a) how much pain is priced into the portfolios? and b) how much pain can they bear? Here's a quick summary of the investment portfolio:

30/6/08 30/6/09
Investment Portfolio value $2,288 $2,015
Weighted avg lease expiry 6.6 6.4
Avg cap rate 7.54% 8.34%
Avg cap rate - office 7.28% 7.91%
Avg cap rate - industrial 7.75% 8.81%
Occupancy (incl rent support) 98.80% 99.10%

And a quick sensitivity check of how this translates to total property holdings:

Reported invt portfolio value 2015.0
Reported avg cap rate 8.34%
Implied rental income 168.1
Assume cap rate +1% 9.34%
Implied portfolio value 1799.3
Change in value 215.7
Covenant impact 37%
10% decline in devpt assets 143.8
Total Covenant impact 39%

My conclusion from this...
Post the entitlement issue, it's unlikely that Australand will have to pass around the hat for more equity again. Even if property values were to fall by another 25% from here (putting the average cap rate around 11%), the gearing covenant should not be breached (my numbers have it remaining well under 50% in that scenario).

That is not to say the portfolio valuation is cheap at the moment. (Remember shopping centres were priced in the low to mid teens in the early 90's.) I wouldn't be surprised to see the average cap rate push into double digits before this market cycle is done.

So let's assume something like this occurs...again on my numbers (I can't quite match up Australand's rental income, cap rate and valuation - so I have taken the conservative valuation), assuming a 25% decline in valuations from here and an avg cap rate of 11%, this puts the NTA on the securities at $0.39. Given the placement is at $0.40, it is starting to look like reasonable value.

Property development

Now to property development. It's volatile business at the best of times - when the going is good, the BRW Rich list is littered with property developers. Trouble is, times ain't so good.

So how are Australand placed? The theme that comes from their outlook is that they expect the market to remain soft (with some hope of a lift in 2010). Essentially, they remain in 'monetisation' mode - selling assets as and when they can. The residential development business is basically breakeven as margins are being squeezed as they focus on offloading stock. Commercial and industrial development is about one third of the size of 2008 - with no office projects and a few pre-commited projects in the industrial sector. All in all this business could better be classed as 'care and maintenance' for the moment.

On the plus side, if you are buying the securities at 40 cents, then you are basically picking up the development business for nix. This is not a bad deal as Australand are managing down the risks from this part of the business while maintaining the development capability longer term. In particular, the capital commitment looks to be well contained ($44m for the 2009 year) and the model of developing assets that are sold into the trusts remains on foot ($113m for 2009).

So add it all up and what do we get?
Australand at 40 cents looks okay. The yield of ~10% seems about right - they are only paying distributions from the trusts and (as you would expect) nothing from the developer. With rent escalating at ~3% per annum and a reasonably good quality portfolio, the longer term yield is sound as well.

Looking at relative value, Australand looks pretty good. Consider the comparisons Australand published with the rights issue documentation...

DPS yield Discount to NTA
Australand 10.30% 43.50%
Stockland 6.80% 12.30%
Mirvac 7.10% 24.80%
GPT 7.50% 27.80%
C'wealth Office 8.50% 38.40%
Dexus 8.50% 38.60%

But maybe that says more about the sector than the absolute value on offer.

Think I have convinced myself that Australand at 40 cents is a reasonable deal. Does that mean I'll be buying it ahead of it going ex-rights tomorrow? Probably not - as my macro view of the market remains bearish. I reckon there will be opportunities to buy quality property companies at deep discounts to fair value in the not too distant future.

There will come a time to invest in the property sector again. The demographics demand it. But based on this latest instalment from Australand - there is no need to rush.

(Postscript - a consolation prize is that the AAZPB are a winner from this latest capital raising. I'll have a quick look at relative pricing tomorrow - but my guess they are a buy...)

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