Rising interest rates are continuing to strain the nation’s residential and commercial real estate market, but a new addition to Morningstar’s coverage universe could provide a more defensive option for investors.

As part of expanding its commentary on ASX-listed real estate investment trusts (REITs), Morningstar recently initiated coverage on Waypoint REIT (WPR), which owns a portfolio of around 400 service stations and convenience retail properties located across all Australia.

Formerly Viva Energy REIT Limited, Waypoint leases its portfolio of service stations to Viva Energy’s (VEA) Shell-branded operators.

Morningstar, which last year also initiated coverage on two other REITs—Charter Hall (CQR) and Centuria Industrial (CIP)—placed an inaugural fair value estimate on Waypoint REIT shares at $2.80, around 10% higher than its recent trading levels.

‘Sensible’ approach to debt bolsters strong ten-year outlook


In initiating coverage on the company, Morningstar senior analyst Adrian Atkins noted the “humble” company's tempered approach to growth, which he says isn’t always common among REITs.

“With a lot of REITs, it can be common to pursue growth just for the sake of it. When debt is cheap and available, they’ll just borrow and when the property prices go up and the gearing falls, they just borrow more debt, buy more, and become a bigger company […] Waypoint isn’t like that at all,” he says.

In contrast, Atkins says Waypoint has spent time consolidating its holdings and minimizing its debt position.

“Waypoint trimmed its portfolio in recent years, selling the riskiest 15% of properties, typically struggling service stations in a regional area where the land value is low.”

That slower approach to growth may prove fortuitous as the market stares down higher interest rates in the short-to-medium term.

“Interest rates have gone through the roof. That’s bad for all the companies with a lot of debt that was easy to manage two years ago. But for Waypoint, gearing is at the bottom of their target range, and they’re probably in the middle of what we think is reasonable.”

Beyond the company’s low debt levels, Atkins also notes a strong earnings margin, which is being driven by low overheads and profitable leases.

“It’s a small team and most of their leases are ‘triple-net’, which means the tenant will pay for all the property outgoings, insurance and maintenance capital expenditure, whereas a lot of other companies are not like that,” he says.

Alongside a 6.5% yield, this amounts to a strong outlook for Waypoint, according to Atkins.

“In the five-to-ten-year outlook, Waypoint looks really solid,” he says.

“We like the trust's solid balance sheet, highly defensive rental income, sensible strategy, and low-cost internal management structure.”

Energy transition clouds longer-term outlook


While the medium-term outlook for the company appears strong, its longer-term prospects are less clear.

Atkins says how the global transition away from fossil fuels will impact the service station industry is very uncertain.

“Once cars are no longer using petrol, and say you have EVs [electric vehicles] —or more public transport, bicycles, trains and electric power—there’ll be a lot less need for service stations […] the service station market is likely just going to shrink and shrink—eventually there might not be very many at all,” he says.

According to Atkins this will likely result in a downturn in the service station industry, which could also result in knock-on costs to the company via its land rehabilitation obligations.

Despite the higher uncertainty surrounding the global energy transition, however, Atkins says these concerns are far enough out to warrant a more moderate 'Medium' Morningstar price uncertainty rating for Waypoint, given the company’s stronger near-term prospects.

“The longer-term structural outlook for service stations is more challenged, but we think that is priced in,” he says.

“Even if this is a problem in 30 years, investors will likely have got their money back in dividends and it shouldn’t impact the valuation too much at this stage.”