Is value emerging in retail REITs?
Retail faces headwinds but there may be opportunities in these unloved shares.
Mentioned: Charter Hall Retail REIT (CQR), Scentre Group (SCG), Region Group (RGN), Vicinity Centres (VCX)
Retail REITs have had a difficult run. COVID restrictions closed shopping malls and many shoppers migrated online. Interest rate increases impact funding costs of REITs who typically carry high debt levels and can influence the valuations of real estate holdings. Inflation is stretching consumers with spending levels dropping in three consecutive quarters.
Retail property trusts often screened as expensive over the past 18 months. REIT security prices fell sharply since December 2021, but retail REITs held up well at first. More recently we’ve seen value emerge in retail REITs, as investors finally acknowledge the impact of higher rates on finance costs, and the softening outlook for rents linked to turnover and the impacts of inflation.
Morningstar Equity Analyst Alex Prineas recently reaffirmed his valuations for these no-moat-rated retail REITs: Charter Hall Retail REIT (ASX: CQR) at $4.15; Region Group (ASX: RGN) at $2.55; Scentre Group (ASX: SCG) at $3.30; and Vicinity Centres (ASX: VCX) at $2.05. Scentre Group and Charter Hall Retail REIT screen as undervalued, both 4-star-rated at present.
All four of the REITs have experienced share price losses over the past year. Charter Hall Retail REIT has fallen 8.37%. Region Group is down 19.11%. Scentre Group has retreated 3.83% and Vicinity Centres is down 6.31%.
We’ve long anticipated headwinds, but we view downside risks as contained, with generally long leases and solid balance sheets. Of these four names, Vicinity Centres has the shortest leases, averaging 3.2 years at December 2022. But that should be enough to carry it through any rough patch, particularly considering its gearing (net debt/assets) is the lowest among these four, at 26% at December 2022. We think it also has further recovery headroom, as its city retail and tourism sites have recovery potential as tourism continues to recover from pandemic impacts, and population grows in the long run.
The other REITs have higher gearing, but have other aspects of defence. Charter Hall Retail’s gearing was 33% at December, but has a long 7.3 year average lease. Scentre Group is highly geared if we incorporate its hybrid securities. But its average specialty lease is 6.9 years, and a strong earnings recovery since lockdowns should help it to deleverage. Region Group’s gearing was 31.7% in December 2022, but has achieved some asset sales since. Region Group sold its holding in rival mall operator Charter Hall Retail REIT in January 2023 for $26.7 million, implying an average sale price of $3.94 per security, well above Charter Hall Retail REIT’s current security price.