Equity Strategy
1 May 2024
A-REITs – Health Check
A-REITs Have Outperformed, but the Rally Has Been Narrow...

The ASX 300 A-REIT index has outperformed the ASX 300 this year to date, although the sector’s performance has been highly concentrated, driven by the outperformance of the two largest index constituents: Goodman Group (GMG) (Focus Portfolio 5%) and Scentre Group (SCG). 

Looking beyond the sector’s headline outperformance, most A-REITs have materially underperformed the broader market this year to date after the consensus timeline of expected RBA rate cuts has been delayed into 2025 in response to stickier than expected inflation data. 

The potential for ‘higher for longer’ interest rates has weighed on implied property sector market valuations and hence the market performance of some A-REITs. 

Figure 1: The ASX 300 A-REIT index has outperformed this year, driven by GMG…
Figure 2: …however the majority of A-REITs have underperformed the market

A-REITs remain well placed over the medium term

The Focus Portfolio retains an overweight exposure to A-REITs. Notwithstanding the uncertainty around the path of central bank policy, our base case remains that over the next 12-18 months lower interest rates will support property sector valuations. 

Historically, the A-REIT sector has outperformed the wider ASX 300 in periods of falling bond yields and/or RBA cash rate cutting cycles. The eventual easing of interest rates will, in our view, support a recovery in the A-REIT sector which remains on a discount to underlying asset valuations on a price to NTA (net tangible asset) basis. 

Figure 3: The A-REIT sector’s valuation discount has widened in 2024
Figure 4: A-REITs have historically outperformed in rate cutting cycles
Figure 5: Focus Portfolio - A-REIT exposures
A-REIT name Ticker Portfolio Weight Sub-sector Beta 12 mth fwd PE 12 mth fwd Dividend Yield % EPS growth (p.a.) % Balance Sheet Gearing 12 mth fwd EPS revisions - last 3 mths Occupancy Weighted Avg Lease Expiry (yrs)
FY24 FY25/FY26
Goodman Group GMG 5.0% Industrial / Data Centres 1.45 26.6 1.0% 13% 11% 9% 2.9% 98% 5.3
HealthCo REIT HCW 3.0% Healthcare 0.83 16 7.0% 14% 6% 34% 0.7% >99% 12.3

Source: Refinitiv, Wilsons Advisory, Company filings. 


Buy HealthCo REIT

Healthscope overreaction presents a discounted buying opportunity

HealthCo Healthcare and Wellness REIT (HealthCo REIT / HCW) is now trading on a steep discount to its NTA (net tangible asset) value. HCW has been materially oversold in our view amidst market concerns regarding its key tenant Healthscope (HSO). 

HSO is currently restructuring its $1.6bn in debt alongside a reorganisation of its portfolio of hospitals, while also engaging with private health insurers (PHIs) and government bodies to improve the sector’s funding.

Notwithstanding HSO’s importance to HCW as its largest tenant – operating 11 HCW (partially or wholly) owned properties and accounting for~49% of HCW’s net operating income – the recent sell-off in HCW’s share price is excessive and is ultimately inconsistent with its strong financial and legal position. 

HCW now trades on a ~27% discount to NTA, which is close to double the average ASX 300 A-REIT’s (excl. office) discount to NTA. HCW’s valuation discount to its peers is incongruent with the demonstrated resilience of HCW’s asset portfolio, noting HCW experienced a meaningful portfolio valuation uplift in 1H24, while other A-REITs and sub-sectors saw valuation declines

As healthcare is an inherently defensive property sub-sector, there is markedly less downside risk to HCW’s asset portfolio book valuations compared to the broader A-REIT sector. As such, HCW’s discount to its A-REIT peers is unwarranted

While HSO’s discussions with lenders and industry players are ongoing and the timeline of events is uncertain, we expect incremental news flow over the coming months. The completion of HSO’s restructure and/or positive resolutions from conciliation with PHI’s and government bodies represent material catalysts for HCW to re-rate higher. 

Figure 6: HCW has been oversold on Healthscope worries
Figure 7: HCW now trades on an above-average discount to NTA, despite limited downside risk to its asset valuations

Private hospital industry challenges necessitate compromise from private health insurers and government bodies - not landlords

Despite outsized media attention towards HSO specifically, all players in the Australian private hospital industry are facing a challenging operating environment with ~70% of private hospitals unprofitable in FY22 according to the ABS. 

Declining hospital margins have been driven by the combination of sticky cost pressures (wages, utilities, medical supplies etc.), which have outpaced the revenues provided by payouts from Private Health Insurers (PHIs). Meanwhile, PHI profits have been increasing in what is a clear shift in how profits are shared between PHI’s and private hospitals. 

Given ~70% of private hospital revenues come from PHI and government payors, a degree of recalibration is required between these parties to maintain a sustainable and well-functioning public-private health system where private hospitals are sufficiently funded to be sustainably profitable. 

Industry engagement is underway between private hospitals and PHIs, with leading private hospital operator Ramsay Healthcare (RHC), for example, flagging at its 1H24 result that it has been ‘successful in negotiating improved revenue indexation with several health funds and public payors’. Given the importance of private hospitals as critical infrastructure within Australia’s health system, we are confident that compromise between PHIs, government, and hospital operators will be achieved to support operator profitability. 

Most importantly for HCW, the onus ultimately lies on PHIs and government bodies to provide greater funding to the private hospitals sector (and hence HSO), and not on landlords like HCW to provide further rent relief, in our view. 

Figure 8: Private hospital margins are falling while insurer profitability is rising

Healthscope is still well placed to meet its rental obligations 

Importantly, HSO remains well placed to meet its ongoing rental obligations to HCW. We note, HSO:

  • Has met all rental payments to HCW in accordance with its lease terms, with no payments outstanding. 
  • Is already benefiting from rental relief provided by HCW, offered as part of HCW’s hospital portfolio acquisition in 2023, which includes a 50% up-front rent-free period over the initial 24 months of the 16-year lease. It is our understanding that HSO has not at this stage requested additional rental relief from HCW – and we do not expect further relief to be provided. 
  • Remains in compliance with its banking covenants.
  • Is in a strong liquidity position, with ~2 years of cash on hand. 
  • Has strong financial coverage to meet its rental obligations at its HCW owned hospitals. 

In summary, the risk of HSO defaulting on its leases with HCW is highly unlikely

We expect HSO’s rental payments to continue to be paid to HCW in full. 

HCW’s strong financial and legal position supports confidence in its earnings

As the landlord of 11 properties leased to HSO, HCW is in a strong financial and legal position, noting:

  • 1st mortgage security – as a landlord, HCW inherently has 1st mortgage security over its 11 freehold hospital properties that are leased to HSO. In other words, HSO’s lenders have no claim to HCW’s assets (beyond their rights under the leases). 
  • Cross default rights – in the unlikely event that HSO defaults on the lease of a single HCW owned hospital, this ultimately would trigger the default of all the leases across its 11 HCW owned properties, which represents approximately 1/3 of HSO’s Australian hospital network. 
  • GenesisCare Chapter 11 as a case study – last year, another major HCW tenant, GenesisCare, filed for Chapter 11 bankruptcy in the US to allow for a global restructure. Throughout this period, GenesisCare remained in compliance with all of its lease obligations to HCW with 100% of its rent paid on time. In this period, we understand HCW had alternative operators express interest in leasing its properties should circumstances have changed. 

Given HCW’s strong legal protections, we expect zero impact to HCW’s earnings or distributions to stem from HSO’s ongoing restructure and industry negotiations. 

HCW's $50m buyback will be earnings per share accretive

HCW recently announced a $50m on-market buyback, which demonstrates management’s confidence in the value of its high-quality asset portfolio, and will be accretive to earnings and distributions per share over 2H24 and FY25. We note at HCW’s current share price, the scale of the buyback could exceed ~7% of its total units on issue. 

Management has also reiterated its guidance for FFO (Funds from Operations) per unit and DPU (Distributions per Unit) of 8cps in FY24. Given the material FFO/DPU per share accretion from the buyback, HCW is well placed to beat its guidance (which excludes the impact of the buyback). This will likely drive consensus upgrades from FY25e onwards.

Figure 9: HCW offers a highly attractive yield with upside risks to consensus from the buyback

Progress on asset sales supports balance sheet strength

HCW’s $200m asset disposal program continues to progress well, with management recently announcing that it has now divested $145m of non-core assets, while the remaining of flagged ~$55m+ asset sales are expected to be executed by the end of FY24. Asset sales will help to fund the unit buyback and investments into HCW’s ~$1bn accretive development pipeline, while also ensuring gearing is maintained at the lower end of the 30-40% target range. 

Figure 10: Gearing is expected to remain at the lower end of the target range

Goodman Group – Still Good Buying

Goodman Group (GMG) remains a core holding of the Focus Portfolio. 

GMG is a well-managed, global integrated property group with its operations split across three complementary segments: property investment, development, and asset management. 

The company has been a consistent earnings compounder over time and remains well placed to continue growing its EPS at a double-digit rate over the long-term. 

Our investment thesis remains intact, noting:

1. Valuation is undemanding 

    GMG currently trades on a forward PE multiple of ~27x, which remains attractive considering double-digit consensus EPS growth over the medium-term, and given the large runway for structural growth longer term, underpinned by its data centres pipeline. 

    2. Data centres potential is significant 

    Demand for high-tier data centre facilities in supply constrained locations is very strong, driven by structural tailwinds from cloud computing and artificial intelligence. GMG is well placed to become a leading global data centre developer, with data centre projects already accounting for ~37% of GMG’s $12.9bn development pipeline. 

    The demonstrated progress in GMG’s data centre pipeline has arguably driven an upward inflection in the group’s long-term earnings growth potential (justifying a higher PE multiple in our view), given the strength of data centre market fundamentals (relative to logistics) and the higher margin nature of its data centre developments. 

    3. Logistics market fundamentals remain strong

    The fundamentals of global logistics markets (GMG’s largest sub-sector exposure) remain attractive. Low vacancy rates and robust rental growth are continuing to be driven by strong demand from retailers, e-commerce players, and 3rd party logistics companies; while the supply of well-located urban infill assets remains scarce. 

    Upcoming catalyst:

    • Q3 FY24 Operational Update – 8 May 2024
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    Written by

    Greg Burke, Analyst

    Greg is an experienced analyst in the Investment Strategy team. He is the lead portfolio manager of the Wilsons Advisory Australian Equity Focus Portfolio and is responsible for the ongoing management of the Global Equity Opportunities List.

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