Investment thesis
LEP reported FY16 results came inline with market expectations. LEP owns a portfolio of hospitality assets (pubs) leased solely to Australia Leisure and Hospitality. The trust was a spin off from Woolworths (similar to Hotel Property Investments – HPI from Coles) all assets are on long term leases which ensure that the underlying business has operation stability.
The decline in bond yields has pushed long duration income assets through the roof and LEP is no different. The current LEP share price reflect the market chase for yield. The forward driver for ALE Property Group is the upcoming market reviews in 2018 with a 10% cap and collar and the full market review in 2028. Currently the underlying assets looks to be fully priced given a sub 6% cap rate.
Key Facts
Valuation
The cap rate which is the primary valuation metric for commercial properties is at a eye watering 5.53%. It had almost 1% in cap rate compression over the last 12 month period. From another perspective the average lease term is 12.3 years so it is still trading at a healthy spread to long term bond yields.
Net asset per security is $2.53 even after the revaluation. The ALE property group share price is trading above $4 which means that it is trading at a hefty premium to asset. Remember buying ASX LEP means buying a portfolio of real estate assets. Current buyers are paying 66% premium to book value of these assets. The buyers expect that the current book value to approach market price which is a expected rise of 66% over a unforeseeable period.
The distribution of 20 cents per share equals a current yield of 4.7%. This means that there is little room for error and shift in treasury yield curve.
Interest cost and hedges
The debt is 100% hedged with all in interest rate is 4.35% but on one tranche the base rate on is 2.95% and market is more like 1.90% after RBA cut in interest rates. Operating income will be boosted by upcoming margin reset in Aug 2017 on the $110 million AMTN facility.
What we didn’t like
The trust has a habit of distributing more than its operating income. For example current year distribution of 20 cents is much higher than distributable profit of 15.11 cents. This was similar to 2015 where distribution of 16.85 is matched against the distributable profit of 14.85 cents. The buyers of LEP stock today are getting even lower yield than 4.7%
The group is looking to expand gearing towards 50%. This can be seen as a stretch as the management is gearing up the balance sheet near the peak of the cycle.
The underlying businesses are dependent on consumer sentiment and can be considered discretionary spending. The property value has also been pushed inline with the growth in house prices since there are instances where the highest and best use for the pubs are residential apartment. A deflation of the Australian housing bubble would pull back some of the property valuation.
LEP ASX Recap
ALE Property has benefited from the secular decline in interest rates. We will be cautious going forward since the stock is trading materially above book value. We will not be chasing yield in this stock.