We recently revisited Centuria Industrial REIT (ASX:CIP) to assess, firstly, the implications from the equity raising for the balance sheet, secondly, the Company’s ability to cover distributions and thirdly, the performance of the property portfolio in light of COVID-19. In light of this, could there shortly be an opportunity to invest in CIP?
Centuria Industrial REIT (CIP) operates as a property investor and fund manager. Its core business being the acquisition and management of industrial properties in key metropolitan locations throughout Australia. CIP’s portfolio comprises 48 industrial properties valued at ~$1.6b. The major changes to the geographical exposure following the acquisition of two industrial assets in December 2019 are an increase in Queensland (32% compared to 21% pre-acquisitions) and a reduction in exposure to NSW and Victoria.
Equity Raising Has Reduced Gearing Levels
Following both an equity raising and acquisition of two industrial properties in 1H20, CIP’s gearing level rose from 34.0% as at 30 June 2019, to 35.5% as at 31 December 2019. Those acquisitions were partly funded by debt. This level of gearing placed CIP has one of the highest leveraged trusts amongst its ASX-listed peers.
The most recent equity raising (completed in mid-April) has seen the gearing level reduce to ~28%. Importantly, there are no debt maturities in the near term and other financial metrics, such as cost of debt and interest cover, remain sound.
While the stated use of the funds raised over the short-term would be to reduce gearing, the other option is to utilise some of the funds to pursue further acquisitions of industrial assets over the near- to- medium term. Further accretive acquisitions are also important from the viewpoint of ensuring that distributions in future years can be at least maintained from FY21 onwards.
Implications for Distributions Following Downgrade to Earnings Guidance
At the interim results release, CIP reaffirmed its FY20 Funds From Operations (FFO) per unit guidance of between 19.6 – 19.9 cents per unit (cpu) and distribution guidance of 18.7 cpu. Since that time, the Company has twice revised down its FY20 FFO per unit guidance, but instructively, has maintained the distribution guidance of 18.7 cpu.
The latest FFO guidance implies -2% to 0% growth on FY19 FFO of 19.3 cents per unit. Given that the distribution guidance of 18.7 cents per unit has been maintained, it is worth noting that the reduced FFO guidance reduces the extent to which distributions can be covered by operating cashflows.
While CIP’s recent distributions have been below FFO, they have not always been covered by operating cashflow. This is partly due to equity raisings typically entitling new unitholders to the upcoming distributions. Accordingly, looking forward into FY21, CIP may not be able to maintain its distribution per unit at FY20 levels (albeit at an elevated distribution payout ratio) in light of COVID-19, unless it undertakes accretive acquisitions.
Is the Property Portfolio Exposed to COVID-19?
Tenants across CIP’s portfolio are weighted to defensive sectors, with 54% of portfolio income derived from tenant customers directly linked to the production, packaging and distribution of consumer staples and pharmaceuticals. Key tenants include Arnott’s, Woolworths, AWH, Visy, and Green’s Foods. These companies account for 35% of income. Further, it is estimated that ~15% of tenants are SMEs/privately owned entities.
We contend that while the industrial property sector will not be immune to any economic slowdown, it is likely to lag other property sectors that more immediately in the front line (i.e. retail and office sectors). To this end, less than 1% of portfolio income comes from ancillary sources (car parks, retail, advertising, etc), occupancy levels remain high, and there is minimal short-term lease expiry risk.
The long-term fundamentals remain solid. In particular, CIP, as a pure-play industrial REIT, remains in a strong position to benefit from the increasing demand (driven by e-commerce, logistics and manufacturing) for infill assets or assets closely located near key infrastructure. The latter was a key reason why the shares consistently traded at a premium to its NTA prior to the onset of COVID-19.
However, the shares are now trading at a discount to NTA of its $2.78 per unit following completion of the recent equity raising. While the decline in gearing levels is clearly a positive, we note a number of factors indicating that CIP, is likely to continue trading in line with, or at a discount, to its NTA over the short term, thus indicating limited upside from current levels.
i. Expansion in NTA is more challenging, given that a meaningful portion of these (30% in 1H20) are derived from market rent increases; which will have to be delayed given the current COVID-19 situation.
ii. While CIP’s recent distributions have covered by FFO, the downward trend in FFO guidance for FY20 places into question whether the FY20 distribution will be covered by FFO.
iii. Further, in the absence of acquisitions and in light of COVID-19, the Company may not be able to maintain its distribution per unit at FY20 levels unless it undertakes accretive acquisitions.
For the last several weeks, CIP has continued to drift sideways. This tightening of the range is quite interesting and it means that CIP is getting very close to making a decent break in one direction or the other. If we see an upside break from here, then we could get a decent rally which could lift CIP to over $3. For now it is one to keep on the watchlist.
Michael Gable is managing director of Fairmont Equities.
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