The overlap of property & powerful long term thematics – Part II
Few topics inspire more parochial debate than property in Australia. While residential property tends to grab the headlines, commercial grade property has had no less support in recent years.
We have discussed this theme in papers written over the past 12 months, which has largely fed off a world of low interest rates. Going back to the early part of this calendar year, we highlighted: ‘despite the hysteria surrounding the US lifting interest rates for the first time in years, rates remain at historically low levels across the globe. We continue to view this as a protracted and grinding cycle: one that provides a degree of support for good quality, high yielding assets.’
Following another rate cut in recent months, little in the macro landscape has changed and so the environment remains broadly supportive. This impacts not only those groups directly involved in the real estate sector, but also a range of businesses whose operations tend to overlap in some way with property. This is especially the case for those companies that are well positioned to benefit from the swelling numbers of tourists visiting our shores.
We believe the growth in services exports and more specifically, tourism is likely to present a constructive landscape to pursue selective investment opportunities.
Before we delve into some potential beneficiaries of these thematics, it is important to highlight that we do not advocate simply picking a positive thematic and wildly throwing capital at it. Reviewing such thematics may merely highlight some companies you may wish to research more deeply. We believe that there is no substitute for quality and value, coupled with execution against a sound fundamental framework. We highlight some of the key business characteristics we find attractive (regardless of perceived thematic support):
- Preference for high ROE businesses
- Easily understood business with bright future prospects
- Strong balance sheet: preference for lowly geared companies
- Strong Cash Flow
- Ability to self-fund growth
- High quality, driven owner managers
With the above noted, it is worthwhile touching on some of the key reasons why we believe tourism now looms as one of the better opportunities for Australia. This argument is supported by our thesis of a low and/or depreciating currency. There’s little doubt the depreciating AUD has acted to substantially cushion the downturn being experienced by the broader economy in the face of significant declines in resources related capex. In turn, this has provided support for Australian services exports.
Figure 1: Australian Dollar versus Yen, Euro and USD. Source: RBA Chart Pack
Concurrently, we have seen the emergence of the Asian middle class, a strong thematic aided by GDP growth rates that are well above developed world averages.
Figure 2: GDP Growth Rates: China, India, East Asia. Source: RBA Chart Pack.
Not only are the broader masses beginning to generate more income (albeit from a very low base when compared to Western economies), their dollar is going further in countries like Australia. As a result, Australia is enjoying a surge in short-term visitor arrivals. Monthly tourist numbers are now up more than 50% on GFC lows (CAGR of ~6.1%), a trend that looks set to continue.
Figure 3: Short-term Visitor Arrivals. Source: ABS
As illustrated below, the Chinese are now challenging our friendly Kiwi neighbours in terms of having the largest number of monthly arrivals. Beyond China, those from ‘The Asian Corridor’ appear to be arriving in increasing numbers as well. Comparing short-term visitor arrivals for April 2015 and April 2016, on a relative basis the highest percentage increase was recorded for Japan (32.9%), followed by South Korea (32.4%), and Singapore (19.7%).
Figure 4: Number of Visitors in the year to April 2015 and April 2016. Source: ABS
The above international visitor trends lead us to review potential beneficiaries. We concurrently consider the degree to which respective asset bases comprise owned property assets.
Three Stocks To Watch
The three stocks we highlight encompass various specialties including accommodation, entertainment, leisure and funds management.
Event Hospitality & Entertainment Limited (ASX:EVT)
Event, formerly Amalgamated Holdings Limited, has been one of the sector’s most consistent performers over many years, having delivered an annual total shareholder return of 17.7% over the past decade. Led by a stable and highly capable board and management team, EVT is arguably one of the highest quality companies in the space.
Figure 5: EVT EPS, DPS & OCFPS 2005 – 2018F. Source: EVT Annual Reports, Thomson Reuters
Today, EVT’s operations encompass Cinemas, Hotels & Resorts, Property and Investment. The various portfolios include prominent brands such as Event Cinemas, Greater Union, Rydges Hotels & Resorts, QT Hotels & Resorts and Thredbo Alpine Resorts.
Figure 6: EVT 1H Earnings Split. Source: EVT 1H Results Release
Consistent with the theme of this article, EVT holds a substantial amount of property on its books. This in part reflects the fact that it wholly owns 24 of its 56 hotel portfolio (i.e. 24 hotels owned, 32 managed). Further, a reasonable portion of its property book has not been revalued for some time. We believe EVT’s property assets are conservatively valued in today’s marketplace.
Specific to earnings, we highlight the potential for upgrades should occupancy and average room rates continue to trend higher. EVT’s first half result noted “Occupancy in the Group’s owned hotels increased by 2.9 percentage points to 78.9% and average room rate increased 4.1% to $167, resulting in an uplift in revenue per room (revpar) of 8.1% over the prior comparable half year. Good domestic demand combined with a resurgence within the inbound market resulted in pleasing profit growth in the Group’s key hotel properties, including those in Sydney, Melbourne, Rotorua and Queenstown.” (source: EVT Half Yearly Report and Accounts, ASX Release 18/02/2016)
In terms of risks, we perceive the growth in online movie streaming (legal and piracy) as well as the rise of Airbnb to be potential longer term threats to the more traditional models of Movies and Hotels. While EVT continues to trade at a modest premium to intrinsic value, the company remains on our watch list of interest.
Ardent Leisure Group (AAD)
Ardent Leisure Group (ASX: AAD) is a specialist operator of leisure and entertainment assets across Australia, New Zealand and the United States. Throughout Australasia, AAD operates health clubs, AMF and Kingpin bowling centres, the Dreamworld, WhiteWater World theme parks, SkyPoint and d’Albora Marinas. The Group also operates the Main Event family entertainment centres in the United States.
Although exposed to similar tourism, leisure and recreational themes, AAD is well diversified by revenue type and increasingly by geography.
Figure 7: AAD Earnings Split. Source: AAD 1H 2016 Results Presentation
Specific to currency movements, we believe AAD is a significant beneficiary of a lower AUD in three key ways:
- Translation of a growing USD earnings base from AAD’s Main Event business
- Increased likelihood of internal travel to benefit theme parks division
- Increased inbound tourism also to benefit theme parks division
Largely as a result of its stapled security structure, AAD also has a meaningful amount of capital currently allocated to property assets. However, with the recent announcement of the divestment of its Marinas division, this will likely change in the coming months.
The logic behind this management decision is by selling off its Marinas division, the proceeds can then be subsequently allocated to funding an expedited roll out of Main Event. We believe this will be a strong positive for growth in profit and profitability (as measured by ROE) over the coming 3 years. AAD currently trades at a meaningful discount to intrinsic value and concurrently offers a yield of approximately 6.7% (unfranked).
Elanor Investors Group (ENN)
At its core, ENN is an investment and funds management company. This description does however belie its significant exposure to both property and tourism.
The Group has three operating divisions: Hotels, Tourism and Leisure; Funds Management and Special Situation Investments. ENN’s hotels, tourism and leisure division includes direct ownership of assets such as Featherdale Wildlife Park. ENN also recently established the Elanor Hospitality and Accommodation Fund, an investment trust that holds 6 Australian Hotels ‘with strong, diversified cash flows and significant redevelopment potential.’ This fund was effectively seeded by two ENN owned properties, Peppers Cradle Mountain Lodge and Mantra Wollongong. Given the growing tailwinds supporting Australian tourism, we remain positive on the prospects for this division in the years ahead.
ENN also appears to be gaining operational momentum in its funds management business, with owned and managed assets now totalling $590m (versus $173m as at its July 2014 listing). ENN typically generates revenue via an acquisition fee upon settlement of any new assets followed by annuity-like management fees thereafter.
One other potential value driver for ENN lies within its wholly owned ‘John Cootes Furniture Merrylands Property’, which has recently received development approval from the relevant government bodies. We believe this asset is arguably undervalued on ENN’s books. ENN currently trades at a slight discount to value while also offering an attractive yield of approximately 7.6%. With that noted, it is important to highlight that ENN is a small-cap and as such, its risk profile is correspondingly higher when compared with both EVT and AAD.
Figure 8: AAD, ENN and EVT investment metrics. Source: Clime Asset Management
When it comes to investing, we believe there are never any guarantees. We believe the diligent application of both top down and bottom up research is beneficial in providing individual investors with some edge in a market full of pitfalls. In line with this thinking, it is our view that the growth in services exports and more specifically, tourism, should provide for some fertile opportunities in the months (and potentially years) to come.
The following paper is a multi-part research series.
Read Part I: The overlap of property & ageing population
Written By Adrian Ezquerro, Senior Analyst. Prices and investment metrics correct at time of writing.
Disclosure: Clime owns shares in AAD and ENN for and on behalf of various mandates for which it acts as investment manager. Adrian Ezquerro owns AAD securities.