Arena REIT (ASX: ARF)
INVESTMENT SUMMARY
- Insolvency fears overblown due to low gearing, substantial childcare stimulus and high ongoing occupancy rates.
- Attractive dividend yield and resilient dividend growth despite higher unemployment and COVID restrictions.
Ticker | ASX:ARF
GICS Sector | Real Estate
Current Price | A$2.36
12m Target Price | ▲ A$3.20
Upside | 36%
Market Cap | A$772m
PE | 14.6x
Div Yield | 6.2%
BUSINESS DESCRIPTION
Arena operates as a real estate investment trust. It leases out its social infrastructure assets to a diversified tenant base in the childcare and healthcare sectors. The company was founded in 2003 and is headquartered in Melbourne, Australia.
INVESTMENT THESIS
Resilient Dividend Growth
Arena will pay a 14c dividend (+4% YoY) in FY20 in line with their guidance revised in May 2021. This is whilst the broader ASX 200 REIT sector is expected to cut dividends by 11% in FY20. Additionally, management has to 3-4% dividend growth for FY21, tracking ahead of consensus expectations of merely maintaining the dividend. Thus, Arena remains one of the few REITs to grow dividends during COVID.
Dividend growth was driven by a 3.4% average like-for-like rent increase, occupancy rebounding quickly and sharply to remain within 5% of pre-COVID levels and a continued successful rollout of new properties. Rent increases are ongoing and relatively predictable as 80-90% of leases have fixed rent reviews and the weighted average lease period is 14 years.
High occupancy levels have been supported by unprecedented childcare subsidies. The $1.6b Early Childhood Education and Care Relief Package (ECECRP) allowed for 99% of childcare services to remain operational as of 27 May 2020. As childcare tenants were provided with ample liquidity and cash flow support to stay afloat, only 2% of rent was abated in the June quarter of 2020 for Arena.
The ECECRP expired on 12 July 2020 and was replaced with ongoing transition payments only a quarter of the ECECRP. Whilst the market has been disappointed with the size of the stimulus extension, upbeat dividend growth guidance from Arena suggests that tenants are now able to stay afloat with less government life support. The transition payments expire on 27 September 2020.
Insolvency Fears Overblown
Arena trades 30% below pre-COVID highs. As the short-term dividend outlook has remained largely unchanged, we believed the market is worried about solvency. However, we believe that insolvency risk is low due to low gearing, higher occupancy rates and substantial childcare stimulus to keep tenants afloat.
When adjusted for a lower AU Treasury 10 Year Yield of 0.89%, REITs are one of the few sectors trading at a discount to historical valuations on a forward PE basis. This is despite the lower bond yields or discount rate applied to cash flows and near-term earnings downgrades also experienced across other sectors due to COVID. We believe the discount applied to REITs is due to the higher insolvency risk attached to higher leveraged companies in an economic downturn.
Arena neither has high levels of gearing nor is experiencing short term earnings pressure. Net debt to equity has fallen to 17.8% after raising $85m in equity at $2.28. The capital raise was scaled up from an initial $60m after being oversubscribed and five directors participated in the raise. Thus, we believe a price floor is set at $2.28 and limits downside investment risk. The earliest debt maturity has also been extended to 2023, providing more than ample time for economic recovery before insolvency, if ever, can be declared.
Another overblown concern is that of prolonged levels of high unemployment which would structurally reduce demand for childcare services. Whilst unemployment has risen to 7.4% in June 2020, it has remained well below that of other developed such as the US which has seen unemployment begin to fall. Thus, we also expect unemployment in Australia to begin recovering near term. Temporarily higher unemployment will only temporarily reduce sales to childcare services but have little to no impact on the fixed rents paid to the landlord.
CATALYSTS
Key catalysts include childcare stimulus extension beyond the 27 September 2020 expiry, a trading update at the AGM in November 2020 and monthly unemployment figures.
VALUATION & PEER COMPARISON
Dividend Yield
We believe Arena should trade at a 4.5% forward dividend yield, at a premium to average pre-COVID historical valuations. The resilience of the business during the pandemic should more than offset the valuation detraction of a marginally slower forward growth rate compared to pre-COVID levels. This implies a price target of $3.20 and an upside of 36% from the last close.
INVESTMENT RISKS
Key risks include sustained long-term high unemployment, premature withdrawal of childcare subsidies and permanent material reductions in demand for childcare due to work from home trends.
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