Dexus (ASX: DXS)
INVESTMENT SUMMARY
- Materially oversold on remote work fears.
- Maintained 50c dividend and did not raise capital during COVID-19.
Ticker | ASX:DXS
GICS Sector | Real Estate
Current Price | A$8.69
12m Target Price | ▲ A$10.85
Upside | 25%
Market Cap | A$9,476m
P/E | 14.1x
Div Yield | 5.8%
BUSINESS DESCRIPTION
Dexus engages in office and industrial real estate development, leasing and tenant services. The Office segment offers domestic office space with any associated retail space, car parks and office developments. The Industrial segment comprises of domestic industrial properties and warehouses. Dexus was founded in 2004 and is headquartered in Sydney.
INVESTMENT THESIS
Remote Work Fears Overblown
Dexus is trading 33% below pre-COVID highs due to fears that the rise in remote work will permanently reduce office demand. We believe remote work fears are overblown given the reassuring 1H21 result and survey data that suggests that permanent remote work in Australia will only be marginally higher post-COVID compared to pre-COVID levels.
Key metrics from 1H21 result:
- 1H21 DPS of 28.8c (+6.7% YoY), maintaining a 100% AFFO payout ratio.
- FY21 DPS expected to be in line with FY20 levels and consensus estimates of 50.3c.
- 1H21 underlying FFO per share of 30.1c (-5.6% YoY) impacted by rent relief and development revenue deferrals to 2H21.
- 1H21 occupancy slightly slower at 96% vs 96.5% FY20.
- NTA increased from $10.86 to $10.96.
The 1H21 result demonstrated a surprising level of earnings resilience. Underlying FFO only fell 5.6% despite hard lockdowns in Victoria, rent relief and churn. Office occupancy only fell marginally by 0.5% to 96% in 2020 despite 4% of leases expiring. This suggests net churn during the height of remote work was below some pre-COVID years.
The slight short-term decline in office demand is consistent with surveys regarding longer-term remote work trends. A survey of 1002 employees conducted by Boston Consulting Group suggests the share of permanent remote work will increase from 11% to 15% because of COVID in Australia.
Source: Boston Consulting Group 2020
We estimate structural office demand will be an estimated 4-7% lower due to COVID. Part-time office use will still require full leases, assuming hot-desking arrangements remain unpopular. Thus, we expect dividends to grow marginally slower than the 5.8% historical long term average rate but not decline.
We also believe that the market is incorrectly extrapolating the declining demand for office space in the US to Australia. Companies that have allowed long term remote work are predominately global technology companies such as Twitter, Square, Facebook and Microsoft which have substantially smaller employee bases in Australia. The largest listed companies in Australia have not announced long term remote work plans.
Office occupancy in Victoria is artificially deflated due to a 50% cap. As restrictions are lifted, we expect office demand to sharply rebound with the rest of the country.
Prudent Capital Management
Dexus expects to maintain its 50.3c dividend for FY21 whilst other income stocks have cut dividends and trade materially closer to pre-COVID levels. The ASX 200 REIT sector (XPJ) reduced its dividend by 32% in 2020 and trades 19% below 52W highs. Transurban halved its dividend and trades 18% lower.
To improve its balance sheet, Dexus divested $2b in assets at book value and did not dilute shareholder value. Comparatively, the travel sector conducted extremely dilutive capital raises at the bottom of the market and yet market capitalisations now trade close to pre-COVID levels.
CATALYSTS
Key catalysts include a successful vaccine rollout, easing of office occupancy caps and FY21 earnings.
VALUATION & PEER COMPARISON
Our target price of $10.85 assumes a 4% lift in dividends to $0.52 by FY23 and is based on management NTA of $10.96 (40% weighted), a historical 3-year average yield of 4.6% (40% weighted) and a peer implied relative yield of 5% (20% weighted).
INVESTMENT RISKS
Key risks include higher permanent remote work or uptake in hot-desking than expected, worsening economic conditions, uncontrolled COVID-19 outbreaks in Australia and rising interest rates.
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