Charter Hall Retail REIT Earnings: Inflation-Linked Leases Ease the Pain of Higher Finance Costs
No-moat Charter Hall Retail CQR REIT’s fiscal 2023 earnings were marginally below our expectations and guidance for fiscal 2024 was marginally ahead by a similar amount. Our fair value estimate rises 4% to AUD 4.30 due to the time value of money. Operating earnings per security, rose 1.1% to AUD 28.7 cents per security, and distributions were up 5.3% to AUD 25.8 cents. Management guidance is for operating earnings to decline in fiscal 2024 to AUD 27.4 cents per security. We assume a distribution of AUD 25.5 cents per security, around the midpoint of guidance of a 90%-95% payout ratio.
The main takeaway from the result is that growth in property income is largely being offset by rising finance costs. That’s likely to remain the case until debt costs peak, which we expect to occur by fiscal 2027, given the REIT’s hedging and fixed-rate debt should have largely expired by then. The REIT’s average cost of debt was 4.3% as of June 30, 2023, and we assume it gradually rises as hedges expire, toward our long-term estimated cost of debt of 6.5%. We expect roughly flat earnings over that period, but revenue growth should drive low-single-digit earnings growth once the interest rate headwind abates.
Charter Hall Retail REIT has slightly stronger revenue tailwinds than some rivals. First, 24% of rent is linked to inflation, which is currently elevated, and another 35% is indirectly linked to inflation via sales turnover clauses in the leases. Around one-third of major tenants have triple-net leases, meaning those tenants pay property costs, mitigating some of the cost impacts of inflation.
Charter Hall Retail REIT securities are down 24% from their 2022 peak and now screen as undervalued. Our estimates put the REIT on a 7.5% fiscal 2024 distribution yield. That looks attractive considering a 10-year bond yield of 4.3% at the time of writing, and our assumption of approximately flat earnings with moderate downside risk, followed by growth once interest costs peak.
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