Buying stocks exposed to residential property has been one of this column’s main themes over the past two years. The logic was simple: record-low interest rates would persist longer than expected, spurring demand for new and established property.
But every idea has its day. Low wages growth, rising unemployment and shaky consumer confidence suggest property-price growth, already slowing, will decline in 2015. Lower house prices would weigh on dwelling investment and consumption.
That’s the theory. I expect house-price growth to moderate or flatten over 2015 rather than tumble. It’s hard to see interest rates rising in 2015 as this tepid economic backdrop persists. Housing affordability should remain solid, and the Reserve Bank still has scope to cut the official cash rate should conditions unexpectedly deteriorate.
I’m more concerned about State-specific property issues rather than national trends. Take Perth as an example. A long-time Perth businessman last week told me activity in West Australia had noticeably contracted after sharp falls in the iron ore price this year. “Perth property prices have to drop if the iron ore price keeps declining,” he said. “It’s already hurt sentiment.”
This column identified Perth-based stgelopers Cedar Woods Properties Group and Finbar Group for The Bull in November 2013. Cedar Woods has a one-year total shareholder return (including dividends) of 1.3 per cent to November 19, 2014. Finbar’s one-year return is flat.
Another Perth-based stgeloper, Peet Limited, has done much worse: down 18 per cent over one year and an average annualised loss of 10 per cent over five years to November 2014. But Peet could be forming a base on its chart, and some brokers are upgrading their price targets.
Chart 1: Peet
Like many property companies, it expanded in too many directions in the lead-up to the 2008 Global Financial Crisis. Investments in retirement villages, industrial properties and an income fund took it away too far away the core business.
Peet’s decline was swift and brutal. After averaging a super-impressive 51 per cent Return on Equity over FY05 to FY08, the ROE tumbled to low single digits in FY12 and FY13. It recovered to 7.5 per cent in FY14, but that is still too low for a small-cap growth company.
Net gearing was 110 per cent in FY12, with $277 million of long-term debt. Net interest cover of just 2.7 times that year showed the precariousness of Peet’s situation. No dividends in FY12 and FY13 also disappointed shareholders.
But there are good signs in Peet’s turnaround. Net gearing fell to 61 per cent in FY14 as it repaid some long-term debt. Net interest cover is back to 8.8 times, and the ROE is starting to rise, albeit off a low base. The business looks a lot simpler these days.
Peet is also becoming more profitable. Earnings before interest and tax (EBIT) of $46 million in FY14 compares with $9 million at its lowest point in FY12.
With a stronger balance sheet, Peet is able to expand through acquisition. It bought half of the Golden Bay Estate in Perth in a joint venture with the Future Fund, and full ownership of the Bluestone Estate in Adelaide, again with the Future Fund. Both are strong acquisitions.
Peet completed a $47 million placement in November at $1.11 a share to fund the acquisition of interests in six residential property stgelopments. The offer was oversubscribed and Peet chairman Tony Lennon bought about $7 million of stock in the capital raising.
Peet says the acquisitions cost $95 million, give 3,000 new lots/dwellings and provide further geographic diversification in two new growth corridors. The acquisitions also give Peet a bigger footprint at a time of still strong residential property conditions.
I like how Peet is paying down debt, attracting strong partners and paying dividends again, usually a good sign in turnaround situations. And that its chairman bought more stock. Even so, Peet’s unfolding recovery may not be reflected in its share price, according to several brokers. Peet has fallen from a 52-week high of $1.52 to $1.15.
UBS has an outperform recommendation and $1.57 price target over 12 months. UBS wrote: “With the majority of the land bank entering the selling phase over the next 2-3 years, we see potential for Peet to benefit from both strong top-line growth (assisted by the cycle) and potential stabilisation/reduction in stgelopment costs (with most infrastructure-related spend undertaken in the FY13-FY15 period).”
Deutsche has a $1.97 12-month target. It wrote: “We believe the announced acquisitions make sense and that in FY15 the acquisitions will be neutral to earnings per share, and accretive from FY16 (in line with management expectations). We continue to rate Peet a Buy with significant upside to the current share price.”
Macquarie Equities Research is also bullish on Peet, with an outperform recommendation and price target of $1.41, implying a 30 per cent total shareholder return over 12 months (from $1.11 when Macquarie issued the research note).
As a small-cap stock, Peet suits experienced investors who are comfortable with higher risk. Property stgelopers such as Peet can be volatile, as can turnaround situations. Plenty disappoint. And the Perth property market is, to some degree, hostage to volatile commodity-price movements and the strength of the resource sector and employment.
Still, there’s a lot to like about Peet’s unfolding tuarnound, its strategy and execution, and its current value for medium-term investors.
Tony Featherstone is a former managing editor of BRW and Shares magazines. This column does not imply any stock recommendations or offer financial advice. Readers should do further research of their own or talk to their adviser before acting on themes in this article. All prices and analysis at November 19, 2014.