Stock Story: Charter Hall

Airlie Funds Management

January 2024

Underappreciated quality.

Business Quality is a key factor in the Airlie investment process, and we typically define a high-quality business as one that can earn a decent return on its capital. The Real Estate Investment Trust (REIT) sector is not typically thought of as a high total return sector due to the low-yielding nature of real estate and high capital intensity to just 'stay in business'. That said, it may come as a surprise that CHC has delivered a total return of ~11.5% p.a. since its IPO in 2006. This performance has been driven largely by CHC's transition from a traditional REIT to a fund manager, which generates fees on client capital with minimal amounts of incremental investment required.  

Now, I know you are probably thinking, "Why would I want to invest in an office fund manager, particularly in the current interest rate environment?" We believe these risks are more than captured in CHC's current price and have provided the opportunity to invest in a high-quality business at an attractive valuation. 

But Office is Dead?

We don't disagree that the 'Work From Home' trend has created meaningful challenges for the Office sector. Corporates have quite reasonably concluded they can achieve substantial rent savings while providing their workforce with increased flexibility. This has resulted in an increase in market vacancy and placed pressure on rents.

Prime CBD Office Vacancy Rates

Source: Jefferies, JLL

This has understandably weighed on Charter Hall, with the share price down 48% since its peak of $21.83 in 2021. While Charter Hall will undoubtedly be affected by weakness in Office, we believe the criticism is not entirely fair given roughly two-thirds of its Funds Under Management (FUM) is in 'non-office' sectors, including Industrial and Logistics (28%), Equities (18%), Retail (16%) and Social Infrastructure (4%). 

Source: Charter Hall

Further, the real estate cliché "location, location, location" remains as relevant as ever. The fundamentals for well-located, new and environmentally friendly buildings are markedly different from those that do not have these characteristics. The figure below highlights the divergent vacancy trends seen between core and non-core regions of Sydney CBD. Equally, the vacancy rate for buildings in Sydney that are less than 10 years old is ~6% versus ~13% for those over 10 years old (source: JLL and Charter Hall Research). 

CHC's Office Portfolio skews to newer, better-located buildings, which has led to superior outcomes including 96% occupancy (vs 85% national average), 89% leasing retention rate and a high-quality tenant base like the Australian Government, multinationals and listed companies (which account for 56% of the Group's property platform income). 

High Interest Rates?

It wouldn't be an investor communication without a quote from Warren Buffett, who said, "Interest rates are to the prices of assets like gravity is to the function of earth". As such, it's no surprise that the 10 Year Australian Government Bond Yield rising from <1% during the pandemic to almost 5% weighed on an asset manager like CHC. Most obviously, it has reduced the value of the assets that it manages and charges fees on.  

Source: Federal Reserve Bank of St Louis

Second, the rapid increase in interest rates has frozen transaction activity in the sector with investors unwilling to make long-term, illiquid investments for fear the price of the asset could fall in the near term. This is not ideal for Charter Hall where transaction activity allows it to acquire new assets, increase its FUM and thereby grow earnings.  

While we don't claim to be economic forecasters, we'd argue that with interest rates at 10-year highs and inflation measures falling, it seems more likely than not that interest rates have peaked. We believe this peaking of interest rates is likely to see transaction activity begin to return and allow CHC to mitigate devaluations in its FUM. From FY19 - FY23 CHC added $5.7b per year to FUM from acquisitions and $2.0b p.a. from developments. Therefore, a return to average transaction and development activity would sufficiently offset a 10% decline in current Property FUM of $71b due to devaluations.

Underappreciated Business Quality

CHC trades at ~15x FY24 EPS guidance, which is a large discount to the ASX 200 of ~22x (excluding financials and resources) despite a track record of growing EPS at 15.1% p.a. over the last 10 years.

Source: Charter Hall

We believe CHC is a higher-quality business than it is given credit for, with several factors often overlooked: 

• ~73% of its revenues are highly recurring, creating a stable, lower risk earnings stream for shareholders, which therefore should warrant a higher multiple. 

• CHC's FUM are relatively 'sticky', meaning they cannot be easily or quickly redeemed. This is somewhat a by-product of redemption terms being structured to align with the fact that the underlying investments are large and illiquid: 

• ~72% of FUM is in 'Wholesale' (unlisted) strategies where institutional investors typically have redemption windows every 5 - 7 years, meaning they cannot pull their money out quickly. 

• ~15% of FUM is in 'Listed' vehicles, which more or less cannot be redeemed. 

• ~12% of FUM is in 'Direct' (unlisted) strategies for HNW individuals, which can typically be redeemed only every 5 years.  

• Many of CHC's 'wholesale' investors have a lower cost of capital (return requirement), which means CHC can pay more for assets, providing it with an advantage in an auction for an asset. 

• There are few other Fund Managers in Australia with the ability to purchase large assets worth more than >$1b, which further reduces competition in auctions for CHC. 

• Funds Management EBITDA Margins have grown over the last ten years to 73%, highlighting the business's scalability. Even after removing the more volatile transaction and performance fees, the EBITDA margin is 62%, which reduces operating leverage and creates a stable earnings stream. 

• As Charter Hall's funds management business has delivered strong performance, and its relationship with equity partners improved, CHC has not needed to 'seed' its investment vehicles with the same proportion of capital. This reduces its overall capital requirements of the business, allowing for both a higher return on capital and greater returns to shareholders. 

• While there is implied leverage related to Charter Hall's investments in its own funds, at the group level, CHC has a very clean balance sheet with virtually no net debt, which provides it with optionality, particularly in a more difficult real estate market.

Attractive Valuation

Despite CHC's rising margins, decreasing capital requirements, proven earnings growth and business quality, it still trades at ~14x 1-year forward EPS which is well below the ASX 200 multiple of ~22x (excluding commodities and banks). Furthermore, we view the company's FY24 guidance of 75 cents per share as 'trough' earnings given it implies virtually no performance or transaction fees. If we normalise FY24 performance and transaction fees to a level that is in line with historical averages, CHC would be trading at ~10x FY24 EPS. We believe that if inflation continues to fall, interest rates stabilise and there is discussion of rate cuts - as we have seen in recent months - CHC's multiple should re-rate to account for the cyclically low earnings and depressed multiple. 

By Jack McNally, Investment Analyst

Funds operated by this manager:

Airlie Australian Share Fund

Important Information: This material has been delivered to you by Magellan Asset Management Limited ABN 31 120 593 946 AFS Licence No. 304 301 trading as Airlie Funds Management ('Airlie') and has been prepared for general information purposes only and must not be construed as investment advice or as an investment recommendation.  This material does not take into account your investment objectives, financial situation or particular needs. This material does not constitute an offer or inducement to engage in an investment activity nor does it form part of any offer documentation, offer or invitation to purchase, sell or subscribe for interests in any type of investment product or service. You should obtain and consider the relevant Product Disclosure Statement ('PDS') and Target Market Determination ('TMD') and consider obtaining professional investment advice tailored to your specific circumstances before making a decision about whether to acquire, or continue to hold, the relevant financial product. A copy of the relevant PDS and TMD relating to an Airlie financial product or service may be obtained by calling +61 2 9235 4760 or by visiting www.airliefundsmanagement.com.au.

Past performance is not necessarily indicative of future results and no person guarantees the future performance of any financial product or service, the amount or timing of any return from it, that asset allocations will be met, that it will be able to implement its investment strategy or that its investment objectives will be achieved. This material may contain 'forward-looking statements'. Actual events or results or the actual performance of an Airlie financial product or service may differ materially from those reflected or contemplated in such forward-looking statements.

This material may include data, research and other information from third party sources. Airlie makes no guarantee that such information is accurate, complete or timely and does not provide any warranties regarding results obtained from its use. This information is subject to change at any time and no person has any responsibility to update any of the information provided in this material. Statements contained in this material that are not historical facts are based on current expectations, estimates, projections, opinions and beliefs of Airlie. Such statements involve known and unknown risks, uncertainties and other factors, and undue reliance should not be placed thereon. No representation or warranty is made with respect to the accuracy or completeness of any of the information contained in this material. Airlie will not be responsible or liable for any losses arising from your use or reliance upon any part of the information contained in this material.

Any third party trademarks contained herein are the property of their respective owners and Airlie claims no ownership in, nor any affiliation with, such trademarks.   Any third party trademarks that appear in this material are used for information purposes and only to identify the company names or brands of their respective owners. No affiliation, sponsorship or endorsement should be inferred from the use of these trademarks.  This material and the information contained within it may not be reproduced, or disclosed, in whole or in part, without the prior written consent of Airlie.

Market Commentary - January

Glenmore Asset Management

February 2024

Funds operated by this manager:

Glenmore Australian Equities Fund

Hedge Clippings | 16 February 2024

Hedge Clippings copped some flak from some quarters recently when we suggested moving Australia Day from the end of January to somewhere nearer the beginning of the month. Our comments were nothing to do with the celebration - or commiserations - that are normally associated with the arrival of the First Fleet, but all about getting workers off the beach, out of the bar, or away from the back-yard barbie and back to work. To put it bluntly, Australia is largely a "no-work" or "no-deal" zone from at least mid-December (and post Cup Day in Melbourne) through to the beginning of February.

This was reiterated (but not quite so bluntly) by the ABS this week when releasing January's unemployment data, which came in at 4.1% - the first time for two years that it has been above 4 per cent. For the past 3 years, the January unemployment rate has coincided with a higher-than-usual number of unemployed people who said they were expecting to start work in the next four weeks.

One can argue that this was not their choice - there may have been fewer jobs on offer - or that they had chosen the beach/bar/barbie option or a combination of the two. Either way, if the holiday season ended three weeks after Christmas instead of five, Australia would be a whole lot more productive. Of course, the likelihood of that happening is about the same as politicians voting themselves a pay cut, or come to that, a longer working year. 

For the record, Federal politicians leave Canberra at the end of November, not to return until early February. Of course, that generally keeps them out of the news, or in some cases off the streets - Barnaby, please note!

Back to the unemployment numbers, the economy, and inevitably the outlook for interest rates:

While employment has been steadily rising (excluding a slight hiccup in the 3rd quarter of 2021) since March 2020 (when all we could think or talk about was COVID), the number of hours worked has been much more volatile, and has been steadily falling since April last year.

There are a whole range of statistics around employment - unemployment, underemployment, the participation rate, and employment to population ratio, and even the NAIRU (or 'non accelerating inflation rate of unemployment') - which collectively leave Hedge Clippings with a headache, but the bottom line, according to the ABS, is they "all point to a slowing labour market during 2023-24, although this follows a particularly tight market in 2022-23."

This shouldn't upset RBA Governor Michele Bullock, given she was on the record in a speech she gave in June last year while Deputy Governor, saying the RBA was forecasting unemployment to hit 4.5% by late 2024, with employment growth still intact, and (and at that time) inflation returning to target by mid 2025. Under these circumstances, she said, "the economy would be closer to a sustainable balance point."

Not wanting to fall into the same ditch as her then boss Philip Lowe had done, she was careful not to make any predictions on interest rates, but did cover herself by adding "Of course these forecasts are subject to a considerable amount of uncertainty."

However, at this stage it looks as if she's on track with the employment forecast, and provided she doesn't ease rates too quickly, she may even get inflation back to the 2.5% target by mid (or late) 2025. At her most recent press conference, she sensibly covered all bases on the next move in official rates - possibly up, possibly down (but don't get excited), or (more likely) on hold for a while longer while waiting for more data, all aiming for the happy space of a "soft landing".

Across the Pacific in the US it's much the same, as Fed Chair Jerome Powell also disappointed the market by dampening expectations for an early easing, in spite of falling inflation, 3.7% unemployment, and solid economic growth. Having faced, and to date turned, the direction of inflation with 11 rate rises, he'd rather keep them where they are, and things going as they are, until the gains are locked in.

News & Insights

New Funds on FundMonitors.com

Investment Perspectives: Global real estate - the outlook and themes for 2024 | Quay Global Investors

A few charts from our Micro Caps CY2024 Overview | Equitable Investors

January 2024 Performance News

Bennelong Long Short Equity Fund

Airlie Australian Share Fund

Collins St Value Fund

DS Capital Growth Fund

Bennelong Concentrated Australian Equities Fund

Insync Global Quality Equity Fund

Delft Partners Global High Conviction Strategy

Bennelong Twenty20 Australian Equities Fund

Cyan C3G Fund

If you'd like to receive Hedge Clippings direct to your inbox each Friday

JOIN OUR MAILING LIST

Murray Ackman: Ignore the billionaires -

diversity, equity and inclusion are good for investors

Pendal

February 2024

AMERICAN billionaires seem to be picking fights with big brands and civil rights groups over whether corporate diversity, equity and inclusion (DEI) policies are discriminatory.

Or even whether they cause aircraft malfunctions.

If you've been following the "woke backlash", you'd be familiar with recent flash points such as the campaign against Harvard's first Black female president Claudine Gay.

Tesla's Elon Musk, hedge fund manager Bill Ackman and Lululemon founder Chip Wilson have all been engaging in civil discourse on social media recently, expressing anti-DEI views.

Musk went as far as suggesting that Boeing, fresh from having a fuselage panel fall off mid-flight last month, was prioritising diversity over safety. That drew a swift rebuke from civil rights groups.

"DEI must DIE," Musk said recently on his X social network. "The point was to end discrimination, not replace it with different discrimination."

This week the Tesla CEO erased mention of DEI in the electric vehicle maker's corporate filings.

Do DEI critics have a point? And what does that mean for investors and companies?

What are the concerns about DEI?

Musk's criticism of Boeing centred around the impact and unintended consequences of connecting executive pay to diversity targets and ESG metrics.

At the start of 2022 Boeing altered its bonus scheme, rewarding executives who hit certain climate and DEI targets.

Boeing is certainly not alone here.

In 2011, just 1 per cent of listed companies had such a policy. By 2021 it was 38 per cent, and the trend continues.

Supporters argue this is positive for companies and shareholders.

The idea is that such policies safeguard future economic results from risks while aligning the managerial objectives with shareholder interests.

Sharemarket analysts look for such policies as a sign that a business cares about a particular issue.

Who's right?

Does linking executive pay to diversity improve a business? Or are such corporate DEI policies a sign of excess?

There are plenty of studies - including from Pereptual's Regnan sustainable investing business - suggesting DEI can drive business outperformance.

A 2021 study from sustainable investing leader Regnan found that DEI - and especially equity and inclusion - can drive business outperformance.

A series of McKinsey & Company reports found "not only that the [DEI] business case remains robust but also that the relationship between diversity on executive teams and the likelihood of financial outperformance has strengthened over time".

Yet Regnan also found many businesses think about diversity and inclusion in a flawed way. For example, DEI policies often focus on the needs of minority groups, while majorities are not always adequately considered.

For investors and companies alike, we believe organisational settings should allow all talent to flourish - including 'majority talent' as well as talent that is traditionally under-represented.

These are essential pre-requisites for an equitable and inclusive workplace. Businesses benefit from fair employment practices, supportive cultures and open decision-making.

What it means for investors

While there is now a lot of ESG measurement going on inside companies, it's fair to say there could be a deeper discussion about how inclusive culture can be good for a business.

But is Elon Musk right to say there is undue focus placed on DEI?

The billionaire's complaints could make sense in the context of a boot-strapped start-up operating from the proverbial garage.

But it feels provocative coming from the CEO of a business with one of the highest market caps in history.

Based on our experience at Pendal, businesses clearly demonstrate what they care about by what they report.

And that is useful for investors.

Investors should expect to see comprehensive DE&I plans from companies. And take caution with companies that ignore these responsibilities.

And they should look beyond the reported diversity numbers to understand if a business has the right structure to allow for diversity and growth.

While it's entertaining to see billionaires argue among themselves, investors must understand how a company thinks about diversity and inclusion if they want to understand whether it is managing risks.

Author: Murray Ackman

Funds operated by this manager:

This information has been prepared by Pendal Fund Services Limited (PFSL) ABN 13 161 249 332, AFSL No 431426 and is current as at December 8, 2021. PFSL is the responsible entity and issuer of units in the Pendal Multi-Asset Target Return Fund (Fund) ARSN: 623 987 968. A product disclosure statement (PDS) is available for the Fund and can be obtained by calling 1300 346 821 or visiting www.pendalgroup.com. The Target Market Determination (TMD) for the Fund is available at www.pendalgroup.com/ddo. You should obtain and consider the PDS and the TMD before deciding whether to acquire, continue to hold or dispose of units in the Fund. An investment in the Fund or any of the funds referred to in this web page is subject to investment risk, including possible delays in repayment of withdrawal proceeds and loss of income and principal invested. This information is for general purposes only, should not be considered as a comprehensive statement on any matter and should not be relied upon as such. It has been prepared without taking into account any recipient's personal objectives, financial situation or needs. Because of this, recipients should, before acting on this information, consider its appropriateness having regard to their individual objectives, financial situation and needs. This information is not to be regarded as a securities recommendation. The information may contain material provided by third parties, is given in good faith and has been derived from sources believed to be accurate as at its issue date. While such material is published with necessary permission, and while all reasonable care has been taken to ensure that the information is complete and correct, to the maximum extent permitted by law neither PFSL nor any company in the Pendal group accepts any responsibility or liability for the accuracy or completeness of this information. Performance figures are calculated in accordance with the Financial Services Council (FSC) standards. Performance data (post-fee) assumes reinvestment of distributions and is calculated using exit prices, net of management costs. Performance data (pre-fee) is calculated by adding back management costs to the post-fee performance. Past performance is not a reliable indicator of future performance. Any projections are predictive only and should not be relied upon when making an investment decision or recommendation. Whilst we have used every effort to ensure that the assumptions on which the projections are based are reasonable, the projections may be based on incorrect assumptions or may not take into account known or unknown risks and uncertainties. The actual results may differ materially from these projections. For more information, please call Customer Relations on 1300 346 821 8am to 6pm (Sydney time) or visit our website www.pendalgroup.com