Relative to its largest rivals, Cromwell is more exposed to economic and property market conditions

Business Strategy & Outlook

Cromwell Property Group is an Australian property company that currently generates most of its income from rent on properties it owns, and a lesser amount from property funds management. The latter includes property management services, investment management, and property acquisitions and development, in collaboration with customers. The group tends to own co-investment stakes in funds or properties that it manages for clients, particularly in its wholesale business. This provides a degree of alignment with clients, as well as providing another indirect source of rental income. Cromwell yearns to grow its funds management business, and is exploring options to dispose of property assets, and instead act as fund manager of those assets. Directly held property investments account for more than half of group revenue, nearly all of this being offices. The office portfolio has significant exposure to less supply-constrained areas such as fringe central business districts, or CBDs, or suburban sites in Sydney, or less built-up capital cities such as Canberra, Adelaide, or Brisbane.

Relative to its largest rivals, this makes Cromwell more exposed to economic and property market conditions. Increasing CBD supply and cautious businesses could particularly hurt tenant demand in suburban and fringe locations. Reassuringly, Cromwell has solid tenants in many sites, with government accounting for circa half of Australian rent, and a decade-long lease to Qantas a big chunk of its Australian rent. A minority of earnings is from funds management activities, but this segment is likely to grow as Cromwell sells property assets and increases its focus on funds management. This segment generates a high return on equity because while it relinquishes rental income, it frees up capital for use elsewhere, while still generating management fees. A portion of revenue comes from indirect property holdings, mostly Cromwell’s stake in the Cromwell European REIT, listed in Singapore.

Financial Strengths

Cromwell targets gearing of 30%-40%. This is aggressive given Cromwell’s portfolio is largely in secondary locations. Group gearing (net debt/assets) as at June 2022 was in the mid-40s, and gearing on balance sheet was just below the top of the target range. Cromwell points out that gearing should reduce once various assets are sold, but this is subject to appropriate prices being achieved. Other assets up for sale include an Italian logistics portfolio and its LDK retirement living business. That makes us nervous given the group’s substantial investments in Europe. There’s a long-term cost of debt of 6.5%, significantly above current levels. Interest-rate risk is hedged but with a weighted average term of just 2.1 years. The group has a manageable AUD 200 million of debt expiries in fiscal 2023, but has AUD 800 million of expiries in 2024. Cromwell doesn’t have a large buffer to the 60% gearing limit specified in its banking covenants. The latter is boosted by the additional earnings from holding the Polish retail assets. Gearing ratios would rise if asset prices fell, which is possible given a spike in interest rates in early 2022, and the effects of hybrid-working yet to be fully felt in office markets. The group has a pipeline of developments, and may make further debt-funded acquisitions, which could also push up gearing. This can be offset by divestments and growing earnings from its funds management business. Cromwell reduced its targeted gearing ratio in 2019, having previously stated a target range of 35%-55%. Gearing needs to reduce meaningfully, likely through further asset sales.

Bulls Say

Cromwell’s portfolio avoids highly priced office assets in core CBD markets, opting instead for cheaper assets in secondary locations that it views as having greater potential for price upside or development.
Cromwell’s solid tenant profile means income on its directly held portfolio is more secure than most of its REIT rivals.
A recovery in population growth could help shore up the value of Cromwell’s assets due to urban infill, with better quality sites achieving more rent bargaining power, and some low-quality sites potentially switching to higher value uses.

Company Description

Cromwell Property Group is an internally managed Australian real estate investment trust. It owns an Australian portfolio of (mostly office) properties and also develops and manages properties on behalf of third-party investors. The group is exploring opportunities to sell some assets, particularly in Europe, and to spin out its office portfolio into a separate REIT, leaving the Cromwell business to focus more on funds management. The timetable is uncertain given higher interest rates are a headwind for property sales.

(Source: Morningstar)

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