Background
Charter Hall Group (ASX: CHC) is a leading property manager and developer in Australia. Its operations can be divided into three main components: property development, investment and fund management. It has a top quality property portfolio with decent diversification in terms of property type:
Business Model
Compared to traditional REITs, Charter Hall's fund management business has a much better business model. The three components complement each other: typically, CHC first acquires property for development (thereby earning development income), then collect rent from the property (earning investment income) and finally selling the property to funds it manage (earning fund management income). Fund management represents the largest source of income, accounting for 80% of total revenue in FY22.
Charter Hall charges a certain percentage of the Asset Under Management (AUM) for managing property funds. Fund management income is therefore influenced by the amount of AUM, which is in turn determined by market valuation of fund property and the ability of Charter Hall to raise new funds. Charter Hall is recognised as a leading fund manager as it has a consistent record of outperforming benchmarks, thereby attracting investor to subscribe its funds.
Charter Hall will benefit from institutional investors allocating more capital to property investments. Indeed, it has completed several large-scale deals with institutional investors (such as GIC, PGGM) this year.
Risks
Undoubtedly, while the fund management business allows Charter Hall to achieve Return on Equity (ROE), it will expose Charter Hall to greater cyclical risks, as investors are less willing to subscribe new funds when the property market is falling. Therefore, Charter Hall is more sensitive to the macro-economic risks, and in particular the property market, compared to traditional A-REITs. Performance fee will also likely to reduce in the current environment given falling property prices.
However, with net cash on its standalone balance sheet (excluding the funds it manage), Charter Hall has ample dry powder to take advantage of the bear market. It is also worth mentioning that most of Charter Hall's sources of capital comes from institutional investors who usually invest for long-term. This provides cushion for the fund management income as these institutional investors are unlikely to withdraw their investments merely because of rising interest rates, as long as the funds are outperforming broader property market. Listed Funds also represent a highly stable source of income.
Valuation
At the last traded price on 13.67 (on 25 Nov 2022), Charter Hall has a PE of 11.8 (including performance fee), or 20 (excluding performance fee). JPMorgan forecasted Charter Hall's operating earnings (excluding performance fee) to grow by 18% in 2023 from 0.67 to 0.79 per share, leading to forward PE of 17.
I believe at current share price level, Charter Hall represents good long-term investment for investors who have faith in Australia's commercial property market. I have started to accumulated shares of CHC at $16, and will continue to accumulate at current price level.
