Investment implications
50% drawdown in share price. From peak to trough, the CHC share price fell ~50% in this cycle. This is the third largest drawdown since listing (GFC -95%) and Covid-19 (-60%). In our view, the market is being too aggressive at discounting the impact of higher interest rates, and the potential slowing of fee income associated with a potentially more difficult operating environment.
Valuation discount has now emerged in the share price. CHC’s earnings multiple is currently ~10% premium to the listed fund managers of Pendal (PDL) and Perpetual (PPT). Over the last 5 years, this CHC has typically traded at a 35% premium. In our view, the current share price does not fully reflect the superior unit economics of a property-based asset manager or the ability to maintain Assets Under Management (AUM) in a macro environment which is potentially more difficult than in the last 5 years.
Rising interest rates are likely to slow earnings momentum. CHC has benefited from falling interest rates for much of the last decade. In our view this provided a tailwind for CHC; 1) rising asset values; 2) increased transaction activity/performance fees; 3) increased investor allocation to property driving fund flows, and 4) strong underlying end-user demand for CHC property assets. At PER ~13x FY23E, any potential slow-down in earnings is largely priced into the share price. AUM growth is likely in all but the most severe property downturn.
We believe CHC AUM growth is unlikely to fall, outside of a severe fall in commercial property prices/activity levels. The pending deal to partially acquire Irongate Group (12%) will add $1.5bn to AUM in 2023. CHC needs to acquire ~$2.5bn pa to maintain a single-digit AUM growth rate.
Market forecasts imply a fall in earnings. The market is currently assuming CHC earnings fall -20-25% in FY23/24E vs FY22E which is expected to be a record year for earnings driven by a blowout level of transaction and performance fees in FY22E.
Strong management, and capital discipline. CHC has a well-respected management team. CEO David Harrison has been in the role for 6.5 years. Incentives are aligned to EPS growth. CHC historically has been an astute allocator of capital over the years, with limited dilution to shares on issues. CHC last raised equity in 2016/17.
Investment view
CHC is a well-run property-based asset manager. We see a period of slowing AUM growth ahead, primarily driven by a change in the interest rate cycle. Significant transaction and performance fee benefits in FY22E, imply negative earnings growth into FY23E (largely captured in market forecasts). This will likely create a headwind for the new investors to consider CHC over the coming 6-12months.
In our view, much of the narrative around higher interest rates/potential for falling commercial property prices and its potential impact on CHC earnings is now captured in the share price.
Over the last 6 months, the earnings multiple has de-rated from a peak of 27x to 13x (now around the long-term average), solely driven by the fall in the share price. With market perceptions around property-based asset managers likely to remain suppressed against rising interest rates into early 2023, we rate CHC a Hold.
3 key investment issues
1) Can AUM growth continue?
CHC is a property-based funds management business. AUM growth is a critical measure for investors and traditionally has had a significant bearing on the valuation multiple applied to the CHC share price. AUM has grown at +27% CAGR (compound annual growth rate) from 2017-2021.
CHC sources capital from three end markets; 1) Wholesale; 2) Listed and 3) CHC direct funds. This provides CHC funding diversification, fee diversification, and term diversification. Whilst CHC is not immune from a downturn in funds flows, CHC has ‘industrial-like’ capabilities to raise capital at scale across the cycle. The wholesale business provides a source of funds flow driven by the growth of global pension assets. The retail-focused channels of listed and direct offer abilities to both raise and deploy capital rapidly.
In our view, AUM growth is likely to slow in a higher interest rate environment; but is unlikely to go fall in all but the most severe property cycles (like prior cycles). Valuation pressures could emerge from higher capitalisation rates but will likely be more than offset by both organic and inorganic fundraising opportunities.
2) Earnings sensitivity to higher interest rates
As an asset manager, CHC’s balance sheet is lowly geared at <5%, and the capital structure is strong. CHC along with Goodman Group (GMG), has one of the lowest earnings sensitivities to interest rates in the REITs sector. This compares to Dexus (DXS), the highest geared REIT in the ASX100 at 32%.
CHC interest costs are currently <2% of net income. Cost of debt is currently 2.4%, hedged at ~50% (hedge profile fades over 5 years). A lift in debt costs to ~3% would take interest cost to ~2.5% of net income.
A higher interest rate environment in our view will soften the overall return environment for businesses exposed to property assets. Returns across almost all aspects of property development, and management are likely to be lower. Performance fee income will likely soften as well. It’s worth noting that CHC has consistently been able to earn ~80-90bps of fees p.a. from AUM over the last 10 years.
3) Valuation of the Property Funds Manager.
CHC trades at a small PER premium (~10%) to equity-based funds managers of Perpetual (PPT) Pendal (PDL), which in our view are inferior business models. CHC’s PER premium has averaged ~35% since 2018. CHC’s has a total fee pool from each dollar of AUM, almost double that of PDL and PPT.
Additionally, CHC has been able to hold fees constant over the last decade – in contrast to management fee pressure in both PPT and PDL.
CHC’s earnings risks from unexpected loss of client mandates are much lower than equity-based asset managers. Wholesale AUM is locked in place for 5-8years, whilst the Retail funds are in structures that promote AUM retention. In contrast, equity based asset managers face much shorter notice periods.
Risks to investment view
The two most significant risks for CHC; 1) the continued ability to source capital across the CHC platform; and 2) the ability to deploy with appropriate returns across acquisition and development opportunities. A decline in AUM or lower investment fee income would likely be perceived as negative by investors.
CHC acquisition of equity fund manager Paradise changes the risk profile of earnings (more volatile).
Further moves into non-property-related income potentially risk a derating of earnings multiple for CHC.
Figure 1: CHC per now in line with equity-based fund managers
Figure 2: CHC vs ASX listed asset managers
Figure 3: CHC gross revenue per $ of aum has been very consistent over the last decade
Figure 4: CHC balance sheet gearing remains one of the lowest among peers.
Figure 5: PER has derated by 50% on fears of rising rates and falling property prices
Figure 6: Dividend yield is low by REIT sector standards. Dividend payout ratio at ~30%.
Figure 7: Return on equity is expected to normalise across 2023/24 (lower performance/transaction fees)
Figure 8: CHC per vs the market has derated by ~50% since mid-2021.
