GPT Joins The Credibility Drain

This story features GPT GROUP. For more info SHARE ANALYSIS: GPT

The company is included in ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

By Greg Peel

The biggest problem with the global credit crunch has proven to be the perennial State of Denial. Wise macro-analysts had been pointing to an alarming rate of growth in US debt in particular and global debt in general well before the US housing market found its peak. But when the “subprime crisis” first hit the most immediate response was to call it a storm in a tea cup.

Thus followed the August to October bounce, when US banks and brokerages were in a complete state of denial over the true value of their credit security portfolios. Only when the accounting laws were changed in November was reality exposed, and thus begun the Great Asset Write-Down and the global credit market moved into an ever deeper state of inertia.

Therein followed a sympathy sell-down of Aussie banks, leading some analysts to cry every week that Aussie banks were immune and valuations were compelling. They have only become more and more compelling as each month passed by. In December the bombshell was Centro, which suddenly woke everyone up to the fact that if you have debt levels of 70% or more in an investment trust  in a credit crunch your days are numbered. Then ABC Learning was a shock – despite its growth through debt.

One by one these dominoes have been falling, and slowly but surely truth is emerging. Some of the glossiest guidance updates have come from banks, but one minute St George is suggesting 8-10% earnings growth and the next it is agreeing to sell to Westpac at a low premium. Mark Gasnier couldn’t pass a ball that fast. Financial engineer Babcock & Brown hit the wall, and analysts were apoplectic about insufficient disclosure. Amazing that a financial engineer should suffer in a major credit crunch.

It was those short-selling hedge funds, Goddammit!

It appears there is many a company management in a State of Denial over funding. From banks to candlestick makers, there is a lot of hope and prayer put into credit spreads returning to some normality. But they haven’t. Across the US, the world and even Sydney there are houses on the market owned by overstretched borrowers that simply are not seeing buying interest at the price. The owners are incredulous. And across the globe values of all properties are collapsing while over-geared investment funds are forced to simultaneously sell in order to reduce debt levels. Why would potential buyers stick their necks out?

It would seem this has been the case for management at the GPT Group ((GPT)), one of the larger and once more respected Australian REITs. For either the earnings capacity of group assets have suddenly fallen a full 27% in just six weeks – the time of the most recent profit guidance update – or someone was kidding themselves about what those values really were six weeks ago. Once again a host of analysts have been taken by surprise, and once again there is a wailing and gnashing of teeth. GPT has lost all credibility now, is a popular response. It’s all very well to bitch and moan but just how reliable can management valuations ever be in these circumstances?

GPT attracted no less than four recommendation downgrades from FNArena database brokers this morning – two from Buy to Hold, one from Buy to Sell, and one from Hold to Sell. Yesterday’s B/H/S ratio of 5/1/2 has now become 2/2/4. The two buys are UBS and Credit Suisse (that latter upgraded last month) and neither have reported this morning.

The problems are across the GPT portfolio. The Group has been unable to realise the expected $8m profit on two office blocks it developed this year. It was unable to find a buyer for its 40% stake in the GPT Wholesale Office Fund. Its European property trust joint venture with Babcock and Brown, which GPT has been excruciatingly trying to wind down for ages now, is losing money. Planned new property funds will have to be put on hold. The US seniors housing market has experienced a downturn. High travel costs have seen hotel earnings cut. Well you could knock me down with a feather.

Six weeks ago, none of this was a problem.

It is not surprise that the previous Buy-raters have been the most scathing. Merrill Lynch, which double-downgraded from Buy to Underperform – suggests poor decision making has overshadowed a premium core portfolio, and that management credibility has now been tarnished. Citi cites some “unfortunate past decisions”. GSJB Were has raised the question of adequacy of communication and execution capability within the business.

But even the previous Sell-raters got a shock. Forecast earnings downgrades have been significant from all brokers. The average target has been cut from $3.52 to $2.65. Take out the two brokers who haven’t yet updated their positions, and that average is $2.19 on a range from $1.75 (Deutsche) to $2.85 (Were).

So once more in this market we ask the question, what happens now?

JP Morgan raises the possibility that GPT’s management has swung into conservative mode, which would suggests these are “kitchen sink” write-downs. However the analysts quickly dismiss the notion and suggest that further asset write-downs are likely. Let’s face it – the global property market is hardly improving and nor is the debt market. Weres notes that “despite the positive impact on risk of the revised distribution policy, GPT is clearly in a state of strategic flux”.

But what analysts are most concerned about is GPT’s 50% “look-through” gearing covenant. At present this look-through gearing (for which there is some element of forecast) is sitting at around 45-47%. This means it would not take much of a fall in asset values to tip GPT over the edge, and we all know what happens to share prices when covenants are breached. There is still some way to go (Citi even suggests the ratio is “safe, although pressured”) and all analysts agree that the great shame is that GPT truly does have a core portfolio of quality assets – but a lousy management. However, in the current environment there has to be a risk.

Fortunately, notes Citi, GPT does not have an interest cover covenant, for this has fallen to only 2.2x. But this fact did not escape the credit rating agency Standard & Poors who joined those shutting the gate after the horse this morning with a rating downgrade to BBB. While this is still “investment grade”, it will push up the subsequent cost of any refinancing.

So analysts have abandoned GPT for now, deciding the risks are just too great. Even if the earnings and distribution downgrades prove harsh, GPT is yet another fund manager who has to spend time winning back credibility. The wider question emerging however, as Weres suggests, is the question of whether GPT’s guidance reduction is setting up a more realistic sector picture in FY09.

Who else is still in denial?

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