GPT Group (ASX: GPT, OTC: GPTGF), the second-biggest diversified Australian real estate investment trust (A-REIT) by market capitalization, once again exceeded expectations with full-year 2012 results.  Management continued to execute on its long-term strategy while delivering earnings growth that beat guidance.

GPT is one of the A-REITs recommended in a January 2013 In Focus feature, Rebuilt A-REIT Balance Sheets Provide Platform to Build Wealth. Based on its full-year 2012 results–which included a distribution increase–as well as management’s measured approach to reorienting its assets we’re adding it to the AE Portfolio as a Conservative Holding.

Execution of its strategy will see GPT well positioned to benefit from growth in the online retailing sector. Adding industrial assets will allow it to profit as well from increasing demand for warehouse space.

Realized operating income per security, which reflects underlying operational earnings, was up 8 percent, well ahead of guidance management provided during its presentation of first-half results, due to solid contributions from each of the A-REIT’s operating divisions, a 100 basis point reduction in average cost of debt and a lower average debt balance, initial savings from its “Fit for Growth” cost-optimization program and the accretive impact of share buybacks.

Retail income was up 3 percent on a like-for-like basis, driven by a very strong contribution from Melbourne Central. The office portfolio performed very well with comparable growth of 3.8 percent. Particularly strong results were reported for Melbourne Central Tower, Farrer Place and Citigroup Centre.

Logistics & Business Parks were up a solid 2.7 percent on a comparable basis. Funds Management income was down as a result of GPT’s lower stakes in the office and retail funds, but distributions per unit were up 1.7 percent across both funds.

 “Fit for Growth” built on the work management has been doing to streamline the business over the last couple of years, enabling the A-REIT to realize the benefits of process improvements and new systems while also providing a strong platform for growth.

GPT realized an earnings benefit of approximately AUD3 million in 2012 and forecast a benefit of AUD10 million in 2013. GPT now has one of the lowest management expense ratios (MER) in the sector, with a forecast MER of approximately 50 basis points in 2013.

Comparable income growth for 2012 was 3.2 percent over 2011 levels, while portfolio occupancy at the end of the year was 98.1 percent. 

Distributions per security were up 8.4 percent, with a final distribution of AUD.051 0.1 percent higher than the estimated distribution announced in early January. The distribution for the full year was AUD0.193.

Statutory net profit after tax was up significantly compared to 2011, driven principally by upward revaluations, the most significant of which was in the second half at Melbourne Central in both the retail and office tower, following strong contributions from Sunshine Plaza, Penrith and One One One Eagle Street in the first half.

This was partially offset by a negative mark-to-market figure in GPT’s interest-rate derivatives due to lower interest rates during the year.

In 2012 GPT’s portfolio delivered a solid result, posting a total return of 9.3 percent, as all three sectors performed well in an environment of weak consumer and business sentiment. The office sector recorded the strongest performance, with a total return of 10.5 percent on strong leasing activity.

During management’s conference call to discuss results it noted “significant progress” on its reweighting strategy with the sale of stakes in two major retail properties for AUD643 million and the acquisition of four logistics and business park assets for AUD143 million.

The retail portfolio posted a total return of 8.6 percent, as weighting to the sector decreased from 61 percent to 56 percent. Despite subdued retail sales, underlying key asset indicators remain positive, with solid comparable income growth of 3 percent and occupancy at 99.5 percent.

Management also noted an upward revision in the value of GPT’s retail portfolio of AUD104 million.

Even as it works to reduce its retail exposure GPT management is optimizing its assets within the sector. Performance within the sector remains mixed; structural changes in retail spending have seen the “leisure” category continue to be impacted, in particular areas such as books, music and games. But “other retail,” which includes cinemas and travel, has had another strong year at 6.1 percent growth.

GPT is down-weighting the weaker apparel category, which represents a significant proportion of gross leasable area and up-weighting to “retail services,” “food catering” and “other retail.”

The evolution of the retail offer to meet the changing market is a key strategy for the leasing and management teams in 2013. Importantly, all new leasing deals in 2012 within the GPT managed portfolio achieved an average fixed increase of 4.8 percent, underpinning retail earnings into the future.

And the portfolio is in a positive position when spending returns to more normalized levels. Vacancies have fallen, arrears and bad debts remain low, and customer traffic was up over the year.

Retail development was solid in 2012, as the AUD300 million Highpoint project is nearing completion.

Highpoint provides a good example of how a dominant regional center continues to be sought after by retailers even in a very tough market. In October GPT opened Stage 1 of Highpoint, which was completed 100 percent leased and on budget. Stage 2 opened in March 2013.

Highpoint is the second-largest retail center in Australia in terms of gross leasable area 156,000 square meters. The development will add David Jones, Woolworths and 118 specialty tenants, including a number of international retailers such as Zara, Top Shop, Chanel and Samsung.

GPT completed two developments during the year, including the AUD700 million office tower at 111 Eagle Street, Brisbane. The A-REIT’s Funds Management business delivered 20 percent growth, and the GPT Wholesale Office Fund (GWOF) is now the best-performing fund in the office sector.

The balance sheet remains solid. Gearing–or net debt–as a proportion of total tangible assets sits at 21.7 percent. Look-through gearing sits at 23.9 percent, which reflects debt in the wholesale funds. The retail fund is geared at 27.6 percent, and the office fund has very low gearing at just 7.2 percent.

Management forecast an average cost of debt for 2013 of 5.5 percent.

GPT’s debt- maturity profile remains relatively flat. In 2012 the A-REIT issued AUD330 million of domestic bonds with domestic medium-term notes now representing 25 percent of total borrowings.

Following the end of the financial year GPT issued HKD800 million worth of 15-year bonds, swapped back to approximately AUD100 million at 195 basis points over the banker’s bill swap rate. This was GPT’s inaugural issue into foreign debt capital markets, further diversifying its funding sources and extending its weighted average term to maturity to 5.4 years.

Interest cover is very strong at 5.2 times, and GPT’s credit rating remains at A-, providing the A-REIT with cost-effective access to the debt capital markets.

Management described 2012 as “a bright year for the office portfolio.” GPT completed a significant amount of leasing, with 152,000 square meters leased across the portfolio and an additional 36,000 square meters of signed Heads of Agreement as of Dec. 31, 2012.

Lease expirations in 2014 fell from 20 percent to 14 percent, 12 months ahead of expiry, due to active outreach by management.

The office portfolio continues to perform well despite challenging market conditions across most markets. Comparable income growth was strong at 3.8 percent, led by 4 percent average fixed rent increases and positive leasing spreads. Occupancy remains high at 95.8 percent, up from 93.6 percent as of June 30, 2012. The portfolio weighted average lease expiry has increased to 5.4 years.

The total value of the office portfolio rose by AUD95 million during the year.

As for logistics and business parks, the focus of GPT’s growth strategy, management grew the portfolio to 12 percent of overall assets from 9 percent at the end of 2011.

Growth has been driven by acquisitions totaling AUD143 million; completion of the Toll NQX deal in the first quarter of 2013 drove this figure to AUD200 million. The logistics and business parks portfolio delivered strong comparable income growth of 2.7 percent, while occupancy remained high at 98.2 percent, highlighting the strong renewal and releasing activity in the portfolio. The weighted average lease expiration is strong at 5.8 years and will increase on completion of the Toll NQX deal.

In December 2012 GPT announced the acquisition of Toll NQX in Brisbane for AUD84.6 million, the largest of the four deals the A-REIT entered into last year. It was completed during the first quarter of 2013. This state-of-the-art logistics facility is in the prime Logan Motorway precinct. The property has been acquired with a 15-year lease to Toll with annual fixed rental increases of 3.5 percent per annum.

AE Portfolio Conservative Holding Australand Property Group (ASX: ALZ, OTC: AUAOF) recently rejected a AUD2.8 billon offer from GPT for its industrial and commercial property divisions.

GPT wants Australand’s AUD2.3 billion of office and industrial properties to reduce its exposure to retail property, which is now almost 60 percent of its portfolio. But GPT isn’t chasing Australand, opting for a measured approach versus rushing into a deal for reweighting’s sake.

During management’s conference call to discuss 2012 results in late February management noted “we are committed to advancing a proposal that’s in the best interests of Australand and GPT securityholders,” emphasizing the importance of understanding “that we don’t actually need to do the deal to achieve our goals.”

Australand’s industrial and commercial assets will “accelerate” GPT’s strategic priorities, but management is confident in its success with or without this particular portfolio. This kind of prudence pays in the long run.

As of May 10 the A-REIT is priced at 1.06 times net tangible asset value. GPT Group–a new addition to the AE Portfolio Conservative Holdings–is a buy under USD4.25.

GPT Group’s financial year corresponds with the calendar year, Jan. 1 to Dec. 31. The company reports full financial and operating results twice a year; it typically posts first-half results in mid- February, with full fiscal year numbers out in mid-August.

GPT recently announced that it will begin paying distributions on a semiannual basis beginning July 1, 2013. The A-REIT has been paying on a quarterly basis, the only one of its kind to do so and one of the very few Australian companies of any stripe that maintained such a schedule.

The final quarterly distribution–of AUD0.0.51 per share, up from AUD0.46 a year ago–was declared April 30, 2013. It will be paid May 17 to shareholders of record as of May 9. GPT traded ex-dividend on this declaration as of May 3.

Dividends paid by GPT are “qualified” for US tax purposes. Based on the “fiscal cliff” compromise reached in Washington, DC, in early January dividends will be taxed at Bush-era rates of 5 percent to 15 percent for investors’ first USD450,000 a year of income for couples and USD400,000 for single filers. Above that the maximum tax rate is 20 percent.

Among the analysts who cover the A-REIT, four rate it a “buy” according to Bloomberg’s standardization of brokerage house recommendation terminology. There are five “hold” and three “sell” ratings on GPT at present. The “best consensus” 12-month target price among the nine analysts that provide such a number is AUD3.90, with a high of AUD4.14 and a low of AUD3.65.