This ASX share doubled market returns but is still cheap: expert

Finding an excellent business in an average sector is a shortcut to find a cheapie, reckons one fund manager.

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With the S&P/ASX 200 Index (ASX: XJO) climbing to all-time highs in recent weeks, it’s harder than ever to find underpriced shares to buy.

But Airlie Funds Management investment analyst Will Granger has a strategy to make hunting for cheapies that little bit easier.

“One of the common scenarios in which we find ‘undervalued quality’ is when a great business sits within an otherwise average sector, as industry peers tend to be priced off similar multiples,” he said on the company blog.

As such, he’s turned to the real estate investment trust (REIT) sector.

“This sector, while ‘defensive’, generates an average return on equity (ROE) only in line with the broader market — at around 12%.”

And Granger reckons he’s hit the jackpot, finding a high-quality gem within that industry.

Charter Hall’s pivot into funds management 

Charter Hall Group (ASX: CHC), according to Granger, has pivoted from an old-school direct-investment REIT into more of a property funds management business.

This has triggered outperformance over its ASX real estate peers.

“One of the ASX’s top performers over the past decade has been Charter Hall (CHC), which has delivered a total shareholder return of 19% per annum since listing in 2005,” said Granger.

“The company’s funds under management (FUM) have grown at a 17% compound annual growth rate (CAGR) over the decade, and now sit at over $52 billion.”

The great news for current buyers of the ASX share is that Charter Hall’s transition is now at a point where it will “drive very strong outcomes for shareholders”.

“Scale begets scale. Charter Hall [is] one of only a handful of managers that can compete for assets greater than $1 billion in value,” Granger said.

“Wholesale capital is relatively ‘sticky’ with ~7yrs between redemption windows. This means investors can’t simply pull their money out at once, enhancing the stability of earnings.”

The property assets themselves have some of the country’s most stable tenants.

“Government account[s] for 12.5% of rental income, Woolworths Group Ltd (ASX: WOW) 6.4%, Wesfarmers Ltd (ASX: WES) 5.9%, and Coles Group Ltd (ASX: COL) 5.2%.”

Another advantage of a bigger focus on funds management is that Charter Hall is now less capital-intensive.

“For each additional dollar of FUM added to the business, the capital investment required for that dollar of FUM has fallen by ~30% in just 3 years,” said Granger.

“As a result, Charter Hall’s incremental return on equity has increased dramatically. We estimate Charter Hall’s incremental return on equity, normalised for any large one-off performance fees, to be greater than 25%.”

Charter Hall stock price looks ripe for the picking

Although Charter Hall shares currently trade at almost 35 times the price-to-earnings ratio, the forward valuation looks cheap, according to Granger.

“We estimate Charter Hall is trading on a PE multiple of 24x FY22 underlying earnings, which is in line with the ASX 200’s PE multiple excluding resources and banks,” he said.

“This is despite the business generating roughly double the average market ROE. Given the company’s strong earnings momentum, high quality of earnings, and above-market returns profile, we see this business as a great example of undervalued quality.”

Early on Wednesday morning, Charter Hall shares were trading at $15.46. They have risen 1.26% for the year, but a whopping 49.1% in the past 12 months.

Should you invest $1,000 in Charter Hall right now?

Before you consider Charter Hall, you'll want to hear this.

Motley Fool Investing expert Scott Phillips just revealed what he believes are the 5 best stocks for investors to buy right now... and Charter Hall wasn't one of them.

The online investing service he’s run for nearly a decade, Motley Fool Share Advisor, has provided thousands of paying members with stock picks that have doubled, tripled or even more.* And right now, Scott thinks there are 5 stocks that are better buys.

*Returns as of August 16th 2021

Motley Fool contributor Tony Yoo has no position in any of the stocks mentioned. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of and has recommended COLESGROUP DEF SET and Wesfarmers Limited. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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