My local petrol station does a roaring trade. Mornings feature queues of tradies buying cheap coffee and afternoons are packed with school kids seeking sugary drinks. In between are residents like me who buy petrol, newspapers or occasionally milk and bread.

The petrol station corners two busy roads and the closest alternative is a few kilometres away. Large apartment developments nearby are boosting car numbers and fuel demand at the station, not to mention ice-cream and drinks sales on a hot day.

If nervous consumers are cutting spending, it’s not evident at my local petrol station. There’s always a line to use the fuel bowsers, even though the petrol is slightly dearer. More people seem to be buying its cheap coffee and on-the-go food, perhaps trading down from dearer options.

Making investment decisions on anecdotes are, of course, dangerous. But visiting the petrol station (I go daily to buy newspapers) is a reminder of the long-term attractions of convenience retail trusts such as Viva Energy REIT (VVR) and APN Convenience Retail REIT (AQR) for income investors.

Business forecaster IBISWorld predicts fuel retailing to deliver annualised growth of 2.3% over 2019-2024, meaning the industry should grow about the same as the economy. Falling petrol sales as more cars use diesel, growth in electric-car numbers and higher rates of public-transport usage (partly because of road congestion) are IBISWorld’s main concerns.

IBISWorld predicts low-margin petrol sales will be subdued over the next five years, forcing petrol-station operators to expand higher-margin, convenience-retail offerings.

My local petrol station is doing that. It added another coffee machine and has started selling pastries, pizzas, donuts and other on-the-go food. It’s even stocking salads and some fresh fruit. An attendant told me some customers visit the store several times daily.

Convenience retail is leveraged to powerful demographic and social trends. Population growth and more cars on the road are tailwinds for petrol stations, and time-poor people are increasingly snacking and eating more on-the-go food in cars – ideal for convenience-store offerings.

My main interest, however, is on the supply rather than demand side. Successful petrol stations typically have hard-to-replicate locations. It would be near impossible (or very costly) to start another large petrol station in my suburb because the area is so built out. As capital-city densification increases, petrol stations with prime locations become more valuable.

Make no mistake: I’m not suggesting convenience retail will take off or that Viva Energy or APN Convenience Retail are badly undervalued. Volatile oil prices, a hypercompetitive retail fuel market, declining car sales, the move towards healthier diets and the general retail malaise are ongoing challenges. But convenience retail has more going for it than several sub-sectors in the Australian Real Estate Investment Trust (A-REIT) market.

I expect private-equity interest in A-REITs to grow this year. National Storage REIT, a niche property trust I have written favourably about several times for this report in the past five years, said in January it received a potential takeover proposal from private equity. National Storage has a total annualised return (including distributions) of 21% over three years.

Private equity has a lot of money to put to work and judging by the NSR interest, might believe the net tangible assets of some niche A-REITs are understating the property’s true worth. That could be true of convenience retail: Viva Energy REIT in February responded to unfounded media speculation that Charter Hall Group may be considering buying a stake in it.

Takeover speculation should be regarded as the cream rather than the cake and never be a basis on its own to buy. More important is an A-REIT’s long-term fundamentals and valuation – areas that convenience REITs currently stack up well on.

Here is an overview of the two key convenience retail REITs.

1. Viva Energy REIT (VVR)

Viva is Australia’s largest owner of petrol service stations with 464 stations in a $2.54-billion portfolio at June 30, 2019. About two-thirds of the stations are in capital cities and Viva’s portfolio is spread across Australia.

Viva Energy Australia comprises 94% of the A-REIT’s income; 7-Eleven, Caltex and Liberty Oil provide the rest. The Weighted Average Lease Expiry (WALE) is 12.3 years, meaning Viva Energy REIT has lots of long-term leases and high income transparency.

Gearing is reasonable at 33% (the targeted range is 30-40%) and the balance sheet has enough firepower to continue acquiring petrol stations. Viva announced around $80 million of acquisitions in approval or due-diligence stage and another $40 million under consideration.

Viva Energy REIT’s strategic relationship with Liberty Oil (a retailer/supplier with more than 250 petrol stations) could unlock value through refurbishment of some Liberty stations. Viva Energy Australia (36% owner of Viva Energy REIT) owns half of Liberty Oil.

Viva Energy’s current unit price of $2.75 compares to a net tangible asset (NTA) of $2.20 per security at its FY19 half-year result. The market is looking for continuing strong growth in the NTA in the second half of FY19 and is willing to pay a premium for Viva.

At $2.75, Viva Energy REIT is yielding 5.2%, based on its estimated distribution. Income investors might find that appealing, given its long-term growth prospects.

For me, Viva Energy REIT looks a touch pricey and is best bought at lower levels, even though it is a quality, well-run REIT with a strong portfolio. A few brokers that cover it have an average price target around $2.40, using consensus estimates. That seems fair.

As an aside, fuel supplier Viva Energy Group (VEA) looks undervalued; Morningstar values it at $3 versus the current $1.68, but it is a different type of stock and a story for another column.

Chart 1: Viva Energy REIT (VVR)

Source: ASX

2. APN Convenience Retail REIT (AQR)

I wrote favourably about AQR for this report in early July 2019 and again later that year when it traded around $3.40. AQR now trades at $3.78 and is my preferred convenience retail REIT. AQR’s one-year total return (including distributions) is 32%.

To recap, well-regarded property investor APN Funds Management launched APN Convenience Retail REIT through an Initial Public Offering in July 2017 at $3 a unit.

AQR owned 70 properties around Australia at end-June 2019. Most are on key roads in capital cities or highways and tenants include Puma, EG Group, 7 Eleven and Viva Energy Australia. Major tenants account for nearly all AQR’s portfolio income.

Like Viva, AQR has a long weighted average lease expiry (11.7 years), reasonable gearing (32.3%) and a 5.5% trailing yield at the current price. Also like Viva, AQR trades at a premium to NTA and is growing through acquisitions (it recently raised equity capital to acquire 13 stations).

AQR’s tenant quality improved with news in December 2019 that Chevron Corporation agreed to buy Puma Energy Australia (it is the tenant in 57% of AQR sites, by gross income). Chevron has a higher credit rating than Puma and thus strengthens the AQR portfolio.

As a $353-million A-REIT, AQR suits experienced investors who are comfortable with small-cap trusts. Distributions should grow steadily each year and there is a good chance of meaningful asset-value increases, based on latest market sales, making AQR a REIT to watch.

More will be known when both REITs report this month. I’ll be watching their NTA growth closely to see if recent petrol-station sales are reflected in higher asset valuations that drive the next re-rating in convenience retail A-REITs. I’m expecting solid NTA increases.

Chart 2: APN Convenience Retail REIT (AQR)

Source: ASX  

Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. It has been prepared without considering your objectives, financial situation or needs. Before acting on information in this article consider its appropriateness and accuracy regarding your objectives, financial situation and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at 12 Feb 2020.