Macquarie Research23 March 2020EQUITIESQuality has consistent outperformed in recessions/bear marketsEarnings impact from Covid-19 on the large capREITs、Notes: 1. We note our Quality is measured as returns on equity; accrual ratio (essentially cash backed earnings); and financial leverage.Source: Factset, Macquarie Research, March 2020AnalystsMacquarie Securities (Australia) LimitedDarren Leung +61 2 8232 8544 Stuart McLean +61 2 8232 2859 Caleb Wheatley +61 2 8237 6699AustraliaO MACQUARIEListed Property SectorQuality time to deal with stressKey pointsTactical tilt towards Quality given current market conditions are expected to be impacted by Covid-19 for some time. Retail malls remain under pressure. Financial covenants and debt facility maturities can withstand stressed scenarios from Covid-19 impacts. Key Outperform recommendations: GMG, MGR, CHC, GPT and DXS. We upgrade GPT to OP; and SGP to Neutral. Downgrade LLC to Neutral.EventWe have reviewed the potential impact of Covid-19 on earnings of the large cap real estate groups. As an extension of our work released on 6 March 2020 (Growing you/ defences), we have also stress tested their balance sheets.ImpactShifting investment style to Quality. We have reviewed which investment style consistently performs in recessions/declining markets in the S&P 500. It is no surprise that portfolios tilted towards Quality consistently outperform the broader equity market. Quality is measured as returns on equity; accrual ratio (essentially cash backed earnings); and financial leverage. MGR, GMG, SGP, and GPT screen as Quality in the A-REITs. Industrial and office preferred.issues in retail accelerated. Industrial and office sectors remain the most preferred, with underlying tenant covenants that are relatively more resilient in a Covid-19 impacted economy. While office utilisation is low, given working from home arrangements, we expect DXS to reaffirm their FY20 guidance. Retail malls are facing increasing pressure to offer rental abatements for tenants. As a sensitivity, three months of 50% rental abatements for specialties represent 12% and 11% earnings headwindfor SCG and VCX/espectively. We note this is before ancillary income, which is typically a variable revenue item as well. Residential markets are likely to face near-term settlement delays/defaults and lower sales volumes. Resi should benefit in the medium term due to low rates and undersupply. Balance sheets.dealing with the stress. We focus on: 1) upcoming debt facility maturities; and 2) financial covenants. SCG is the only large cap REIT with upcoming maturities in the next 18 months that is not covered by existing debt facilities and/or cash. The REITs are generally sufficiently far away from the financial covenants. As a sensitivity, SCG and VCX need to see asset values decline by 49% and 44%, respectively, to breach gearing covenants.Stock recommendationsDXS, GMG and GPT are our preferred defensive names, while CHC and MGR should have good leverage when the market focuses on post Covid-19. We remain underweight the retail landlords (SCG, VCX - both rated Underperform), with downside risk from Covid-19 in the near term and potential rent resets in the medium term. We downgrade LLC to a Neutral, factoring elevated risk in timing of development returns resulting in downside risk to the balance sheet. We upgrade SGP to a Neutral due to the implied residential valuation. We upgrade GPT to Outperform, given a strong balance sheet and defensive characteristics.Please te page 24 fen impeHant disclosures and analyst certifieatien, or en ouf website .We highlight a historically strong correlation between development WIP and development earnings.Fig 30 Strong correlation between development WIP and development earningsFig 31 Loss of development earnings is likely to be offset by deployment of balance sheetoooooooo5 0 5 0 5 0 53 3 2 2 1 1oooooooo5 0 5 0 5 0 53 3 2 2 1 1Development revenue ($m)Development WIPQ 5 o 5 o 554.4 3 3 2q 5 9 52 L L 6o oo o4 2$6TUW TOTOS OOTUW 二& d zTum otooq gTum w,。 二Tuw ?0Da ，coTum cd eTuw 二 &力。 LTum 0TOS OTUW 60,。a 80,。 a1421,197Operating earnings Loss of development Redeployment ofbalance sheet1,210Development revenueDevelopment WIPPro-forma(FY21)Source: Company data, Macquarie Research, March 2020Source: Company data, Macquarie Research, March 2020Source: Company data, Macquarie Research, March 2020We conduct a scenario analysis based on the expected return from deployment and the lost development activity.Fig 32 Losing 50% of development activity and deploying at 10% ROIC results in a 7% earnings headwindSource: Macquarie Research, March 2020Assumptions Lost development WIP (LHS) / Return on deployment (RHS)6%8%10%12%14%(10%)6%|11