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Treasure Chest: Buy Stockland, Sell Mirvac

Treasure Chest | May 24 2017

This story features STOCKLAND, and other companies. For more info SHARE ANALYSIS: SGP

Citi believes Stockland is offering a more attractive valuation than Mirvac Group in the property developer space.

– Resi mix-shift favours Stockland
– Mirvac's office upside priced in
– Stockland's retail downside overestimated

 

By Greg Peel

Citi believes the Australian housing cycle has peaked.

Both Stockland ((SGP)) and Mirvac Group ((MGR)) are in the business of developing apartment blocks. With the housing cycle peaking, the risk is a glut of apartments will lead to price declines. Where the two developers differ is in Stockland’s exposure to retail complexes vis a vis Mirvac’s exposure to office blocks.

In theory, both developers should suffer from a downturn in the housing cycle. Yet Citi believes the mix-shift underway in housing is benefitting Stockland and dragging on Mirvac.

The broker sees Stockland as best positioned given a favourable product mix-shift which should lift average selling prices as the company enters the medium density market in a more meaningful way. Stockland has greater scope for margin stability due to product mix and embedded price growth.

By contrast, Citi believes the market is underestimating the potential downside implications of Mirvac’s residential mix-shift, suffering from an unfavourable shift towards master planned communities. This could result in prices declining by -8% in FY18 and -5% in FY19 even before factoring in a rollover in residential conditions.

Mirvac is at risk of falling short of apartment settlement guidance due to extended settlement times, tighter lending conditions and slowing pre-sales activity.

There’s no denying retail businesses are enduring a tough time in Australia at present, and that’s before the feared arrival of Amazon in 2019. This has weighed on investor sentiment towards retail-leaning Stockland. But Citi believes the company’s discount department store risk is manageable due to a weighted average lease expiry of 8.3 years, favourable lease structures, diverse rent sources, above-trend operating metrics and improving specialty sales productivity trends.

Stockland should also benefit from the Green Hills redevelopment, which could add 6% to retail net operating income (NOI). Even taking a pessimistic view on retail, Citi believes Stockland can still achieve a compound annual growth rate in NOI of over 3%.

There’s also no denying the office market, particularly in Sydney and Melbourne, is strong. Office markets are experiencing double-digit percentage rental growth thanks to solid demand. There is also a double-whammy occurring in Sydney, as supply is reduced by construction of the Sydney Metro and conversion of former office blocks into residential and hotel complexes.

Mirvac has already repositioned its office portfolio via disposals and future growth appears strong, underpinned by the company’s development pipeline and favourable leasing conditions. But the broker believes its 8.4% compound net income growth assumption already reflects this, and with long lease expiries and longer dated developments, there appears little impetus for further material upside.

By contrast, Citi suggests Stockland still has plenty of time to reposition its retail portfolio ahead of Amazon’s arrival.

The broker believes relevant share prices already capture Mirvac’s office upside while overestimating Stockland’s retail downside. Stockland is the better positioned of the two with regard residential apartments. Stockland is nevertheless trading at price/earnings multiple one standard deviation below its long-run average and one standard deviation below the PE of Mirvac.

Having previously rated both stocks as Neutral, Citi has now upgraded Stockland to Buy and downgraded Mirvac to Sell.

Ord Minnett is the only other FNArena database broker to rate Stockland a Buy (or equivalent), suggesting, back in April, strong residential volumes will drive better margins out to FY19 to underpin 5-7% per annum earnings growth.

UBS recently downgraded from Buy on a valuation call, believing the residential market was not going to get any better. That made three Holds, while Morgan Stanley is on Sell following a downgrade in March due to the diverging office and retail sectors. The consensus target, following a tick-up from Citi, is $4.82.

Citi is now the only broker to rate Mirvac as Sell. The stock otherwise attracts four Buys and two Holds. The consensus target, following a tick-down from Citi, is $2.34.

The same office/retail divergence theme that had Morgan Stanley downgrading Stockland had the broker similarly upgrading Mirvac to Buy. Otherwise, the general theme among those rating Buy is Mirvac’s greater exposure in its residential business to the more reliable NSW market – presently the country’s leading state in economic growth.

Credit Suisse (Neutral) earlier this month echoed Citi’s believe that Mirvac’s FY17 settlement guidance of 3,300 lots will be hard to achieve given it would require the highest number of fourth quarter settlements ever achieved. The last time Mirvac found itself in this position it indeed missed guidance, Credit Suisse noted.

And the broker joins Citi in believing the housing cycle has peaked.

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