Australia | Aug 08 2018
The next phase of growth is being revealed at Lend Lease as increasing amounts of capital is being allocated to development.
-Benefits of a vertically integrated business becoming clearer
-Tailwinds in urbanisation pipeline as well as FUM platform
-Construction business not as smart but still expected to grow substantially
By Eva Brocklehurst
Lend Lease ((LLC)) is looking like a winner for several brokers, as it transforms into an integrated global real asset developer and manager. The company's track record is helping to underpin its competitive advantage, as the next phase of growth materialises.
Goldman Sachs has emerged more confident after reviewing its investment thesis for Lend Lease, believing the driver of earnings growth for the next five years will be the amount of capital deployed to development and the rate of return generated on that capital.
The benefits of the vertically integrated business have become clearer to Morgan Stanley, too, as the company has successfully delivered over $16bn in projects over the past five years. This has accelerated product origination and development while using less capital per project.
From December 2017 to June 2023 Goldman Sachs expects Lend Lease to allocate an additional $3.6bn of capital to development. This should reflect capital required for medium-term opportunities, the residual cornerstone investment stakes in funds under management (FUM), and an incremental investment in the US telecommunications towers.
Morgan Stanley agrees the US telco business could be a key catalyst. Ongoing execution, in the broker's view, should mean a step-change in completions and income diversity that results in lower risk, lower gearing and improved returns.
The $750m cash injection delivered by the restructuring and partial sell-down of the retirement business over the first half of FY18 reduced gearing to just 1.9%. Goldman Sachs expects gearing to peak at 12% over the medium term, at the lower end of the company's 10-20% target range, as capital is deployed towards the rolling out of of the urban renewal and associated cornerstone investment stakes.
The company's secured urbanisation development pipeline stands at $57bn, with 73% secured via land management or phased drawdown agreements. For the balance, Goldman Sachs calculates land prices were set, on average, in FY13, with Barangaroo as early as FY09, providing a significant buffer against any future adverse market movements.
Rising rates could reduce near term margins, but Morgan Stanley agrees capital efficient structures have tended to lock in sale prices relatively early. Rising interest rates could also drive medium-term demand, as capital partners move up the development risk curve to offset potential market risk.
The broker envisages tailwinds provided by the urbanisation pipeline as well as the broadening FUM platform, with growth in the past five years of development driving 16% growth in FUM.
The funds management business has high-quality predictable earnings, although Goldman Sachs expects the contribution to operating earnings (EBITDA) from management fees to remain at around the current 9-10% level.
Morgan Stanley considers Lend Lease one of the few fund managers able to connect capital partners with the new product that it builds, allowing for FUM growth ahead of the rises in property values. The broker suggests ongoing execution could close the 30% gap to a market multiple that is applied to this division.
Goldman Sachs raises estimates, along with an increase to the target price to $25.20 and upgrades to Buy from Neutral. The stock is added to the broker's conviction list with earnings estimates upgraded for FY18-21 by an average of 12% per annum. The broker forecasts FY18 net profit of $769m.
Citi's top picks for the A-REIT sector are in office and industrial amid a focus on funds management, which includes Lend Lease. Macquarie also likes the Lend Lease development business, with the view somewhat clouded by a weak construction performance, likely to be revealed at the FY18 results. Lend Lease reports its results on August 22.
Brokers acknowledge the construction business is not looking as smart, but is still expected to grow earnings substantially over the next three years, primarily reflecting engineering provisions taking in the Australian business in the second half. Ex-provisioning, Goldman Sachs forecasts an average earnings growth rate of 14%.
Morgan Stanley expects construction earnings will recover off a low base and contribute around 30% to FY19-21 growth and, while this remains the area of most risk, remains comfortable with forecasts, given the volume growth and depressed valuation multiples. The broker expects a reversion in Australian construction earnings to around 2017 levels and is also cautious about engineering, given the sub scale and poor track record to date.
UBS acknowledges the recent news flow highlights a globally diversified business with a competitive edge but does not believe a market multiple is warranted, reflecting the exposure to Australian residential markets and ongoing weakness in construction earnings.
There are three Buy ratings and two Hold on the database. The consensus target is $21.30, signalling 0.9% upside to the last share price. Targets range from $19.50 (UBS) to $23.05 (Morgan Stanley).
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