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Residential Gap Looming For Mirvac

Australia | Feb 12 2019

Mirvac is expected to continue benefiting from strong office & industrial property markets, while a rundown of apartment pre-sales in FY20 could create an earnings hole in that year.

-Residential sales falling sharply, fewer new apartment launches
-Significant residential supply shortage may evolve
-Benefiting from a deliberate re-positioning in office & industrial property

By Eva Brocklehurst

Office/industrial and development profits sustained Mirvac Group ((MGR)) in the first half and the market welcomes management's confidence in the short term earnings outlook, given concerns over residential sales. The company is benefiting from strong office markets and limited defaults, which were noted at less than 2%.

The residential margin is expected to stay elevated in FY19 at 25%. Nevertheless, residential sales fell sharply in the half-year and UBS believes the market is overlooking deterioration in the outlook. The broker has become more cautious about FY20-22.

Residential sales fell -40% in the first half and annualising this takes sales down -70% from their peak, or back to pre-FY12 levels. Fewer new projects explains part of the reduction in sales and new apartment launches are expected to be minimal in the next 18 months.

Hence, pre-sales should run down significantly in FY20, a big year for pre-sold apartment settlements. Ord Minnett suspects the market may look through FY20 earnings and take FY19 and FY21 as more representative of the company's earnings capacity.

Mirvac has tightened FY19 guidance to earnings per share growth of 3-4%, implying 16.9-17.1c. yet Macquarie questions whether this is indeed a positive refinement, as guidance should have lifted to 3-5% to account for the buyback.

The broker suggests this miss either implies marginally weaker underlying earnings or the company being particularly conservative. Distribution guidance was maintained, implying 11.6c for the full year.

Meanwhile, Mirvac has noted retail property remains competitive as retailers adapt to a growing share of online transactions, and an excess supply of food catering options is inhibiting growth. Still, Macquarie notes retail leasing spreads remain solid at 2.7%.

Residential

Credit Suisse finds the residential product is proving to be resilient and the company is still on track to achieve more than 2500 lot settlements in FY19.  While market conditions in residential may have deteriorated, Mirvac is still experiencing strong demand from owner-occupier buyers and the focus is on middle ring medium-density property.

A strong drop in building approvals and record numbers of completions has signalled to the company that a significant supply shortage is likely to emerge in the next few years.

Opportunities are presenting in Sydney and Melbourne which would which fit Mirvac's criteria, bringing 18% internal rates of return and 18-22% margins. Mirvac is in no rush to restock its pipeline, Credit Suisse points out, with significant value and margins in the current land bank.

The company has not acquired land since 2015, as vendor expectations still need to ease up for Mirvac to be active, but Macquarie notes management has increased its scrutiny of this area.

The main driver of this scrutiny is a belief that Sydney and Melbourne will become under-supplied, given the recent contraction in the housing market. Macquarie also notes the company has identified a longer tail of residential settlements, given the availability of credit is patchy.

While the company was keen to warn analysts about using average property price declines to extrapolate outcomes for its residential portfolio, the broker contends that slower sales are a signal that the market is clearly softening.

Ord Minnett expects residential earnings (EBIT) will peak in FY20 because of high apartment settlements at Eastbourne, St Leonards and Marrickville. The broker allows very elongated settlement periods in all projects.

Office/Industrial

Office and industrial segments were driven by strong net operating income growth of 40% as well as development earnings. The company is benefiting from a deliberate repositioning in this segment, Citi affirms, yet is unsure if office & industrial can decouple from residential conditions.

The broker suspects investors are likely to favour the pure-play stocks, limiting the potential for a sustainable re-rating. Future upside is to be captured from leasing activity on an under-rented office portfolio, Credit Suisse believes, as well as additional income from completions.

The broker considers the office segment is well-positioned to benefit from positive leasing spreads and revaluations. Management intends to dilute exposure to Sydney CBD over time and focus on Sydney's fringe and Parramatta. This is the result of the spread between Sydney CBD rents and surrounding suburbs reaching record highs.

The industrial portfolio is benefiting from its 100% weighting towards Sydney with the positive momentum in industrial markets. Occupancy was maintained at 100%. Future development will be focused on the Elizabeth Enterprise project at Badgery's Creek.

FNArena's database shows two Buy ratings three Hold and one Sell (UBS). The consensus target is $2.55, signalling 0.9% upside to the last share price the dividend yield on FY19 and FY20 forecasts is 4.6% and 4.9% respectively.

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