Australia | Sep 01 2020
This story features LENDLEASE GROUP, and other companies. For more info SHARE ANALYSIS: LLC
Lendlease has outlined a welcome strategy to ramp up earnings from development and investment while simplifying its business. However, uncertainties continue.
-Improved perception of earnings quality
-Lack of detail on the development pipeline
-Simpler business as non-core assets are exited
By Eva Brocklehurst
Development and recurring investment earnings are now the focus for Lendlease ((LLC)), which has outlined ambitious targets while signalling it will continue to look at new opportunities.
The company aims to increase investment earnings over the next five years to take assets under management to $100bn by 2030, target a return on invested capital of 6-9% and increase invested development capital to $5-6bn from $4.8bn.
Lendlease will subsequently have a simpler and more productive operating structure and Citi believes this will lift the perception of modest earnings quality that has weighed on the stock. Therefore the changes are positive.
UBS is cautious, pointing out the relationship to earnings from the increase in development is not clear, as profits can be booked at various stages depending on the project structure. Therefore it remains difficult to forecast with any degree of confidence.
Management expects development production to rise to over $8bn per annum which would be a more than 80% increase on levels of the past five years or so and, using assumptions based on the company's targets, Macquarie has calculated an FY25 operating earnings range of $650-1.1bn, noting the balance sheet is reasonable, taking into account the medium-term strategy.
As asset sales are completed and the company obtains additional debt and retains more earnings, Macquarie calculates gearing should rise to around 15.7%. However, this remains in the middle of the targeted gearing range of 10-20%.
The strategy makes sense to Credit Suisse as it helps increase predictable annuity-style earnings that in turn could lead to a re-rating. The focus on operating earnings and the improvement in perceptions of earnings quality is also welcome.
Nevertheless, the broker agrees timing is everything and it is unclear as to exactly when this run-rate for production will be achieved as there are several assumptions that need to be made regarding the timing of the roll-out.
Credit Suisse finds no reason to adjust underlying assumptions at this stage and suspects, in the near term, the company still needs to deal with challenging market conditions, exit the services business and complete the Melbourne metro project with no incremental impairments.
Morgan Stanley considers the biggest impediment to execution will be market conditions and the extent of demand for leasing commercial or residential assets. Lendlease will set up more "programmatic partnerships", the broker notes, where it will bring co-investors into multi-asset projects rather than on an asset by asset basis, creating more development performance fee opportunities.
Ord Minnett would have preferred more detail on the development pipeline, funding and completion timeframe to support the targets but considers this strategy review a meaningful step towards the next phase of growth.
The increase in capital allocated to the investment division will be achieved through re-allocation of group capital, with growth in capital employed funded in part by retained earnings and in part by incremental debt. The headline target for return on invested capital of 6-9% could screen high, although Credit Suisse points out this is directed to partnerships/joint ventures/funds with leverage.
In simplifying the business, Lendlease has announced the sale of the US business Telco Towers, for around book value at $300m. The retirement portfoliio in Australia will be sold down and the company intends to ultimately own 20-25%.
UBS calculates a potential 25% sell-down at book value implies a return of $500m and this capital could be reinvested, but again highlights earnings are not "crystal-clear" and still include development revaluations.
The broker points out that both Mirvac ((MGR)) and Goodman Group ((GMG)), other developers/fund managers, exclude development profits on owned stakes. The end result is that they should trade on a higher earnings multiple to reflect this exclusion.
UBS, too, finds significant omissions regarding details on the provisions/write-downs to exit non-core businesses or end-market demand for development product. There is also no changes to management/structure outlined.
Over the past ten years the company has done a good job growing the asset base by retained earnings but Credit Suisse notes this has been negatively affected by the poor performance of the soon-to-be-offloaded engineering division, and the impact of the pandemic in the second half of FY20.
While acknowledging scope to attract investment to fund the urban regeneration plans – a business Lendlease is very good at – Credit Suisse has issues with timing and funding of incremental investments and finds a lack of clarity at the individual project level.
Hence, investors should look at the stock from a top-down perspective, the broker advises, based on the capital employed and target returns, rather than trying to approach an earnings target by building up from an individual project level. The distribution policy is based on operating earnings and will be on a payout ratio of 40-60%, which will more closely aligned dividends with underlying cash flow, the broker adds.
FNArena's database has four Buy ratings and one Hold (Ord Minnett). The consensus target is $13.96, signalling 20.4% upside to the last share price.
Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.
FNArena is proud about its track record and past achievements: Ten Years On