Will There Be Upside From Lendlease Targets?

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Lendlease is accelerating its developments to meet key targets by FY24 and the focus is now on the path to execution. Will this provide upside to the stock?

-Beyond FY24 it remains unclear if production targets are sustainable
-The 8-11% ROE target will not be met until FY24
-Can Lendlease manage gearing or will it need to resort to raising equity?
 

By Eva Brocklehurst

The theme for Lendlease ((LLC)) over the next 6-12 months centres on accelerating development and simplifying the business. In a recent briefing the company updated on cost savings, added detail to development activity and reaffirmed its targets.

The focus is now on execution and Citi is of the view this will be a key to re-rating the stock from its current multiple of 12x FY24 estimates, believing there is upside if this can be achieved.

The sustainability of development targets are key and, if successful, Ord Minnett agrees the stock could re-rate, although adds the proviso that development trajectories are rarely smooth and volatility is likely to feature.

Morgan Stanley, taking a contrary view, suspects the business may lack upside over the next year or so. Moreover, beyond FY24 it remains unclear if production targets are sustainable or adequately funded.

The broker accepts there are plenty of reasons to like the stock, as profit could double by FY24 and there is renewed focus on a strategy whereby around $8bn per year in completions can be achieved. There are also enviable relationships with business partners.

Nevertheless, Morgan Stanley calculates over the next 12 months development work in hand needs to rise to around $20bn so that this target can be achieved. The revised profit structure also means any outperformance in progressing work in hand will not result in profits until after FY24.

For a company with an inconsistent track record, Morgan Stanley asserts it is too early to be bullish – downgrading to Underweight from Equal-weight – and FY22-23 earnings are unlikely to excite. Investors buying the stock today should be aware, the broker points out, that there are hurdles that will not be met for the next two years while the development segment is rebuilt.

Citi, on the other hand, remains confident a multiple re-rating can occur, although it may take a little longer than previously envisaged. Management has also underscored its belief in the future of "gateway cities" and a focus on sustainability, which is increasingly important to institutional investors, the broker adds.

The Australian communities business is expected to return to targeted settlements of 3-4,000 per annum in FY23 and alternative capital strategies will be assessed once performance in this area is restored.

The strategy is all about FY24, which Credit Suisse finds clear enough, although agrees investors will need to back management's ability to deliver. The broker also notes that investors/analysts appear to be reviewing the stock from the bottom up, i.e. looking at individual project contributions towards overall earnings.

Instead, sustainable development completions, in order to generate sustainable revenue and returns, are really what the "unofficial endgame" appears to be about. Thus the broker believes this removes the focus on individual project contributions. Lendlease will not undertake risky structures that decouple profits and cash flow, which Credit Suisse believes should be welcomed.

Targets

Financial targets include 8-11% for operating return on equity (ROE) by FY24 and more than $160bn per annum in targeted cost savings of which 20% will be at the group level. Lendlease is targeting more than $16bn in new development starts in FY22-23 in a ratio of 38% commercial, 36% residential for sale, 14% communities and 12% residential for rent.

UBS calculates, to achieve $8bn per annum in development completions, Lendlease needs to move $16bn in projects into production in the next 24 months and around 74% of this relates to apartments and commercial, where the outlook is subject to demand and outside management's control.

The broker deduces, for a company that usually does not provide guidance, Lendlease appears to be trying to manage market expectations lower by stating the 8-11% ROE target will not be met until FY24.

Achieving the target is down to the contribution from the One Sydney Harbour development which is worth $3.3bn and Morgan Stanley is concerned as to whether this level of production can be sustained in FY25.

Moreover, even if the completion rate is reached there is no guarantee the return on invested capital (ROIC) target of 10-13% will be banked. The broker's calculations suggest that, even if all goes to plan, ROIC may merely reach the bottom of this 10-13% target.

With FY22 a re-basing year, Credit Suisse believes Lendlease has a line sight on its objectives, although acknowledges the risk the FY24 targets are not met. The broker divides investors into two camps: those that are patient and those that want evidence the strategy is working before getting on board.

The broker can envisage how Lendlease could achieve its strategic objectives with the existing asset base, debt capacity and retained earnings but this assumes impairments or provisions don't get in the way.

Longer term, Lendlease is targeting more than $70bn of funds under management by FY26. There is also a renewed focus on Australia and Asia originations, which Credit Suisse suspects is in light of the relative weighting of development work to the US/UK/Europe.

The company has reiterated expectations of a restructure charge of -$130-170m in the first half of FY22 will be recognised and cost savings benefits will then be recognised from the second half.

Given the cost reduction program is material, Macquarie had anticipated Lendlease would increase ROE targets and divisional ROIC targets. Yet the company has chosen to keep these targets static.

All up, therefore, it appears to the broker Lendlease has chosen to re-set returns to equity holders lower across the broader business for the near term, partially driven by delays to developments, particularly in London and San Francisco.

Funds?

Credit Suisse does not believe raising equity to fund strategic objectives is part of the company's plan yet, with gearing currently at 5%,  ramping up developments to facilitate growth in production and increase co-investments while maintaining gearing within the target of 10-20% will be a challenge.

Gearing could also increase to around 19% in FY24 on Morgan Stanley's calculations. Sale proceeds may be yet to come through, but then the company needs to leave funds for ramping up developments and restructuring as well as for outflows in engineering.

Macquarie is also cautious about the targets/timetable and believes management of the balance sheet will be critical. Without funding Lendlease may reduce capital in retirement, military housing and communities portfolios, the broker suggests.

Yet this is not straightforward, as the focus on deploying development capital with more incremental increases in investment while lowering funding requirements also delays the transition in earnings towards more predictable investment.

FNArena's database has three Buy ratings, two Hold and one Sell (Morgan Stanley). The consensus target is $12.69, suggesting 6.7% upside to the last share price. Targets range from $11.40 (Morgan Stanley) to $14.27 (Citi).

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