Company Reports

We remain confident Lendlease’s earnings should improve, but we think the balance sheet is one of the concerns that depressed Lendlease’s security price to new depths in calendar 2024. Lendlease’s 23% gearing, revealed in February, breached its target of 10%-20% gearing, and interest cover worsened to 2.2 times, down from 3.0 times in June 2023. Management declined to disclose the covenant minimum, but 2.2 times would be a low ratio for a property trust, let alone Lendlease’s huge development and construction commitments.

Lendlease is a diversified global property developer, landlord, property manager, fund manager, and builder on a range of development projects, funds, and completed properties around the world. Interests have included include apartments, offices, retail property, aged care facilities, retirement and military accommodation, roads, and rail tunnels.

Lendlease reported core business operating profit after tax of AUD 61 million for the first half of fiscal 2024, down 42% from the same period last year, reflecting tougher real estate market conditions with slower activity and lower property valuations. Management expects core operating earnings to improve, and our expectation of a second-half skew in development completions underpins our full-year estimate of AUD 257 million in operating profit after tax. We reduce our fair value estimate for no-moat Lendlease by 8% to AUD 13.30 per security given the near-term headwinds in development. The security currently trades at a 51% discount to our fair value estimate. The market is likely losing patience with Lendlease’s recovery; however, assuming a better second half, we think the group is still moving in the right direction, even though the pace of the turnaround is disappointing.

Lendlease is a diversified global property developer, landlord, property manager, fund manager, and builder on a range of development projects, funds, and completed properties around the world. Interests have included include apartments, offices, retail property, aged care facilities, retirement and military accommodation, roads, and rail tunnels.

The federal government’s migration review was released on Dec. 11 and it suggests high population growth remains the status quo. The review tinkers with various visa rules, but contains no major reduction in migrant numbers, suggesting high migration will persist, relative to precoronavirus levels and versus other developed countries.

Earnings underwhelmed in no-moat Lendlease’s fiscal-2023 result, but underlying progress was respectable. Our fair value estimate is unchanged at AUD 14.45 per security. Time value of money was offset by unexpected provisions relating to receivables due from the 2021 sale of a United States telecommunications business, and increased provisions for United Kingdom government action on residential buildings.

We don’t think it makes sense for Lendlease to trade near its net tangible assets of 8.09 as at December 2022. About half the group’s EBITDA comes from funds management, development and construction, businesses that are largely excluded from the NTA calculation. Admittedly, construction is in a lull, with EBITDA margins for the December half a low 1.8%, down from 2.6% in the prior half and below the 2%-3% target range. Management recently confirmed it will cut staff in that division, which doesn’t bode well for construction margins in the near term. We view construction as a low-margin, risky business with its main virtue to provide Lendlease with expertise for its development business rather than generate profit. Given the headwinds from lockdowns and shortages of raw materials and labour since 2020, we’re relieved that construction margins did not collapse into negative territory, and would not view a further decline in margins as a major negative, so long as it is modest and temporary. Meanwhile development and funds management look set for substantial earnings growth as Lendlease expands its development pipeline, with about half the pipeline being residential property.

We see risks to Australian office demand as widely overestimated, despite our expectation that work-from-home will endure post-pandemic. Several REITs remain modestly undervalued, particularly those focused on prime grade offices, with long leases, and solid balance sheets. We raise our fair value estimates for three particularly high-quality office-heavy REITs: Dexus, GPT, and Mirvac.

We cut our fair value estimate for no-moat Lendlease by 24% to AUD 13.10, due to a dilutive equity raise and medium-term earnings impact from coronavirus. However, the group’s huge development pipeline remains extremely valuable, and after a large fall the shares look undervalued to us.

No-moat Lendlease’s half-year result incorporated loss provisions for its engineering and services business, but the actual half-year profit number was a sideshow. Two things are more important to our valuation: whether any further loss provisions are made, and the company’s ability to execute on its pipeline of future construction and development work around the world.

Narrow-moat Lendlease’s announced sale of its engineering business does not fully insulate the company from project risk, as we had initially anticipated. Nonetheless, we make no change to our AUD 15.60 fair value estimate, as we already incorporated substantial uncertainty, and assumed that little value would accrue to Lendlease from the sale. Despite a negative reaction in the stock’s price, shares continue to look expensive.

Lendlease’s AGM today didn’t reveal much specific news, but it did suggest that the business is on track to meet our expectations. However, we think no-moat Lendlease shares once again look expensive after very strong performance. Our fair value estimate is unchanged at AUD 15.60.

After a disappointing first half, no-moat rated Lendlease recovered some form in the second half. Net profit after tax of AUD 467 million for the full fiscal year translated to earnings per security of 82.4 cents and a distribution of 42 cents, slightly ahead of our expectations. We increase our fair value estimate slightly to AUD 15.60, given reduced uncertainty around the group’s volatile engineering business and some revenue being delivered in the fiscal 2019 year that we previously expected in later years. After the security jumped sharply following results, the name screens as roughly fairly valued.

No-moat Lendlease’s AUD 21 billion development agreement with Google in the greater San Francisco area is a positive step. It signals a desire to move past its recent struggles with cost over-runs and timing delays in engineering and construction. The multiyear development includes affordable housing for rent and sale, along with colocated retail and hospitality offerings. At a 15% margin--our assumption for the long-term profitability of Lendlease’s U.S. development pipeline--we estimate the contract could add more than AUD 200 million of EBITDA annually over the 10- to 15- year agreement, nearly 15% of our long-term profit forecast. Nonetheless, we already included a sizable step-up in development revenue in our projections, and combined with lumpiness in project timing and uncertainty over eventual funding, we maintain our AUD 15.20 fair value estimate. Following recent solid performance, shares now screen as fairly valued.

We reiterate our AUD 15.20 fair value estimate for no-moat Lendlease following transfer of coverage to a new analyst. Shares screen as slightly undervalued. While there remains near-term risk from construction and engineering delays and cost-blowouts, we remain optimistic about the firm’s fund management operations and growth through urban regeneration.

Lend lease reported first-half fiscal 2019 earnings of AUD 16 million, down from AUD 426 million in the prior corresponding period due to foreshadowed AUD 500 million of anticipated losses on multiple engineering projects. Leading on from this, Lendlease has decided to exit its engineering and services businesses and over the next six months work out the optimal approach to sell or separate engineering from the broader business. This is quite a back flip, as the firm had previously flagged its engineering business benefited from competitive advantages and was essential to its integrated model.

A year ago, Lendlease flagged AUD 200 million of post-tax losses in relation to problems on what is believed to be four Australian engineering projects. These losses have now increased by a further AUD 350 million, pointing to inadequate systems over project management, risk management, and quality control. The additional post-tax losses equate to AUD 0.62 per share and an estimated AUD 0.82 per share on a pretax basis. Adjusting for these and an anticipated pull back in the level of engineering work the firm undertakes going forward in Australia reduces our fair value estimate to AUD 17.20 from AUD 18.50. The losses on the engineering projects are definitely negative news for Lendlease, but we think the market has over-reacted, shaving approximately 20% or AUD 1.8 billion off Lendlease's market capitalisation.

Lendlease Group reported fiscal 2018 earnings of AUD 792 million, or AUD 137 cents per security, or cps, up 1.3% and marginally above our forecast of AUD 135 cps. The result was messy, with construction EBITDA falling AUD 260 million due to engineering related impairments, but largely offset by significant uplift in noncash revaluations of investments by AUD 228 million to AUD 305 million. We forecast fiscal 2019 earnings grow 2% to AUD 140 cps, with a strong recovery in construction earnings, but a higher tax rate of 27% and lower revaluation gains.

Following a series of meetings with management, we have increased confidence in Lendlease Group’s processes around capital allocation and risk management. We’ve made a series of revisions to our forecasts, which include higher return on equity for the development business, increased near-term earnings from asset sales, and a faster rate of growth in assets under management. Following these revisions, our fair value estimate increases to AUD 17.50 from AUD 16.00, with no-moat Lendlease continuing to screen as overvalued at current levels.

The hugely diversified nature of Lendlease Group’s business means results are rarely clean, but earnings for the six months to December 2017 were particularly convoluted. Lendlease is in the business of developing and selling assets, but it is disconcerting the recognition of profit continues to come well ahead of the cash in many instances. Noncash revaluation gains exceeded AUD 300 million, almost half the pretax profit of AUD 624 million. Some of these gains will be crystallised in the near term, whereas the valuation uplift for the 75% stake in the retirement business isn’t expected to be sold for maybe five years. That said, there is still significant valuation uplift expected from Lendlease’s stake in Sydney office towers we foresee being sold within two years. Nonetheless, the booking of profits in advance of cash receipts presents risk of a significant earnings hole if asset values were to retrace, the likelihood of which is increasing as U.S. 10-year government Treasuries inch higher.