Lendlease: We Think Earnings Trough Has Passed and We Anticipate Further Recovery

We don’t think it makes sense for Lendlease LLC 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 believe the market is sceptical, refraining from crediting a recovery until Lendlease actually delivers earnings and cash flow growth. We also think investors want to be confident there will be no new loss provisions, after previous losses in its jettisoned engineering business and elsewhere.

We reaffirm our AUD 14.45 valuation for no-moat Lendlease, and the stock screens as significantly undervalued. We expect operating earnings to more than double over the next five years and cash flow to follow. We estimate Lendlease will generate AUD 500 million in operating profit in 2024, compared with a market-cap of roughly AUD 6 billion, which would put the stock on a forward price/earnings ratio of 12, with further recovery still to come.