Company Reports

We transfer coverage of no-moat Lendlease and lower our fair value estimate by 15% to AUD 8.50 per security. The reduction follows a review of our longer-term forecasts. We’ve tempered our revenue growth expectations for development and construction, but increased our margin expectations given the business simplification. We’ve also lowered expectations for investment returns. Nevertheless, our fair value estimate remains at a premium to the latest estimate of net tangible assets per security of AUD 6.07 in June 2024, down 23% from a year earlier. We think this is reasonable given the significant high-margin fees and cash flow expected from Lendlease’s asset management business.

Lendlease kicked off a major shift in strategy in 2024, with plans to exit its international development and construction businesses, and focus on Australia. The group is a diversified property developer, landlord, property manager, fund manager, and builder on a range of development projects, funds, and completed properties around the world. However, within a few years, its offshore interests will mainly be limited to owning and managing mature investment assets, not development or construction projects. This will involve completing work-in-progress, selling its Asian, European, and United States development projects that haven't already started, selling its offshore construction capabilities, and its retirement and US military housing businesses, and Australian communities development.

Lendlease kicked off a major shift in strategy in 2024, with plans to exit its international development and construction businesses, and focus on Australia. The group is a diversified property developer, landlord, property manager, fund manager, and builder on a range of development projects, funds, and completed properties around the world. However, within a few years, its offshore interests will mainly be limited to owning and managing mature investment assets, not development or construction projects. This will involve completing work-in-progress, selling its Asian, European, and United States development projects that haven't already started, selling its offshore construction capabilities, and its retirement and US military housing businesses, and Australian communities development.

No-moat Lendlease’s major shift in strategy sacrifices some long-term upside as it exits overseas development and construction in return for near-term catalysts which should unlock value. Lendlease investors have rightly become impatient after a long wait. Catalysts could include an on-market buyback of AUD 500 million or more, AUD 4.5 billion in asset sales (much of it by fiscal 2025), and a simplified business focused on segments in Australia where Lendlease has usually made good returns. Selling its multidecade, incomplete development and construction pipeline leaves value on the table for buyers and prompts a 23% reduction in our fair value estimate to AUD 10. Even so, the securities screen as substantially undervalued.

We place no-moat Lendlease under review as we evaluate the company’s change of strategy, which was revealed this week.

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.

We reduced our valuation for no-moat Lendlease by 2% to AUD 13 per security on news that the Australian Taxation Office issued a revised income tax assessment for 2018, which gives rise to a liability totaling AUD 112.1 million.

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.