UK Infrastructure Deal Offers Upside For Lend Lease

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By Chris Shaw

Historically, property development group Lend Lease ((LLC)) has generated between 20-25% of its net profit after tax from asset sales, so the announcement by the company last week it has launched a UK infrastructure Fund has been well received by the market.

The fund will see Lend Lease invest $35 million and PGGM Vermogensbeheer B.V. of the Netherlands invest $355 million, with Lend Lease to recognise $80-$85 million of net profit in the first half of FY11 by selling UK PPP equity stakes into the fund. PPP stands for Public Private Partnership.

This should continue in FY12, as Citi estimates Lend Lease should earn revenues of about $48 million and net profit after tax of around $33 million in that year from the sale of additional UK PPP equity stakes into the fund. As well, Citi notes Lend Lease will earn revenues at around 30-basis points annually on the value of funds under management.

The key point of the deal in Citi's view is the transaction highlights an improving environment for asset sales for Lend Lease, which implies a higher level of confidence in the ability of the company to execute its asset recycling strategy.

UBS notes the deal also relieves a lot of the pressure that was on Lend Lease's earnings in FY11, while at the same time releasing some existing and future funding capacity at the group level. The other benefit of the deal for the broker is it creates a medium-term source of profits for Lend Lease as new PPP projects can be sold into the fund once they are constructed.

This should continue to support earnings, as BA Merrill Lynch notes Lend Lease intends to invest an extra $500 million into PPP's globally over the medium-term. Assuming a period of six years between the initial equity investment and its release and 100% equity uplift, BA-ML estimates this additional $500m could generate up to $150 million in EBITDA (earnings before interest, tax, depreciation and amortisation) before operating and bid costs.

While it has lifted its FY11 numbers by 4% to reflect the deal BA-ML suggests the additional investment planned for PPPs offers some upside to its forecasts in coming years. BA-ML's earnings forecasts in earnings per share (EPS) terms currently stand at 63.9c in FY11 and 68.4c in FY12, which compares to consensus EPS forecasts according to the FNArena database stand at 64.6c and 70.7c respectively.

While its forecasts are unchanged on news of the transaction, JP Morgan agrees earnings risk is to the upside for Lend Lease as the creation of the UK Infrastructure Fund should see the booking of an after-tax profit of $70-$80 million. This is well above the broker's previous forecast of a profit of around $30 million.

The UK Infrastructure Fund announcement might not be the end of the good news for Lend Lease, as JP Morgan notes there is also some upside risk to earnings from the recently completed transaction with Sekisui House of Japan.

UBS agrees there could be some additional announcements in coming weeks, noting Lend Lease is likely to soon gain development approval for the Barangaroo project, worth around $6 billion The company could also be awarded construction contracts for the Royal Adelaide and Melbourne Cancer Hospitals.

On UBS's numbers Lend Lease has around $1.6 billion in available cash and $700 million in debt facilities as at the end of June, while FY11 asset sales should realise in the order of $350 million. The broker sees this as providing the company with the financial firepower to consider other growth options that may become available.

With the outlook for asset recycling and therefore improved earnings, the market view is Lend Lease is cheaply priced at present. As an example, JP Morgan's average valuation for the stock is $9.66, which is around 20% above the current share price.

While near-term operating conditions are somewhat patchy this is enough for JP Morgan to see value, meaning no change to its Overweight rating on Lend Lease. Others are similarly positive, Citi noting the stock is trading on only an 11.6 times earnings multiple in FY12 despite expectations of a return to double digit EPS growth in coming years.

The FNArena database shows a perfect six-for-six Buy ratings for Lend Lease, with a consensus price target of $9.17. Macquarie is the laggard with a target of $8.03, the other brokers covering the stock in the database all showing price targets of $9.00 or better.

Shares in Lend Lease today are unchanged as at 11.15am, last trading at $8.07. Over the past year the stock has traded in a range of $6.70 to $10.46 and the current share price implies upside of around 11% to the consensus price target in the FNArena database.

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