Stockland Tightens Focus On Retail And Residential

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-Focus on residential and retail
-Gearing likely to increase
-Question of funding sources
-Move into medium density
 

By Eva Brocklehurst

Property owner and developer Stockland ((SGP)) has completed a strategic review. The company had looked at a structural break-up but concluded the current stapled and diversified structure was more value enhancing. The two core segments will be residential communities and retail. The asset allocation targets include 70-80% in commercial property and 20-30% in residential and retirement. Stockland's portfolio is expected to grow to $7.5 billion in the next five years from $5.5bn currently. The focus is on non-metro shopping malls with a strong staples contingent and a move into medium density residential communities.

Earnings guidance for FY13 has been reduced, implying around 22c per share. The company will take a $10-12 million restructuring provision in the second half, which explains part of the downward revision. The other part is a further $49m in residential impairments. The distribution is expected to be held at 24c for both FY13 and FY14. BA-Merrill Lynch suspects the company won't return to the 29.3c per security earnings era of FY12 until FY17. JP Morgan flags the fact that as all earnings are coming from the trust, all have to be paid out. The company hopes to build retained earnings in the corporation in order to smooth the distribution profile. JP Morgan observes, if the company sells large stakes in retail assets, it may be forced to pay out higher distributions, given the capital gains in those assets.

The company is considering re-activating the distribution reinvestment plan and underwriting 50% or more, as it focuses on retaining an A minus credit rating and 20-30% gearing range. It's this gearing range that Macquarie thinks may be breached, the broker asking how the company will fund the substantial retail development pipeline. This has increased to $1.5 billion and was previously expected to be funded through the sale of office and industrial assets. The quantum of capital in office and industrial is now expected to be unchanged. The company will retain a "tactical" 5-10% weighting in office, perhaps taking that down to zero in the longer term. Macquarie estimates gearing will rise to over 30% in the next five years and $300m of asset sales or equity would be required to bring it back down. Among Macquarie's assumptions are: retail development spending delivering a yield on cost of 7.5%, 2.5% per annum value growth in the assets over five years, $500m of office asset sales reinvested into industrial and $150m repatriated from residential into retirement development. 

Taking into account asset sales in the second half, Macquarie's forecasts for operating cash flow and assumptions listed above, there remains a liquidity shortfall of around $650m. Hence, the company has flagged the underwriting of 50% of the distribution over the next year. Another $400m in additional liquidity is still required and the broker expects this in the form of debt, asset sales or additional equity. Capital partnering has been mentioned as a source of capital but management did not see this as a large component. Macquarie thinks opportunities will likely take place in large development assets to enable the company to recognise further commercial development profits, in the manner in which others do, such as Westfield Group ((WDC)) or Mirvac ((MGR)).

The company also stated it may consider breaking interest rate swaps, which are significantly out of the money, to manage interest coverage ratios and maintain the credit rating. JP Morgan doesn't like hedge restructuring as it does not create value but believes if it can assist Stockland keep the credit rating, then it will have advantages as to cost and access to debt.

JP Morgan sees the key drag on Stockland's returns being overheads. Retirement, as an asset class, offers a number of challenges and the broker finds it hard to envisage the monetising of Stockland's investment any time soon, given the absence of any institutional interest in the asset. Retirement is no longer a standalone aspiration and no further capital will be allocated to acquire low yielding established retirement villages. In terms of any JV, the company said there is potential for further scale if a deal can be reached on capital efficient terms. As for anything near term with FKP Property ((FKP)), this has been dismissed by the company.

The Western Australian residential segment contributed most to the company's national sales in the March quarter and rose to 47%. The Queensland market also had volume improvement and was up 33% quarter on quarter. Victorian sales rates appear to have stabilised while NSW sales were relatively low, albeit most of this was impaired stock. The move into medium density was not a surprise to Macquarie. The broker notes Stockland has undertaken some projects that fit this description in the past and targets are not overly aggressive. Stockland will move into medium density development on existing masterplanned communities but will not move into high rise or smaller inner urban projects. Lot sales are now targeted at 5,000-6,000 per annum. This is a range rather than the minimum target of 6,500 that was outlined previously. Merrills notes the goal here is to avoid putting pressure on the business to simply sell as many lots as possible. 

Stockland has a mixed rating on the FNArena database. There are two Buy, two Hold and three Sell. The consensus target price is $3.79, suggesting 4.3% downside to the last share price. The dividend yield on consensus forecasts for FY13 and FY14 is 6.1%.
 

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