Lend Lease Sell-Down Overdone

This story features LENDLEASE GROUP. For more info SHARE ANALYSIS: LLC

– Lend Lease announces effective profit downgrade
– Brokers unsurprised
– Value evident given over-selling

By Greg Peel

Shares in development and construction company Lend Lease ((LLC)) have underperformed the ASX 200 by 15% since early May, notes Macquarie. To some extent that fall has been in sympathy with the development and construction sector, given profit downgrades from peers, but BA-Merrill Lynch notes LLC has fallen twice as far as the property sector, including yesterday’s additional 70c routing. Interpolation suggests to Merrills the market is valuing LLC’s Valemus domestic construction business on a PE of 3x, down from 7x, which is well below peers.

The question is as to whether Lend Lease actually deserves such a de-rating.

Yesterday Lend Lease management announced the company was “on track to deliver a solid [FY13] result in line with market expectations”, and in doing so made little change to guidance. However the lack of change masked movements within the numbers.

Lend Lease has sold its 25% stake in the Jem mixed-use project in Singapore into a managed fund and in so doing booked a tidy profit (around $50m), released some capital and set up for a stream of funds management revenues. Selling assets after they have been developed is “the nature of the LLC business,” notes CIMB. The sale also means Lend Lease’s tax rate falls from a previously guided low teens to 4-8%, creating a boost to FY13 earnings.

The company has also announced a restructure of its Australian Construction & Engineering business into sector-based businesses of building, engineering and infrastructure services. The restructure will cost $20m.

If we balance out these moving parts, we arrive at a profit expectation little changed from guidance. But from an operating perspective, the numbers represent a profit downgrade.

Lend Lease has downgraded its expectations due to weakness in the Australian and EMEA (Europe, Middle East & Africa) construction sectors. This is largely what set off the selling yesterday, despite market-wide weakness in Australian construction being “arguably well known,” as JP Morgan suggests. Merrills, for one, had already downgraded its own Australia/EMEA forecasts and would have expected the market to have considered the impact already factored in through prior share price falls, particularly given Australia/EMEA represents only 25% of group operating profit.

There is little doubt the current domestic construction outlook is challenged, but UBS notes Lend Lease is better positioned relative to peers given its internal development pipeline and recent PPP (public/private partnership) wins. The construction revenue backlog will increase into FY14 and management is also addressing margin pressure with cost cutting. JP Morgan suggests the step-up in earnings from the mixed-use development pipeline and Lend Lease’s geographically diversified operations are providing some cushion for weakness elsewhere.

Citi supports the “cushion” argument, while forecasting Australian engineering construction to fall by 10% over FY14-15. LLC’s record backlog and development pipeline are again cited as advantageous.

Asset recycling is what it’s all about, and aside from the potential profits available in FY14 from a Bluewater sale, management has listed several other recycling “levers” that can be pulled to drive growth ahead, including sales of equity stakes in infrastructure projects. And let’s not forget Barangaroo. The Jem sale “shows the significance of well-developed assets,” says CIMB, “and how much profit they can deliver”.

The bottom line is that while analysts have adjusted their earnings forecasts and reduced their target prices (FNArena database consensus falls to $10.43 from $11.00) the general feeling is LLC has been oversold, whether by association, by the markets failure to fully understand LLC’s bottom-up model, or by what Credit Suisse suggests is “double counting” – selling on suspicion and then selling again on the news. Yet given the weak construction climate, analysts do not expect much in the way of share price outperformance in the near term.

CIMB sums up the view in suggesting little will excite the market up until the Bluewater sale in FY14, and only then will the FY15 earnings lift be visible for the market to become excited. CIMB retains its Outperform rating without expecting too much too soon. No ratings changes flowed from the update yesterday, leaving seven out of eight FNArena database brokers on Buy or equivalent and only a slightly more conservative Citi on Neutral. Citi suggests value does “not yet look compelling” given increased concerns around the construction outlook and execution risk which will likely constrain near-term share price performance.

The other brokers are looking further ahead in recommending the medium term value within the stock at this level.

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