A Valemus Re-Rating For Lend Lease?

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– Lend Lease completes Valemus acquisition 
– RBS Australia lifts forecasts to reflect the deal, retains Buy rating
– Expects a share price re-rating from FY12 earnings delivery

 

By Chris Shaw

The FNArena database shows brokers are marginally positive on property development, construction and management group Lend Lease ((LLC)), with three Buy ratings and four Hold recommendations among those covering the stock.

RBS Australia is one of the brokers with a Buy rating. The stockbroker has reiterated its recommendation to reflect Lend Lease's recent acquisition of Valemus. The deal has brought Abigroup, Baulderstone and Conneq into the Lend Lease fold, which RBS Australia expects will generate a higher base of regular income going forward. This is significant as Lend Lease as a property developer generally has a high level of earnings volatility.

The Valemus deal also means a higher proportion of group earnings will be generated from construction and project management. RBS Australia estimates earnings from these operations will now approach 50% of group earnings.

The other positive of the deal for RBS Australia was the price paid by Lend Lease, which the broker viewed as attractive. This is likely to become evident in terms of earnings improvement from FY12, so to account for the Valemus acquisition RBS Australia has lifted earnings forecasts.

Earnings per share (EPS) estimates for RBS Australia have increased by 2.4% in FY11 and by better than 15% in both FY12 and FY13. The changes represent expectations of a strong growth outlook for construction activity in Australia, as well as increased investment in infrastructure and population growth, meaning additional property development opportunities. 

EPS forecasts now stand at 73.4c this year, 88.6c in FY12 and 106c in FY13, which compares with consensus estimates according to the FNArena database of 68.1c in FY11 and 84.5c in FY12. 

This upside potential is one factor behind RBS Australia's Buy rating, as the broker expects delivery of expected earnings in FY12 will likely see a significant re-rating of the Lend Lease share price.

Another factor in support of RBS Australia's Buy rating is the view now is the appropriate time in the cycle to be exposed to property developers. This is based on the assessment asset values worldwide at present are generally stable, while cap rates mean investors can get value without the need for significant leverage. Cap rate is calculated by dividing a property's net operating income by its purchase price.

Finally, RBS Australia notes Lend Lease management continues to improve internal operations, which is supportive for margins. Additional acquisitions remain possible, RBS Australia noting the Conneq business in particular operates in a highly fragmented industry where consolidation is likely. Geographical expansion is also expected as for example Lend Lease remains under-exposed in the Western Australian market.

The contrast between RBS Australia's Buy rating on Lend Lease and Hold ratings elsewhere in the market is a valuation issue, as RBS's above consensus earnings estimates imply additional value not being factored in by other brokers.

BA Merrill Lynch is an example of this, as following a review of the Australian REIT sector last week the broker downgraded to a Neutral rating on Lend Lease on relative valuation grounds.

The changes to earnings forecasts for RBS Australia mean an increase in price target to $11.12 from $10.70. The consensus price target according to the FNArena database stands at $10.03, with RBS the high marker and BA-ML the lowest with a target of $9.40.

Shares in Lend Lease today are weaker and as at 10.45am the stock was down 10c at $8.67. The market in general is struggling with yet another day of heavy losses. Over the past year Lend Lease has traded in a range of $6.70 to $9.28, with the current share price implying upside to the consensus target according to FNArena of almost 16%.

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