Lend Lease Strength Lies In Diversity

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-Lend Lease result mixed
-Development pipeline the driver
-Residential weak
-Still issues to be resolved
 

By Eva Brocklehurst

Lend Lease ((LLC)) half year results were better, in line, mixed and/or messy – depending on broker emphasis. What was generally agreed as good? Development is coming along, with progress being made at key sites including Barangaroo in Sydney and Elephant and Castle in London. Macquarie sees the most positive aspects as the global construction pipeline, where Lend Lease is the preferred bidder and has potential revenue of $17.8bn, underpinning future earnings from the construction business.

JP Morgan also finds there are encouraging signs of recovery in Lend Lease's profitability outside of Australia, noting improved demand for US operations. Moreover, Lend Lease's Asian operations should benefit from ongoing construction activity, and the start of profit recognition on the US healthcare development business should provide another source of earnings and realise return on capital. UBS sees earnings being on track for FY13, despite the discrepancy between reported earnings and operating cash flow. The broker's current forecasts assume net profit of $562m, implying a first/second half skew of 55%/45%. The higher contribution to first half earnings relates to Barangaroo profits, Greenwich profits and fees on Australian public-private partnerships, partially offset by lower construction earnings and higher group services costs.

Deutsche Bank is upbeat, noting the contraction in the Australian construction margin reflects the fact that projects have yet to reach profit recognition thresholds. There are also around $1.5 billion in major Australian construction projects where Lend Lease is at the preferred bidder stage. JP Morgan believes construction is well positioned to deliver good earnings growth, noting a strong level of backlog is likely to support operations. Nevertheless, the broker does assume demand for Australian engineering and commercial construction will come under some pressure over the medium term, as capex intentions are reeled back in resources and governments remain fiscally constrained.

What was not so appealing? Macquarie sees Australian residential segment as weak, finding the total number of units settled was flat compared with the prior corresponding half and a substantial step down from the previous half. Furthermore, product mix is adversely impacting sales prices. UBS also finds the residential segment is a challenge but notes that is not Lend Lease specific, more a figment of the overall housing market. The broker maintains there is an attractive apartment development pipeline that should contribute from FY15 onwards.

UBS expects Australian apartment earnings to increase from $16m in FY13 to $102m in FY16 with major project contributors being Showground Hill and Barangaroo in Sydney and the International Convention, Exhibition and Entertainment Precinct and Waterbank in Perth. JP Morgan thinks, outside of the development pipeline, low consumer confidence will weigh on the Australian residential operations. There are early signs of recovery in the London residential market and this should help UK earnings.

Looking ahead, there are some issues that still need to be resolved. Macquarie notes Lend Lease is still in negotiation with NSW government regarding the location of the hotel at Barangaroo, as the original proposed location over the water was not approved. Lend Lease will relocate only if it does not have adverse implications for commercial returns. Also, operating cash flows lag earnings. UBS notes that this trend will continue as Lend Lease ramps up its development pipeline for future development profit generation. Therefore cash flows will remain weak over the next 18-24 months. So the broker thinks management needs to de-risk future development earnings through progress on key development sites and would like better disclosure in this regard.

Macquarie is concerned about the Adelaide desal project which is not yet complete. This is the final project that was indemnified as part of the acquisition of Valemus that settled in March 2011. Going forward, Lend Lease is fully exposed to adverse project outcomes here.

Near term catalysts for a re-rating of the stock will be progress at Barangaroo as well as pre-sales at Elephant and Castle and Showground Hill. Until such time UBS has retained a Hold rating, one of two currently on the FNArena database. The other six brokers are maintaining Buy ratings. A revised consensus target price post result to $10.83 from $9.83  suggests around 7% upside from the current traded price.
 

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