Stockland Benefits From Resi Recovery To Show in FY15

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-Well placed for residential recovery
-Impaired stock, supply constraints
-Potential for earnings leakage to FY15
 

By Eva Brocklehurst

Real estate investment trust, Stockland ((SGP)), is trying to make the most of improving residential demand. Deposits taken on residential property in the first quarter were up 33% on the prior corresponding quarter and the strongest since 2011. Conditions are improving in all states and management indicated to brokers at the recent quarterly briefing and Sydney site tour that sales rates have been maintained in the last two months.

Citi accepts the company is making the most of the improved conditions but there are still challenges ahead. None the least is production time – the span between when deposits are taken and settlement transpires. Production is usually a range of 3-9 months and Citi calculates this to mean that much of the current sales activity will fall into FY15. While this sort of lag is not unusual, it is something the investor needs to monitor. The broker observes that, were production to lag deposits more than 12 months, then sales rates would be affected. At present the outlook is for a solid FY14 earnings report – the company is guiding for 5,000 settlements in FY14 – with strong contracts in hand for FY15.

The residential recovery is also tempered by the impaired stock situation and supply constraints. Credit Suisse thinks earnings will remain modest while Stockland trades through low margin and impaired projects. The company expects operating profit margins to improve to 11-13% by FY16, from the current 6.6%. Outside of residential, the rest of the business is in line with expectations, but Citi notes retail portfolio metrics are looking a little weaker. Specialty sales growth was flat in the quarter, affected by developments and new tenants on lower rents. This volatility is likely to continue as centres under re-development come and go. Citi thinks there is upside for the stock as operating profit margins recover in the residential segment as this could mean impaired inventory sells more quickly.

JP Morgan's positive view on the stock is driven by the improving residential business and low retail occupancy costs, as well as strong relative productivity. The broker accepts settlements are slightly constrained by production capacity in new projects, and short term profitability will be affected by low margins and impaired projects. Still, improving sales rates will provide the buffer and the company should carry strong pre-sales into FY15. JP Morgan notes price growth has also emerged in Melbourne and that is ahead of the flat prices that Stockland had assumed.

Stockland has reiterated a commitment to growing residential property holdings within the urban infill locations and will also contemplate strategic alliances. The earnings growth guidance of 4-6% for FY14 is maintained but the brokers thinks the Calleya project in Western Australia could be a key swing factor. The planning approval was received in October but it will depend on how lots can be settled as to whether the project contributes anything to FY14.

Credit Suisse has suggested that Australand ((ALZ)) may offer an opportunity for Stockland to expand in the apartment and industrial segments. The company has stated it does not hold stakes in other companies but the broker thinks Australand offers potential earnings accretion, given the high 8.05% cap rate on the investment portfolio and the ability to reset hedges and reduce the cost of debt. Moreover, Stockland has demonstrated a commitment to grow the industrial portfolio through the recent acquisition of the Forrester Distribution Centre at St Marys for $73m.

The stock presents the most attractive leverage to the housing sector among large cap A-REITs, in Morgan Stanley's view. What constrains the company, from most viewpoints, is the physical construction and planning approval timelines. Delays have the potential to push income into FY15. Morgan Stanley notes the company confirmed it will sell part stakes in mature retail assets and offset any capital gains by closing out-of-the-money swaps but there's still a high cost of debt relative to peers, at 6.3%. Still, the broker is happy that the company is setting expectations sufficiently low to beat the prior year, when full year results are delivered next August. The 7.7% 3-year compound annual growth rate is sufficient for Morgan Stanley to retain an Overweight rating.

BA-Merrill Lynch is the other way inclined. The broker has an Underperform rating and nothing from the investor update has changed that view. Merrills prefers Mirvac ((MGR)) and Lend Lease ((LLC)) for exposure to the residential recovery. These two are trading on lower FY14 forecast multiples and have lower distribution pay-out ratios. Merrills also highlights the timing issue and the swing factor in Calleya. Additional approvals are still needed to launch that project and to meet earnings growth expectations at the top end of the guidance range lots will need to settle in FY14.

There are three Buy ratings, two Hold and two Sell on the FNArena database. The consensus price target is $3.94, signalling 2.8% upside to the last share price. Price targets range from $3.53 to $4.26. The dividend yield is 6.3% for both FY14 and FY15 consensus forecasts.

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