-Earnings growth priced in?
-Narrowing distance to peers
-Development & acquisition strategy
 

By Eva Brocklehurst

Aged care provider Regis Healthcare ((REG)) is gearing up to open a net 1,028 new places, expected to deliver a boost to earnings growth. The company updated the market on its development pipeline along with the first half results. The bulk of developments will be delivered from FY17 which resulted in modest guidance for FY16.

First half results were weaker than UBS expected, the key reason being higher staff and interest costs. The broker updates its forecasts to allow for the new places and expects this to deliver 10-11% to profit growth in FY17 and FY18.

The broker does not believe there is substantial risk associated with the trend decline in RADs (refundable accommodation deposits). Government changes in July 2014 created a slight shift in resident preference for DAPs (daily accommodation payments) but, as resident preferences tend to be sticky, the broker does not envisage any changes in preference are enough to cause balance sheet risk.

The government is set to review the current aged care funding environment this year and outcomes should be set out in late 2017. UBS rates the chance of further negative funding changes before then as low.

In evaluating the non-organic growth in the aged care sector, in the form of acquisitions or developments, UBS believes traditional measures of returns do not properly account for the timing difference in income from either strategies. The broker uses an internal rate of return (IRR) measure and concludes that acquisitions actually provide better shareholder value.

The broker believes the current market has priced in the earnings growth in the stock, as Regis Healthcare is trading on the highest multiple with the lowest growth outlook in the sector. The company is a high quality operator with a strong track record and, while it is appropriate for the market to ascribe a premium for greater certainty, UBS believes the stock is fully priced at current levels.

RAD inflows fell slightly short of Deutsche Bank's expectations and are expected to remain subdued in the second half. Nevertheless the broker remains confident the development pipeline will deliver stronger income in FY17, as a number of newly developed sites open.

This should support a return to double digit earnings growth and a stable debt profile. The uplift in staff costs offset some of the benefits of refurbishment payments and higher DAP payments, the broker contends.

The increased preference for DAPs and the large capital expenditure incurred in the first half resulted in a weaker net cash position and, while this is not expected to reverse in the second half, Deutsche Bank remains confident it will stabilise as new facilities are opened in FY17.

Payment preferences among industry peers suggest a trend towards a combination of RAD/DAP. RADs are a standard bond price set by the facility while the DAP is the equivalent which is paid periodically. The proportion of incoming residents opting for a combination of payments is now 41% versus 28% in the prior half. Those electing a RAD only payment fell to 51% from 68%.

Deutsche Bank notes Regis Healthcare has a much lower proportion of RAD-only payments and higher proportion of RAD/DAP combination payments that its listed peers.

Morgans is happy with the results and the guidance that promises the second half will be similar to the first. Minor reductions are made to forecasts relating to higher depreciation charges.

The broker previously applied a 10% premium to valuation to set its price target but has now halved that premium, given the valuation gap to other listed players is closing. The price target falls to $5.73 from $6.00 and as the shares are trading within 10% of that target the rating is moved down to Hold from Add.

The broker remains a strong supporter of the aged care sector and will look for any price weakness as an opportunity to upgrade. Upside risk comes from more operational beds on hand, while the downside risk relates to any changes in government funding arrangements.

Macquarie has no qualms, upgrading to Outperform from Neutral. Guidance for the full year was above expectations and the payroll supplement headwind has now cycled. An additional 234 development places are being created, with growth expected to be 20% by 2019.

The broker is also at ease with the potential impact from changes to the regulatory environment, which are as yet unclear. Macquarie likes the company's consistent and disciplined strategy based on developments, in tandem with acquisitions when targets are attractively priced.

FNArena's database shows two Buy and two Hold ratings. The consensus target is $5.91, suggesting 14% upside to the last share price. Targets range from $5.70 (UBS) to $6.20 (Deutsche Bank).
 

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-Development costs increasing
-But growth profile is robust
-Queries re US cash flow inclusion
 

By Eva Brocklehurst

Toll road developer and operator Transurban ((TCL)) rolled out a dividend increase and a robust growth pipeline in its first half results, demonstrating confidence in the traffic outlook. Traffic growth and earnings from the Melbourne and Sydney assets were strong. Brisbane remains the weakest of the east coast networks, because of softer economic conditions in Queensland. US road earnings are also benefiting from an improving economy.

The pipeline of projects appears full but Macquarie observes it falls short of the company’s objective to have one project in construction and one in development in every region. NSW is the market which misses those targets. The most obvious opportunity there, in Macquarie's view, is the reorganisation of the CCT/M1 and the Sydney harbour tunnel and bridge slated for around 2023.

Strategic development costs are increasing and management has signalled investment is not necessarily delivering an immediate return, although Macquarie observes the company is attempting to cater to a changing environment, flagging more details about the potential impact of technology will be available for the upcoming investor briefing.

UBS notes earnings growth of 14% lagged the 19% revenue growth, which was unusual. This stemmed from a 2.7 percentage point decline in margin to 73.7% but, excluding new projects in start-up mode, this moderates to 76.1%, a 0.3 percentage point decline. The broker expects the elevated costs of new project developments should also moderate.

Transurban has plans for $4bn in capital to be deployed over the next five years on projects for which it is in exclusive negotiations. UBS expects gearing capacity and the dividend reinvestment plan will be sufficient to fund this capital.

The 21% growth in proportional costs surprised Morgans. Several items contributed to this, with the start of the Legacy Way and ramp up of express lanes, as well as investment in growth projects.

Transurban is now factoring in the US express lanes into its calculations, with a $28 contribution for the first time to free cash flow. This surprised both Morgans and Macquarie, as the company had previously indicated it did not expect to have access to these cash flows until later in the decade.

The quality of this cash flow will be questioned further if the express lanes are still in distribution lock-up, which Morgans maintains is yet to be confirmed. Macquarie warns that counting trapped cash flow as part of a distribution measure is a very low-quality entry on the books.

Morgans reduces proportional earnings estimates by 2.0%, noting that this does not include estimates for the Victorian Western Distributor project, which if it proceeds may add 60-70c per security to valuation. The broker also notes the company has merged service and fee revenue into toll revenue, thus making the revenue result less clear on a composition basis and reducing the ability to compare with historical data.

Deutsche Bank likes the quality of the portfolio but believes the stock is relatively expensive. The company’s development pipeline to 2022 requires up to $8.2bn in capex to be invested and the broker suspects these may necessitate some additional equity funding going forward, although management maintains timing of the projects will also assist funding needs.

Nevertheless, free cash flow growth is robust, as is the development pipeline, in Morgan Stanley's view. The broker considers the amount of operating expenditure growth is acceptable at this point in time, and while debt risks are increasing, they are manageable.

Investor concerns are mainly about the debt levels and rising costs, but Morgan Stanley believes the company can service and refinance its holding company and project debts under most reasonable adverse cases. The broker endorses management's practice of optimising debt costs versus re-financing risk by pushing out the debt tenor, rather than by simply minimising costs.

The broker believes investors appreciate the strength, diversity and growth prospects of the Australian road network and are increasingly re-rating the US roads, now that the company is announcing traffic and revenue growth in that region. Morgan Stanley does not include major growth projects such as Victoria's Western Distributor in its analysis but believes that could add a further 90c per share to valuation should it proceed.

There are three Buy ratings and three Hold on FNArena's database. Macquarie remains restricted on rating and target. The consensus target is $11.04, suggesting 3.2% upside to the last share price. Targets range from $9.99 (Morgans) to $12.00 (UBS).
 

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-Substantial low-quality asset divestment
-Issue now of where funds are redeployed
-Some way to go with merger synergies
 

By Eva Brocklehurst

Vicinity Centres ((VCX)) is streamlining its business, having recently undergone a merger with Novion and being formerly known as Federation Centres. The company will undertake asset sales of $750m to $1bn by the end of 2016.

JP Morgan was most surprised by the quantum of sales, which are in addition to eight prior sales and the ACCC-enforced off-loading of the company's stake in Karingal. The broker estimates these future sales will be 1-2% dilutive to earnings but meaningfully accretive in terms of portfolio quality and long-term growth.

The company's merger implementation is on track to achieve 75% of targeted synergies by June 2016. There will be no impact on FY16 earnings and guidance of 18.8-19.1c per security has been re-affirmed. The company is targeting through-cycle earnings growth of 3.0% and total returns of 9.0% going forward.

Now is a good time to trade up the quality spectrum, in JP Morgan's opinion, because retail cap rates are converging, in that the yields do not adequately reflect the greater long-term growth in high-quality assets. A cap rate is the ratio of book value to the income produced by the asset. JP Morgan also expects a meaningful premium to book value from the non-core asset sales.

To the extent acquisitions are possible, the broker believes they are likely to be sub-regional, or outlet assets. Management has stated that timing of sales to coincide with opportunities for redeployment of capital, while ideal, is not always possible Management has also signalled a preference to own assets entirely, although joint venture will be pursued selectively to gain access to quality and as a means of mitigating risk.

The $1.8bn bridging finance facility will be closed by the end of 2015. UBS welcomes this news and notes the main outstanding project is the full integration of the IT platform, which is expected to take 12 months. The broker calculates the market is only attributing 16% of the stock's value to long-term growth, which compares with around 28% for Scentre Group ((SCG)).

This means the market is attributing twice the amount of long-term growth to Scentre Group compared with Vicinity Centres, something UBS considers is unrealistic over the medium term. Still, the broker does not anticipate the gap will close quickly as there are lingering concerns over Vicinity Centres' debt, development pipeline and merger integration.

Morgan Stanley expected this announcement would be an opportunity for management to update its major growth drivers, portfolio strategy and capital management strategy. The latter two were adequately covered but the broker believes growth drivers for the near-term need to be clarified further, in addition to providing conservative long-term targets which highlight the potential for valuation upside.

The broker is underwhelmed by the growth target (3.0%) particularly since the company has undergone such large corporate restructuring and incurred around $500m in costs over the past two years. The growth target seems conservative to Morgan Stanley, particularly over the short to medium term.

With potential upside from ancillary income, further savings in procurement and revenue synergies from improved quality the broker still expects free cash flow growth over the next three years in excess of the sector average of 5.2%.

Macquarie expected Vicinity Centres to be aggressive on asset sales, as it now has a larger earnings base. The exact assets being included for sale were not disclosed but Macquarie has identified around $2.3bn in real estate that is lower quality, with a combination of low sales productivity and high occupancy costs.

The main question is over the redeployment of funds. With development returns likely to be under pressure the broker considers deployment into the current pipeline is unattractive, particularly from an earnings perspective.

Factoring in the recent fall in the share price relative to the Australian Real Estate Investment Trusts (A-REITs) index, Macquarie observe valuation appeal is emerging. However, with a complex integration process under way and dilutive asset sales on the horizon, the broker suspects the stock will lose its appeal against a backdrop of rising long bond yields. Hence, an Underperform rating is maintained.

Credit Suisse is also of the opinion value may be emerging, given the stock has underperformed the sector by 10% in the year to date. The broker supports the shedding of weak, low-growth assets and redeploying funds into higher-returning assets. Still, consensus estimates need to be trimmed, in the broker's opinion.

There are three Buy ratings, two Hold and one Sell (Macquarie) on the FNArena database. The consensus target is $2.95, suggesting 7.1% upside to the last share price. The dividend yield on FY16 and FY17 estimates is 6.4% and 6.7% respectively.
 

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- 4.7bn Australian and UK apartment settlements at risk
- Apartment demand appears to be peaking
- Lend Lease underperforming the index as a result
- Management, analysts agree risk overstated
 

By Greg Peel

Global stock markets hit their peaks around six months ago and have corrected ever since, potentially now consolidating at lower levels ahead of a resumption of the longer term bull market. The emphasis is of course on “potentially”.

The major driver of the correction has been fear of a slowing economy in China. As the chart below indicates, the past six months have seen the ASX200 fall by as much as 17% before recovering to around a 10% fall. Shares in property developer and index constituent Lend Lease ((LLC)) have nevertheless fallen by as much as 28% to recover to be around 25% down.

Why the underperformance, or if you like, downside outperformance of Lend Lease?

Lend Lease builds apartments. Lots of apartments. The company pre-sells those apartments ahead of construction and takes a deposit. In any economic backdrop there is always a risk buyers will default on their settlement payments.

The economic backdrop in Australia currently is twofold. From the global perspective, China is slowing. From a domestic perspective, Australia has seen a boom in apartment construction as prices have risen substantially, but as supply begins to overwhelm demand, the warning bells have been sounded by everyone from stock analysts to the RBA that the peak may now have been seen.

Lend Lease sells a lot of its apartments in Australia to the Chinese. Thus the market is perceiving a double-whammy risk. Thus Lend Lease shares have de-rated by a greater percentage than the index.

This risk was the primary topic Lend Lease management wanted to address at its recent investor day. The company has never been in the business of issuing specific quantified earnings guidance, but stock analysts attending the briefing came away praising the detail management provided to make its case that the risk is not as ominous as the market appears to believe.

Lend Lease has pre-sold $5.2bn worth of apartments globally and $4.7bn of that total represents Australia and the UK. Of that amount, Chinese buyers represent 20% and other foreign buyers 25%. Lend Lease will attempt to settle on over one thousand pre-sold apartments per annum for the next four years. Therein lies the risk.

But Sydney apartment prices are up 15% in a year and 25% in two years. At the same time, the Aussie dollar has fallen, such that in US dollar terms, 2014 pre-buyers are up as much as 40% ahead of completion. At Barangaroo for example, 12 of the 159 apartments in the first residential stage have already been on-sold, and capital gains on those sales have ranged from 24 to 52%. Lend Lease is holding 10% deposits on the initial sales, and the company’s margin on those initial sales prices averages over 20%.

Lend Lease is thus carrying a solid buffer, and there is very little incentive for buyers, Chinese or otherwise, to default on final settlement. There will always be some buyers who are forced to default of course, and Lend Lease’s long run average default rate is 3%. The company’s current default rate is between 1 and 3%, so no signs of above average default risk at this stage.

Stock analysts have run the numbers based on elevated risk nonetheless, in various different ways. Credit Suisse, for example, calculates Australian apartments represent 17% of Lend Lease forecast earnings for FY16-19. Were 20% of settlements to default, and those apartments are never re-sold, the broker would be forced to cut its earnings forecast by 4.4%.

To put that in perspective, Lend Lease’s worst ever default rate experience occurred just after the GFC hit. A single project saw a default rate of 13%, but all those apartments were later sold at a profit.

Moreover, Lend Lease is not seeing any notable drop-off in demand. Indeed, enquiries are up strongly year on year. The next release of Barangaroo apartments will number 350 and the company has received 1100 expressions of interest, requiring $10,000 registration fees.

All of the above does not mean Lend Lease management is smugly waving off talk of elevated risk as a load of nonsense. Analysts note the company is renowned for its discipline. New apartment releases in the UK will now require a 20%, not 10%, deposit for example, and management is considering the same for the 350 Barangaroo apartments noted above. In Melbourne, Lend Lease will not proceed with new construction unless a 70% pre-sale threshold is reached.

Perhaps the most telling takeaway from Lend Lease investor day, analysts agree, is management’s declaration that it currently holds the highest level of confidence in the earnings outlook for the business in the group’s history.

Having de-rated by a substantial margin beyond that of the ASX200 over the past six months, analysts also agree that Lend Lease shares are undervalued. Six stockbrokers in the FNArena database cover the stock, and all six are carrying Buy or equivalent ratings.

The consensus target is $17.43, suggesting 33% upside.
 

Technical limitations

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