Tag Archives: Property and Infrastructure

article 3 months old

Opportunities in WA-Exposed REITs

-WA softer but still growing
-NSW, Qld recovery offset
-FDC growth double peers
-SGP upside to Qld demand
 

By Eva Brocklehurst

The Western Australian property market is well past its peak. Brokers attending tours of key commercial and residential assets in Perth have come to this conclusion as the resources boom starts to wane. Still, the state's economy is outperforming on some metrics. The population is growing and unemployment is below the national average. Residential property is expected to show further volume decline in 2015, while the CBD office vacancy rate, currently at 14.7%, is expected to peak in 2015. Land price growth has been a little stronger but should also start to slow. Retail turnover growth in the state was materially below the national rate in the year to September but, as JP Morgan observes, unlike the volatility in the office market, retail cap rates (income as a proportion of book value) and rents have been relatively stable.

JP Morgan expects residential volumes will remain at reasonable levels because WA has the strongest population growth and employment. House prices are up 2% in the past 12 months and while underperforming the Australian average, are still likely to stall. Citi was keen to witness first hand what effect the slowdown in mining was having on WA property. While there is evidence the residential market has slowed, demand appears to be stabilising. Land lot sales picked up in the September quarter and house price growth, while moderate, remains positive. It appears the years of above-trend population growth have not been met with a commensurate response in dwelling commencements. The risk may lie to the downside but Citi finds there is evidence of equilibrium emerging in WA. 

Key stocks in this regard are developer Stockland ((SGP)) and Australian real estate investment trust (A-REIT) Federation Centres ((FDC)). The two companies have hosted tours of WA assets and the state is a key part of their portfolios. WA consisted of 34% of Stockland's settled lots in FY14, while it represents 50% of Federation Centres' development pipeline.

Citi is forecasting a 6.3% earnings growth rate to FY16 for Federation Centres, which is more than double that expected for peers. The company has more WA exposure than any other retail landlord but Citi is increasingly comfortable about the opportunities that present. The company boasts ample balance sheet capacity for investment and new low cost debt to help fund this. The company's portfolio has suffered in the past from a lack of investment, which Citi observes was because most of the centres were held by financially distressed vehicles. Arguably this is why Federation Centres enjoys a wider array of value-adding developments. As Citi expects retail rent growth could be lower for longer, the numerous growth levers at Federation Centres' disposal stand the company in good stead.

JP Morgan likes Federation Centres as it has some strong development opportunities in WA. The company plans to spend $750m across two large projects, Mandurah and Galleria, amid the stated intention of recycling out of weak centres and enhancing others to increase the quality of the portfolio. There are three Buy ratings, one Hold and three Sell for Federation Centres on FNArena's database. The consensus target is $2.70, which signals 1.5% downside to the last share price. The dividend yield on FY15 and FY16 forecasts is 6.1% and 6.4% respectively.

Both brokers believe Stockland is similarly well placed, insulated from the mining-related slowdown by the upside to demand that is emerging in Queensland. Citi likes the potential for recovery in in operating profit margins from residential development and considers margin recovery is a more powerful earnings driver than either price or volume gains. A run-off in impaired inventory is also considered a most important driver, a multi-year event that is somewhat independent of current strength in residential markets.

WA will continue to be a moderating, albeit sizable, portion of settlements in the next few years and the brokers expects a slowing of volumes in Perth will coincide with a recovery in NSW and Queensland. Stockland has ten WA projects with around 17,000 lots for an expected end value of $4bn. JP Morgan notes Stockland's lot sales volumes provide a good indication of the Perth land market. Net deposits in Perth in the September quarter were 34% below the cyclical peak set in the March quarter of 2013 and WA's contribution to national sales reduced to 26% from 47% over the same period. The broker expects this reduction in the national contribution will continue in 2015.

Margin recovery should be the story for Stockland for the next 2-3 years, in JP Morgan's opinion. Earnings are on track for the company's 11-13% operating profit margin target by FY16. Stockland has four Buy ratings, two Hold and one Sell (Macquarie) on FNArena's database. Target prices range from $3.76 to $4.57. The consensus target is $4.31, suggesting 3.6% upside to the last share price. Stockland has a forecast dividend yield of 5.8% for both FY15 and FY16.
 

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article 3 months old

A-REIT Outlooks Diverge

-Modest retail A-REIT growth likely
-But valuations still favourable
-Housing well placed despite likely curbs
-Scentre Group sells stake in NZ assets
 

By Eva Brocklehurst

The backdrop for retailing landlords is challenging. Macquarie expects comparable income growth will remain in the low single digits for Australian shopping centres. Given fixed escalators for specialty leases of 4-5%, the broker expects negative re-leasing spreads will prevail and this is not a particularly attractive growth profile.

This may be surprising as occupancy levels are resilient across most portfolios and the broker observes an improved spending outlook is finding its way into the shopping centres. Still, for the landlords, the spending recovery is not expected to be reflected in better rents. Given extensive supply additions this will largely absorb retail sales growth in shopping centres. Given the significant amount of capital that is still seeking high quality retail real estate, and lower total return requirements, Macquarie continues to anticipate a favourable backdrop for valuations over the next few years despite the modest income outlook.

On that basis, noting a cautious stance on sub-regional assets, Macquarie retains Underperform calls on Federation Centres ((FDC)) and Stockland ((SGP)). The broker's survey of consumers in the sector also reveals a growing trend towards online grocery shopping, which will be to the detriment of specialty tenants at supermarket centres. The broker's survey indicates local landlords are competing for a sales portion that is insufficient to support fixed rental escalators and supply additions. This supports an Underperform rating for Charter Hall Retail ((CQR)) and Shopping Centres Australasia ((SCP)).

Macquarie is Underweight the large regional mall owners as well - Scentre Group ((SCG)) and Novion ((NVN)) - formerly CFS Retail - given low earnings growth and dividends that remain in excess of free cash flow. GPT ((GPT)) remains the broker's preferred exposure, given its expectations for superior earnings growth into FY15.

Morgan Stanley concurs that the outlook for the retail sector is dimming because of soft wages and weak jobs growth but believes Australian real estate investment trusts (A-REITs), overall, can outperform. Despite limited absolute upside, the broker points to the sector's relatively high degree of earnings certainty. Moreover, some stocks offer yield appeal as well as above-market earnings growth and low downside risk.

Those with exposure to housing remain the best placed. On this aspect, the broker expects policymakers will attempt to curb house price growth to more moderate levels via jawboning, increasing risk weightings for mortgages and through some form of macro-prudential policy. Morgan Stanley believes there is no room for complacency in the housing-led growth story but remains confident the authorities will not err by killing the golden goose, assuming policy will be calibrated to hold house price growth to 4-6%.

Stock selection remains key in this regard for the broker, with Goodman Group ((GMG)), Scentre Group, Dexus ((DXS)) and Lend Lease ((LLC)) considered the best positioned of the A-REITs for outperformance. Those Morgan Stanley considers most likely to underperform are Novion, Charter Hall Retail and GPT.

The A-REITs sector outperformed in October, with the sector up 21.7% in absolute terms and 14.7% against the broader market. Moreover, JP Morgan observes re-leasing spreads have become less negative. The broker observes this outperformance was assisted by compression in 10-year bond rates of 20 basis points and, among the large caps, was led by Dexus, Scentre Group, Stockland and Shopping Centres Australasia. The broker notes Scentre Group has had its best specialty sales growth in Australia since 2009 during October.

Scentre Group has entered into a joint venture to sell a 49% stake in five NZ shopping centres and the sale reflects an 8.2% premium to the June 2014 book value in NZ dollars. The pricing is attractive, in JP Morgan's view, and Scentre Group will retain full management and development rights over the assets. The broker considers the sale a strategic move but believes the company will eventually exit lower quality assets. JP Morgan considers the stock offers the best quality portfolio of any A-REIT, and the best track record. Deutsche Bank is also keen to dispel the idea that de-leveraging will kill earnings growth, estimating this latest sale for Scentre Group will result in free funds dilution of just 0.4% per annum per share out to FY18, for a 210 basis point reduction in gearing.
 

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article 3 months old

Peet Seizes Opportunities

-First JVs with Future Fund
-Significant upside to stock
-Positioned for opportunity
 

By Eva Brocklehurst

Residential developer Peet ((PPC)) has acquired stakes in six assets, consisting of two existing projects and four future developments. Brokers welcome the expansion and consider there is much to like about the stock. On FNArena's database there are four Buy ratings, no Hold, no Sell. Targets range from $1.41 (Macquarie) to $1.97 (Deutsche Bank) and the consensus target of $1.69 suggests 48% upside to the last share price. Macquarie believes Peet is on a solid trajectory, with further potential catalysts being progress on debt reduction and more evidence of strong residential conditions.

The company's share of the total acquisition price for the assets is $55m, to be funded through a $47m equity raising, of which the chairman will contribute $7m, and a share purchase plan capped at $5m. The total price for around 3,200 lots is $95m. On Macquarie's calculations the acquisition price per lot is reasonable, given the majority is already in production. The combined impact of the acquisitions and capital raising is expected to be earnings neutral in FY15 and accretive from FY16.

Citi finds it difficult to allocate the asset value going onto the balance sheet on the basis of the information provided and, on face value, it appears to be higher than expected, given the company is intent on reducing on-balance sheet investments. To Citi, also, the major risk with Peet is the high volatility in earnings and that, as a small cap stock, it is highly exposed to one segment - residential housing. That all said, the broker acknowledges the long-term stability in management, sound interest coverage and a diversified land bank in terms of price and geography, and retains a Buy rating.

The acquisitions make perfect sense to Deutsche Bank and the broker continues to believe the stock has significant upside. The acquisitions are mainly in Perth and consist of 25% of Golden Bay Estate, 50% of Midvale/Stratton with two medium density sites in the town centre. Outside of Western Australia the acquisition comprises land next to Aston Craigieburn (Victoria) and 50% of Bluestone Mount Barker (Adelaide). The Golden Bay and Bluestone acquisitions are the company's first public joint venture with the Future Fund.

UBS believes Peet is in an enviable position where it can be both opportunistic and selective in its land purchases. The increased position in Western Australia in the face of moderating resources activity could generate some debate but UBS is comfortable that the company is very familiar with the assets, while the ability to undertake off-market purchases with established partners at attractive prices de-risks the transactions. The broker observes the skew of Peet's earnings will move more towards capital efficient funds management and joint ventures.

UBS has incorporated increased sales from Golden Bay Estate and Mt Barker into estimates and reduced debt and cash level forecasts accordingly. Thee broker increases FY16 earnings forecasts by 2.4% and FY17 by 2.9%. Midvale/Stratton and medium density projects are in the planning phase, with development from 2016, while Craigieburn is longer dated. UBS believes the stock has potential to be re-rated as it begins to earn a more respectable rate of return on its invested capital base.
 

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article 3 months old

Stockland Outlines Strong Earnings Trajectory

-Plans to accelerate medium density
-Superior returns versus retail peers
-Solid office leasing, communities growth
 

By Eva Brocklehurst

The recovery in Australian residential building is driving earnings growth and opportunities for Stockland ((SGP)), with the company reiterating FY15 earnings growth forecasts of 6-7.5% at its AGM and maintaining its distribution guidance at 24c.

The September quarter was Stockland's best in terms of residential sales for the past four years and JP Morgan considers the company well positioned to achieve guidance. Stockland expects to settle around 6,000 lots in FY15 but the current rate is above this level, with the broker noting 6,672 net deposits taken over the past year. To JP Morgan the key metric is a recovery in the operating margin, which was knocked down in FY12 and FY13. The company targets 11-13% by FY16, compared with the 9.1% achieved in FY14, and the broker sets its estimates at 12.5%. This margin recovery should come from greater volumes, lower overheads per sale, fewer impaired sales and new, more profitable projects. The company's medium term target for margins is 15-16%. JP Morgan retains an Overweight rating and $4.38 target.

The company is progressing with its medium density strategy and wants to accelerate expansion in this area but UBS suspects this will be a challenge, given the intense competition for development sites. Moreover, the value of sites continues to climb and the broker suspects Stockland may end up overpaying for sites in its quest to build scale in this market. UBS also expects Stockland to actively seek capital partners for its large assets to capitalise on the strength in the capital transaction markets and secure funding for redevelopments.

Macquarie took the outlook in its stride and stands out on the FNArena database with its Underperform rating. Macquarie accepts the earnings trajectory is strong but believes that is already factored into the company's price and the stock is trading above its valuation range. In contrast, Credit Suisse considers the stock offers compelling value when compared with the other Australian retail real estate investment trusts. Retail comprises 45% of the stock's enterprise value. This comparison is particularly relevant as the broker retains a Neutral rating. After the October rally the sector's forecast total return fell to 5.2%. Stockland, by comparison, offers 11.7%. Office leasing activity also supports FY15 expectations with the broker noting occupancy has lifted to 92.9% from 90.3%.

Credit Suisse expects the communities segment growth will be around 32% this year and this will underpin growth at the top of the guidance range. The broker believes the company is being conservative around contingencies and interest allocation and this should allow margin expansion in FY16, even if volumes moderate. In this regard Deutsche Bank, too, considers Stockland is building a buffer against future weakness with its conservative approach to both residential cost allocation and contingency allowances. Deutsche Bank retains a Buy rating and considers there is around 8% upside to its $4.50 price target.

It too early to call how residential markets will perform for the remainder of the year, in Morgan Stanley's opinion, but the broker remains comfortable that the company can deliver earnings growth that is superior to its sector peers. Still, Morgan Stanley also believes this is factored into the price, so positive earnings revisions are unlikely to be material in future.

FNArena's database has four Buy ratings, two Hold and one Sell. The consensus target is $4.31, suggesting 3.1% upside to the last share price. Dividend yield on FY15 and FY16 forecasts is 5.7% and 5.8% respectively.
 

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article 3 months old

Weekly Broker Wrap: Ebola, Oz Pathology, Banks And Developers

-CIMB advises buying leisure on weakness
-More pathology centres erode margins
-Some value restored to equities
-Efficiency programs buying time
-Banks may underperform post results
-Regulation implications for developers
 

By Eva Brocklehurst

Ebola is capturing attention as it rages in West Africa. The disease is unlikely to become a global epidemic but Australian resources stocks that are exposed to West Africa are taking the threat to their operations seriously. CIMB considers the main risk to leisure and travel stocks is fragile investor sentiment, rather than earnings specifically, and investors are advised to buy these stocks on share price weakness generated by Ebola news flow. Disease experts note the virus is transmitted by body fluids only and is unlikely to change its mode of transmission. In this context, the SARS outbreak in 2002-3 was a much greater global threat as it was transmitted by airborne droplets, as is the case with influenza.

In terms of miners, CIMB observes Perseus Mining ((PRU)) has the largest risk with its only asset, Edikan gold mine, being in Ghana. Ghana has avoided the outbreak so far and the company has precautions in place to protect workers. Newcrest Mining's ((NCM)) Bonikro gold mine is in Cote d'Ivoire but contributes only 5% to the company's production. Ausdrill ((ASL)) obtains around 36% of its revenue and 53% of its earnings from Africa, contracting to five mines in Ghana, two in Burkina Faso and one in Cote D'Ivoire. None of these countries have yet reported an Ebola outbreak. There is marginal upside for health stocks Ansell ((ANN)) and CSL ((CSL)) in CIMB's opinion, if the virus is not contained, but it is notable that these stocks were not affected during the SARS outbreak.

***

The roll-out of Australian pathology collection centres continues, with Medicare data showing 562 centres were added over the past 10 months. Primary Health Care ((PRY)) continues to have the largest base of collection centres while Sonic Healthcare ((SHL)) has been the most aggressive in rolling out centres recently. Healthscope ((HSO)) has also added 80 centres over the past 10 months. The roll-out is irrational in Credit Suisse's view and results in inflated operating costs and no apparent revenue gain for any particular provider. Should weak volume growth persist through FY15, Credit Suisse expects the increased costs associated with the roll out will likely procure margin erosion for all providers.

***

The market correction from September has restored some value and UBS envisages some opportunity in US dollar-exposed cyclicals, given their recent underperformance. The broker remains Neutral on mining and Overweight on energy stocks, based on the strong growth in free cash flow expected from the energy sector. UBS has upgraded banks to Neutral from Underweight, given capital concerns are factored in and bond yield risk is receding. The broker adds James Hardie ((JHX)) to the portfolio, as the recent share price decline has meat the stock is trading below the price target for the first time in a while. This stock replaces Fletcher Building ((FBU)) as the broker prefers James Hardie's cyclical US dollar exposure. Westfield Corp ((WFD)) has been removed as it has outperformed since the market peak.

Deutsche Bank observes most of the growth in FY14 was driven by efficiency gains which are not sustainable drivers of earnings. With few signs of acceleration in revenue the broker fears the earnings recovery could fizzle out. Over the past year there appears to be a growing realisation that the macro environment is not bouncing back strongly, setting Australian corporates on the same cost cutting path that the US began several years ago. The broker expects a couple more years of delivering on efficiency programs should buy time for headline growth to return. Another question the broker attempts to answer is whether the equity market is back at normal multiples after being overheated mid year. In sum, Deutsche Bank does not view the current average price/earnings as appropriate, given persistently low bond yields.

Goldman Sachs attempts to identify stocks with the highest internal rate of return under a takeover and re-gearing scenario. While valuations are lower, the dispersion in multiples across the market has widened to more usual levels and the broker believes this development is an important driver which will facilitate more scrip-based mergers & acquisitions. Moreover, the lower Australian dollar should provide offshore acquirers with greater confidence to pursue Australian assets. The broker asserts the model's predictive performance is robust, as evidenced by Transfield Services ((TSE)) receiving a proposal this week. Top-rated large industrials in the model include Qantas ((QAN)), Downer EDI ((DOW)), Leighton Holdings ((LEI)), Orica ((ORI)), Myer ((MYR)) and nib Holdings ((NHF)). Resource stocks in the model include Alacer Gold ((AQG)), Western Areas ((WSA)), Sandfire Resources ((SFR)), Independence Group ((IGO)) and Imdex ((IMD)).

***

Property is clouding the horizon for Australia's banks. Macquarie believe recent announcements regarding macro prudential regulation represent a significant change in view from the Reserve Bank while the government is getting serious about foreign buyers. International experience indicates 2-13% underperformance by banking sectors that are faced with this type of intervention. Domestically, the sector has not skipped a beat, which is mainly because of "dividend harvesting" leading into the FY14 results, in Macquarie's view.

The broker advises investors to be wary, as banks may give back the dividend, and more, after the results, considering the headwinds that are forming for the sector. Last time the RBA attempted to cool the market, in 2004/5, Macquarie observes the banks underperformed by around 7%. While there is no signal that cash rates will start moving higher any time soon, macro prudential actions are equivalent to a tightening of rates, the broker warns.

Macquarie expects the implementation of such measures will take some heat out of the housing market to the detriment of Stockland ((SGP)) and Mirvac ((MGR)). While a crash is not expected in the residential market, downside risks are rising. The RBA and Australian Prudential Regulation Authority have both recently stated that new policy is likely before the end of the year. The earnings implications for residential developers will depend on the extent of measures, but a 10% reduction in current volume assumptions means Macquarie's earnings forecasts would be reduced by 1-2% over FY15-16.
 

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article 3 months old

Weekly Broker Wrap: Supermarkets, GPs, Housing, Steel, Insurers, Banking

-Grocery weak for CCL, GFF
-Health insurers engaging GP sector
-JP Morgan downgrades steel sector
-Bell Potter positive on insurers
-Banks: higher capital vs funding tailwind
 

By Eva Brocklehurst

Deutsche Bank's supermarket pricing study suggests grocery price trends have improved over the past three months. A continuing factor has been inflation in fresh products. The broker concedes food and liquor sales are not immune to the current weakness in consumer sentiment but inflation is likely to be the main driver for supermarkets, so the trend bodes well for the upcoming first quarter sales figures.

The broker's data suggests Coca-Cola Amatil ((CCL)) refrained from aggressive price promotions and, as a result, experienced positive year-on-year price improvements in the September quarter. This is in line with management's commentary after the first half result, revealing it was working on balancing the trade off between price realisation and volume growth. As a result, Deutsche Bank suspects CCL has experienced weak volumes in the grocery channel. Promotional activity in supermarkets' proprietary bread over the quarter has continued to erode price gains made over the year. The broker's channel checks suggest the selling of bread at 85c has been strong, which is not helpful for Goodman Fielder ((GFF)).

***

UBS observes, just as major ASX-listed hospital operators were undervalued five years ago relative to their strategic value, so national GP operators are in the same camp now. Taking a 5-10 year view on the evolution of the Australian healthcare sector the broker points to the growing engagement between private health insurers and general practice. Consistent with offshore developments, the broker expects GPs will evolve a more strategic role in the provision of integrated care, particularly for the chronically ill. Add to this a trend to consumer-driven care, where patients monitor personal health indicators and seek GP advice.

These trends signal to UBS that the geographical footprints of GP operators such as Sonic Healthcare ((SHL)), Healthscope ((HSO)) and Primary Health Care ((PRY)) become more significant. Previously the corporate function was simply administration but it now involves coordinating services. With the changes already underway, UBS envisages a transformation in GP-health insurer links, anticipating there will be valuation uplift for GPs. The broker takes the preliminary step of raising its GP valuation component in these stocks by 20%.

***

The magnitude of the Australian housing recovery improved in the first half of this year. Citi notes Sydney housing remains the highlight, favouring companies which can leverage the whole value chain in construction products. The broker reiterates a Buy call on GWA ((GWA)) but expects the housing recovery will only positively impact the company from the first half of FY15. Peet ((PPC)) in contrast should benefit more immediately from improved activity, given its early stage exposure.

Detached housing looks to be responding to the low interest rate environment, creating lower risk for building product companies compared with construction materials in the near term. A slowing in in resource capex has caught up with the engineering sector but Citi expects a recovery in infrastructure spending will support top line growth from FY16 onwards. Given this backdrop the broker's preferred pick is Lend Lease ((LLC)) with its exposure to long-term infrastructure investment.

***

Australian steel spreads widened in the September quarter as a result of resilient steel prices, continued weakness in iron ore prices and a declining Australian dollar. JP Morgan expects this will be the case until early in 2015, when spreads will start to narrow. The broker has downgraded earnings estimates across the steel sector. For BlueScope ((BSL)) and Sims Metal Management ((SGM)) the downgrades primarily relate to moderating steel prices and spread forecasts. For Arrium ((ARI)), the deeper cuts are largely because of downgrades to iron ore price assumptions.

***

Bell Potter remains positive on the general insurers. The Bureau of Meteorology anticipates at least double the risk of an El Nino weather event by the end of the year. This would result in drier than usual weather on the eastern seaboard. These events tend to correlate to a net beneficial impact on insurers. The threat of bushfire activity in such periods is a key risk but the actual damage tends to be smaller than for storm or flood related events, given lower average land and building values in rural areas. Meanwhile, commercial premium growth expectations are considered achievable. Discounting in the first half crimped top line growth but Bell Potter believes this was anticipated, and more than offset, by better margins.

The broker forecasts returns to remain stable, as lower market gains are offset by lower claims expense, although Insurance Australia Group ((IAG)) is expected to experience a small decline in returns, given a higher proportion of equities/alternative investments in its portfolio. The greatest upside potential belongs to QBE Insurance ((QBE)), given its investments are shorter in duration, while its claims liabilities are longer. The broker has Buy ratings for all three stocks in the sector IAG, QBE and Suncorp ((SUN)), reflecting the defensive nature of the industry.

***

Credit Suisse observes trends in personal and corporate insolvency are benign or improving across each of Australian banks' key markets. In relation to Australian corporates, the Reserve Bank recently stated that indicators of business stress improved over the past six months and failure rates are well below recent peaks in 2012. In Australia, in the September quarter, the number of aggregate personal insolvencies increased 8% sequentially while bankruptcies increased 14%.

As the Murray review of the Australian banking sector looms, JP Morgan highlights the case for higher capital measures, but drags to profitability from higher capital requirements are likely to be fully offset by the funding tailwind being received by the major banks, via lower interest rates, or by equivalent change in mortgage discounting behaviour from the sector. Wholesale funding costs continued to decline in the September quarter and major banks have looked to increase their net issuance. This environment provides the backdrop for the Murray inquiry's outcome, expected in November. JP Morgan's base case is for a 17% total capital ratio by 2018, in part achieved through issuance of an additional $70bn in tier 2 sub debt at a cost of $1bn to the system.

The broker does not believe this is as challenging as first thought, if it is accompanied by the introduction of senior unsecured bail-in debt akin to the moves in Europe. With major bank share prices now trading at a 10% discount to fair value the broker looks to the upcoming G20 meeting in November to obtain further clarity on whether senior unsecured bail-in debt is being recommended globally.
 

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article 3 months old

Lend Lease Reinforces Positive Earnings Outlook

-Strong residential pre-sales
-Infrastructure pipeline growing
-Clear earnings profile
-Some concerns over valuation
 

By Eva Brocklehurst

Lend Lease ((LLC)) is sailing with the wind. Brokers welcomed the re-statement of the company's strategy and outlook at the recent investor briefing. Execution of existing projects and a large construction backlog are central to Lend Lease's strategy but the company continues to assess opportunities to weight its net investment beyond Australia, in particular with regard to Malaysia and the US. Opportunities in healthcare and seniors living are also increasingly sought, albeit they remain at the margin of the company's businesses.

Development pre-sales are not slowing and UBS observes there is a $13.0bn backlog in the company's construction/infrastructure work in Australia which compares with $9.3bn back in June. Investment capital flows are strong and 67% of development capital is now invested in production versus 21% in FY12, which maximises development earnings in FY16/17. FY15 earnings are largely de-risked and growth of 10% in FY16 and FY17 is considered easily achievable. For UBS there is no question about momentum, it is valuation. The price to earnings ratio is at 14.1, and the broker expects the favourable backdrop will moderate and provide some downside risk in the short term.

The company is shaping up well for the next three years in CIMB's view. The profitability outlook is very clear, especially for the major project pipeline. Management is content with its existing strategy but has signalled an intention to expand the existing healthcare exposure and CIMB believes Lend Lease's integrated model will work well in this regard. Lend Lease's construction division is being rewarded by increased expenditure on road infrastructure as well as the company's own development pipeline. The brokers observe investment management is also performing well.

CIMB considers the company's earnings profile is being underestimated by the market for the next three years. This profile is largely dependent on the development division, which is also strongly underwritten by apartment pre-sales. These may not yet been recognised in the profits but are considered gold plated certainties nonetheless. The broker is well aware of the difficulty in replacing major projects in the company's portfolio as underlying asset prices increase but for the near term, believes the stock deserves an Add recommendation.

With an increasingly busy construction work book the company looks well placed, in Macquarie's opinion. Residential pre-sales strength is maintained and Lend lease has launched the next phase of apartments at The Green. The next phases of Richmond, Victoria Harbour, Darling Harbour, Barangaroo and Waterbank are on the slate. Beyond its Australian base, Lend Lease is looking to allocate incremental capital offshore into urban regeneration opportunities as it believes the Australian economy will underperform other global economies in the next few years. Despite this, Macquarie considers the Australian infrastructure backdrop is very positive for Lend Lease with recent wins on NorthConnex and East West Link. Indeed, the company has indicated the level of activity on Australia's east coast has escalated quicker than it expected. The next opportunity is the Stage 1a of WestConnex, which is a $400m project to widen Sydney's M4.

Macquarie also acknowledges the value proposition is diminishing with a re-rating of the share price, but believes this proposition will be supported by the ultimate delivery of earnings growth in FY16 and FY17 and, given the high degree of certainty in that regard, the broker maintains an Outperform recommendation.

Other insights Macquarie gathered include the observation that institutional interest in Australian retirement is low and selling down a stake in the Australian retirement business is still a couple of years away for Lend Lease. The company is still looking to expand retirement investment into Asia, if the deferred management fee model is the appropriate approach in the region. The company suspects commercial real estate is nearing the top of the market and wants to be disciplined and capital efficient in considering re-stocking opportunities. As a result, Lend Lease also indicated that if it cannot find the right sites in which to invest, it may consider some form of returning capital.

Lend Lease expects organic growth over the next few years and will not rely on acquisitions. Still the company intends to increase its development presence in the US across residential and healthcare and hopes to secure 2-3 large urban regeneration projects in this region in the next few years. FNArena's database contains six Buy and two Hold ratings for Lend Lease. The consensus target is $15.23, which signals 2.2% upside to the last share price. Targets range from $14.50 (UBS) to $16.02 (Macquarie).
 

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article 3 months old

A-REITs: Regulatory Uncertainty Clouds Residential

-Rising risk with investor housing
-Pressure from rising bond yields
-Sydney CBD becoming more up-market
-Can lower AUD boost office demand?
 

By Eva Brocklehurst

Since the Reserve Bank of Australia flagged its concern over investor activity in the housing market, uncertainty around future residential conditions has increased. The RBA is expected to announce measures to curb investor lending by the end of the year, although any tweaking of macro prudential arrangements is likely to be conducted by the Australian Prudential Regulation Authority. The current Financial System Inquiry is also a risk that is relevant to the Australian home loan market, with APRA being concerned about the credibility of internal capital models as a measure of financial strength. In this environment the residential Australian Real Estate Investment Trusts (A-REITs) are facing an uncertain outlook, in Morgan Stanley's opinion.

In this respect, Mirvac ((MGR)) has the greatest exposure to the investor segment of the housing market, predominately from its mix of medium and high density apartments versus land subdivision, as opposed to Stockland's ((SGP)) portfolio mix. Still, given the investor segment has been an influential driver of volumes, Morgan Stanley suspects changes could also affect Stockland. Moreover, if macro prudential regulations are introduced with a loan-to valuation-ratio component this could also affect first home buyers.

BA-Merrill Lynch too expects that macro prudential measures to curb house prices, and investor exuberance, may be on the way in Australia. A-REITs were down in line with the broader market over September, selling off as bond yields rose on expectations the US Federal Reserve would begin contemplating rate rises. Those A-REITs favoured for their yield exposures were the worst performers, such as BWP Trust ((BWP)), Investa Office ((IOF)), Dexus Property ((DXS)) and Charter Hall Group ((CHC)). The sector is trading in line with Merrills' valuations, suggesting it is fully valued. The sector offers an implied total return of 8.2% on the broker's estimates. In a rising US rate environment, historical data suggests to Merrills an underweight position in Japan & Australia is the safest play, with market weight for Hong Kong & Singapore and overweight reserved for China & India.

On the retail scene, UBS has conducted a review of the Sydney CBD's planned transformation, observing the landscape will change over the next two years with a pedestrian strip in George St from Bathurst to Hunter Streets and the construction of light rail planned for April 2015. This is expected to transform landlords including Mirvac, Charter Hall, Investa Office, Dexus and Lend Lease ((LLC)), which will benefit fro greater accessibility and exposure to office and retail offerings. Rents in the area may also benefit but are not expected to surpass the rents from Pitt St Mall, which the broker observes is among the top 10 most expensive retail strips globally by rent per capita.

More international retailers are descending on the CBD and luxury groups are eager to secure prime locations. Sydney's CBD is highly concentrated and UBS observes luxury brands desire to be adjacent to existing retailers with similar cache, such as Louis Vuitton and Prada, while fast fashion is intent on obtaining street frontage. The broker's feedback suggests landlords are favouring offshore tenants over established domestic retailers, which are being displaced. Rents appear well supported but, despite the demand for retail space, UBS is wary about growth. Office landlords are also becoming more active in maximising space. UBS expects existing food courts such as Australia Square and MLC will undergo a re-positioning towards more up-market eateries.

In the case of office space, the broker ponders whether the lower Australian dollar will boost white collar employment and hence office demand. The current supply of office space reflects subdued employment growth while office landlords are seeking to develop more efficient space. UBS economists forecast a modestly improving trend in jobs growth and the recent drop in the currency should help in terms of office demand. Still, the broker believes this may take some time to play out, with the vacancy rate yet to peak. The Australian dollar also needs to sustain its lower rate. Hence, while the broker does not expect office fundamentals to deteriorate, CBD office markets are approached with caution.

UBS maintains a preference for retail A-REITs, particularly non-discretionary, over CBD office and has moderated its view on residential markets, given the uncertainty over pending forms of macro prudential tightening. UBS economists note that the latest housing data suggests a moderation in the pace of lending, which should provide a little comfort for the RBA. Key picks are Goodman Group ((GMG)) as its business model and investment themes are robust, Federation Centres ((FDC)) as it continues with developments and syndicate acquisitions and remains on track to deliver 7-8% growth in FY15/16. The broker has Sell ratings Dexus, Investa Office and CFS Retail ((CFX)) on relative valuations. The broker remains underweight office A-REITs in a REIT portfolio context but, given the recent pull back, acknowledges there is less conviction in the Sell ratings on Dexus and Investa Office.
 

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article 3 months old

Brickworks Underpinned By Dwelling Activity

-Back seat for investments, property
-Decision on CSR/BLD JV key catalyst
-Difficult comparables being cycled
 

By Eva Brocklehurst

One of the best residential construction scenarios in many years underpins the Brickworks ((BKW)) building products business. This segment of the company is benefiting from the upturn in dwelling activity, with improved volume and profitability in bricks, roof tiles, masonry and pre-cast concrete. Investment and property earnings, while remaining relatively stable over the longer term, are likely to take a back seat in FY15. 

The company's FY14 investment performance was weaker than Deutsche Bank expected, made up for by stronger-than-expected land sales. Management expects activity in Australia's housing market will be the strongest for a decade during the first half of FY15, with robust orders in the pipeline. Brickworks' final distribution of 28c was in line with expectations but it was the first time the final payment has increased since FY10. Management provided no quantitative guidance for FY15 but does expect property earnings to be lower, with a reduced contribution from land sales.

Brick pricing is strong in some markets while competitive in others. Moreover, Deutsche Bank expects pricing outcomes may improve if the joint venture between Boral ((BLD)) and CSR ((CSR)) in bricks is approved. A decision on this JV is considered likely by the end of the year and may usher in more disciplined pricing in the industry. The broker reiterates a Buy rating on the stock, given the leverage to the residential sector and the evidence of strong pricing momentum, with a target of $15.19. The business has developed a pre-cast concrete and masonry division over the last 3-5 years, increasing exposure to the higher density dwelling sector. While pre-cast is currently running to expectations and masonry has been restructured this is where, if Brickworks does not achieve continued category and price growth, it may negatively impact on Deutsche Bank's forecasts.

Citi observes progress in improving margins but also a lack of leverage in building products, largely because of patchy pricing outcomes and higher input costs. The challenge is evident in Western Australia, in particular, where competition is placing market share ahead of profits. The broker is also awaiting the decision on the CSR/BLD JV, believing that Brickworks' decision to add capacity in the east coast will boil down to a choice between market share or pricing-based returns. Better to just let demand build at this stage, in Citi's opinion. The broker believes the stock does not offer much upside and retains a Neutral rating and $14.50 target.

Bell Potter believes the first half is likely to offer the best operating conditions in over a decade for residential building products but this is now reflected in the earnings base and, as lead indicators for dwellings appear to be peaking, Brickworks will start to cycle difficult comparables. The broker has reduced profit forecasts for both FY15 and FY16 to reflect a lower Australian dollar coal price forecast for New Hope Coal (((NHC)) - hence Brickworks' investment earnings - and a modest reduction in the contribution from building products.

Having outperformed the sector recently, Brickworks' discount applied to the building products business has closed to 5% from 15%. Bell Potter downgrades the rating to Hold from Buy with a target of $14.55, reflecting lower earnings, unfavourable marking-to-market of investments and a higher net debt balance by year end. 
 

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article 3 months old

Charter Hall Ventures Into Hospitality

-Benefit from longer leases
-Reasonable total returns
-Large stake, elevates gearing
 

By Eva Brocklehurst

Charter Hall ((CHC)) in joint venture with HOSTPLUS, a superannuation fund, will acquire 54 hotels for $603m on a sale and lease back arrangement with Woolworths ((WOW)). Woolworths is the majority owner of Australian Leisure and Hospitality Group (ALH) which, in turn, is the largest and most profitable pub operator in Australia.

Macquarie observes that, after this transaction, Charter Hall has limited capacity for further co-investment without equity recycling. Earnings growth guidance for FY15 has been upgraded to the top end of the prior range of 5-7%. Macquarie estimates the transaction to be 3% accretive on a full year basis and considers it another example of Charter Hall's ability to partner with a domestic superannuation fund on a large scale. The portfolio offers an initial yield of 6.8% and includes Dan Murphy's and/or BWS retail tenancies. Dan Murphy's leases involve base rent plus a turnover provision.

The 50% equity commitment from Charter Hall to the JV is relatively large for the Australian real estate investment trust (A-REIT), and will be funded via cash and a $100m undrawn debt facility. Charter Hall typically takes a 10-20% stake. Key to the transaction is the beneficial increase in the weighted average lease expiry (WALE) which Charter Hall obtains for its on-balance sheet investments. WALE increases to 9.6 years from 7.5 years with this venture and property investment income, as a portion of total earnings, to 67% from 61%.

Significantly, the transaction is in line with Charter Hall's strategy to increase exposure to longer lease terms and the extended WALE shores up the predictability of future earnings. JP Morgan notes that to facilitate this, Charter Hall has taken the option to expand the balance sheet at a relatively low yield and higher level of co-investment than usual. However, as BA-Merrill Lynch points out, this 50% co-investment should not be taken as a given for the level of equity participation in future ventures. 

Merrills compares the initial yield of 6.8% to the 6.42% for ALE Property ((LEP)), landlord to 86 ALH pubs. On that basis the transaction appears fair, with 26% of the income derived from Dan Murphy's and BWS. Charter Hall's returns will be boosted by funds under management (FUM) fees but no property management fees will be generated, given the triple net lease structure whereby capex is borne by the tenant. The transaction will use the majority of Charter Hall's excess liquidity and bring gearing to the top end of the target range. Nevertheless, management is confident of recycling capital to reduce leverage by the end of FY15. This transaction will rank third largest in the A-REIT's investment portfolio but, as Deutsche Bank observes, Charter Hall has demonstrated an ability to sell down relatively high initial stakes in newly formed vehicles.

Based on historical norms, the yield could be viewed as reflecting a portfolio premium. JP Morgan estimates that a 10-year unleveraged internal rate of return for the joint venture's ALH portfolio is likely to be 8.75%-9.25%. Overall, the broker believes this is a reasonably compelling total return. The only distinctive feature of the portfolio is the proportion of assets in regional locations - 35%. At a less favorable point in the property cycle, JP Morgan suspects there could be a greater risk of some cap rate softening - book value versus income - for these assets.

Strategically, UBS believes the transaction is ideal, as it extends WALE with a strong credit quality tenant and a high quality capital partner. Still, the broker is mindful of the size of the stake and the increased leverage, which increases Charter Hall's reliance on external equity in the short term and tilts the stock back towards property ownership. UBS observes real estate fund managers are in a sweet spot at present as asset values are generally increasing and there is continued support from existing and new wholesale investors.

Hospitality is a new asset class for Charter Hall but Credit Suisse notes the risks are largely alleviated by the 20-year lease terms and triple net leases. Again, comparisons show ALE has low income volatility and stable cap rates, with only 80bps variance since 2005. Charter Hall's cap rate - 6.8% - appears high against ALE's - 6.4% - but then Credit Suisse notes ALE's assets are materially under-rented. Moreover, Credit Suisse observes, after this transaction, Woolworths still has more than $1bn in net property acquisitions accumulated since 2008, which may provide more growth for the Charter Hall JV.

Earnings will be affected from FY16 as Charter Hall begins to pay tax but, given the ability to frank dividends, domestic investors will be entitled to a franking credit. A lower value will be attributed to these credits by the market in Macquarie's opinion as not all investors will be able to utilise them. Macquarie assumes an 8% group effective tax rate from FY16.  Deutsche Bank highlights a three-year compound earnings growth rate of 3.7%, which reflects assumed incremental tax headwinds from FY17.

ALH was acquired by Woolworths (75%) and Bruce Mathieson (25%) in 2004. Since 2010 Woolworths has divested and leased back more than $2.8bn in property assets.

Charter Hall has a consensus target of $4.46 on the FNArena database, signalling just 0.7% upside to the last share price. There are three Buy ratings and four Hold. Distribution yield on FY15 and FY16 forecasts is 5.4% and 5.7% respectively.
 

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