One of the biggest global themes of the last century, if not several centuries, has been urbanisation. Hundreds, probably billions of people have moved from farms and small rural villages to concentrated towns and thriving cities.
Most expected the urbanization theme to continue. According to World Urbanization Prospects: The 2018 Revision, a report from the United Nations, the proportion of the world’s population living in cities was projected to rise from 55% in 2018 to 68% by 2050, which with population growth, meant 2.5 billion people would move to urban areas.
But Covid-19 has changed the thinking of some experts. Geoffrey Garrett, the former Dean of the Wharton Business School, one of the world’s leading business schools whose alumni includes Donald Trump, Elon Musk and Warren Buffett, says that the pandemic could reverse the trends of globalisation and urbanisation. He writes:
“After coronavirus, people will be more fearful of crowded trains and buses, cafes and restaurants, theatres and stadiums, supermarkets and offices. Crowded spaces are the lifeblood of cities. But now crowds are seen as major health risks. People who have the ability to exit the city will increasingly be tempted to do so. People who cannot leave will feel at increased risk, hunker down, and reduce their movements and contacts. It is hard to think about Manhattan without the subway and 10-deep pedestrians on Fifth Avenue. But that may be the increasing post-COVID reality.”
Other experts argue that the impact of Covid-19 will be temporary and that population growth, together with the enormous appeal of cosmopolitan cities, will see urbanisation continue its upward march.
This is particularly relevant to Lendlease (LLC) because a key driver behind its strategy is urbanisation. There are other tailwinds as well – global infrastructure spending, an ageing population and sustainability – but it is the urbanisation theme and gateway cities that stand out.
Lendlease is an interesting stock for several reasons.
Firstly, from a price perspective. It got thumped in the March sell-off and is still about 35% below its February peak of $19.46.
Lendlease (LLC) in 2020
Secondly, it has taken steps to strengthen its balance sheet, raising $1.2bn via an institutional placement and share purchase plan at $9.80 per share. This has taken its gearing level below 10% and given it total liquidity in excess of $5bn (cash on hand plus undrawn loan facilities).
Thirdly, it is a global company, with about 55% of its revenue (45% of EBITDA) being derived offshore, most particularly in the USA, UK, western Europe and parts of Asia.
Finally, it articulates a compelling business model.
The Lendlease story
Lendlease operates through three segments – development, construction and investment. Its business model is to integrate these activities, such that more than one segment is engaged in a single project. If focuses on development of inner city mixed used developments, apartments and communities in gateway cities.
Development is the largest segment, with the company targeting it to generate 40% to 50% of EDITBA, construction is targeted to generate 10% to 20% of EBITDA and investments 35% to 40% of EDITBA. Overall, the group targets a ROE (return on equity) of 10% to 14%.
Two other former segments, engineering and services, are being divested. Now classified as “non-core”, Lendlease’s engineering business has been sold to Acciona for $180m (less expected restructuring costs of $550m).
Lendlease’s development pipeline is $112bn (up from $76bn at the end of FY19) and includes 21 major urbanisation projects across nine global cities. These include Thamesmead Waterfront in London, plus a partnership with Google in the San Francisco Bay area. Major development projects in Australia include Barangaroo, Melbourne Quarter and Victoria Harbour. Overall, the pipeline breaks down into $68bn of apartments, $30bn of commercial buildings and $14bn of communities (developed land lots).
In construction, Lendlease has “backlog revenue” of $14bn, down from $16bn at the end of FY19. The work is diversified by sector, client and geography, with 29% commercial, 20% residential, 18% defence and 11% social infrastructure. Government clients account for 40% of the work, corporate 42% and internal Lend Lease 18%. Major projects include Crown Sydney, HMAS Cerebus, a retail centre in Kuala Lumpur and a convention centre in New York.
The investments segment comprises of both capital intensive activities ($4.0bn in total of co-investment positions in managed funds and direct property) and capital light activities ($37bn of funds under management and $30bn of assets under management). Operating earnings are roughly 50/50 between the capital intensive and the capital light activities.
In the half year to 31 December, Lendlease reported core profit after tax of $308m, and a non-core profit of $5m. This correlated to a return on equity of 9.8% (target 10% to 14%). Noting the increase in the development pipeline, the construction backlog revenue and an expected doubling of funds over management as the pipeline is delivered, CEO Steve McCann said at the time: “Our core segments are well placed for medium term success”.
Post-COVID-19 trading updates
Lendlease (LLC) provided a trading update on 28 April (where it withdrew its forward-looking statements given at the time of the February profit result), and again on 1 July. It says that:
- Core profit after tax for the full year to be in the range of $50m to $150m (this implies a second half loss of $158m to $258m). This reflects the COVID-19 impacts on the group and includes a reduction in the valuation of investments of $130m to $160m;
- Engineering exit costs will be $550m pre-tax (on track with previous forecast), with $525m pre-tax to be booked in FY20. This would leave a statutory loss for the year of $230m to $340m after tax;
- The development segment has experienced delays in the conversion of a number of opportunities and has been impacted by delays in apartment sales and elevated cancellations across the community’s business. Enquiries in the community’s business have now returned to pre-COVID levels;
- The joint venture to deliver the first residential tower at One Sydney Harbour would contribute $100m in FY21 profit after tax;
- The performance of the construction segment was impacted in all regions, with impact greater in international regions. Most projects are now operational;
- Earnings from the investment segment will be impacted in both FY20 and FY21;
- Good progress had been made in the core businesses since the last update on 28 April; and
- No final dividend for FY20, although a small distribution may be paid from the Lendlease Trust.
What do the brokers say?
While disappointed with the trading update, the brokers are positive on Lendlease and remain supportive. Covid-19 has hit the company harder than expected, with the second half loss higher than the brokers’ forecast. They are relieved, however, that the engineering sale will be completed on schedule in FY21 and suggest that “most of the bad news is now behind the company”.
Several brokers suggest that investors will need “patience”. Most forecast a return to profitability in FY21.
The consensus target price (according to FN Arena) is $14.26, 12.3% higher than Friday’s close of $12.70. Individual targets and recommendations are shown in the table below.
What’s the bottom line?
When I started researching this article, I thought that a company so aligned to the urbanisation theme might find the operating environment pretty tough going forward. But as I have looked further into the breadth of the development pipeline and the work in residential, community and defence projects, I am not as convinced that this is such a big issue.
I like the business model and the connections between the segments, but as a developer/construction company/ financial engineer and asset manager, the challenge is around the ability to execute.
My sense is that there is ‘no hurry’ to buy Lendlease, as there is still considerable uncertainty as to the impacts of COVID-19. Also, I expect more of a market correction, so I am prepared to wait. Buy in the next market down-turn, this stock will be on my radar. Ord Minnett summarises it well with: “the potential rewards are high for those willing to go the distance”.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.