Recovery Is Underway at Lendlease and the Business Is Transforming

Business Strategy & Outlook:

Lendlease is a diversified global property developer, landlord, property manager, fund manager, and builder on a range of development projects, funds, and completed properties around the world. Interests have included apartments, offices, retail property, aged care facilities, retirement and military accommodation, roads, and rail tunnels. The group is evolving on numerous fronts: selling noncore businesses; seeking better returns on capital; accelerating its development pipeline; and shifting focus outside its homebase of Australia. Lendlease sold its risky engineering business in calendar 2020, though it retained liability for three engineering/ construction projects–two practically complete, and one complex project (Melbourne Metro) with several years to run. Lendlease found a buyer for its engineering services business after two years of marketing, and the price was respectable. Once this exit is complete Lendlease’s project mix will predominantly comprise residential and commercial property developments. The group’s ongoing business comprises three segments: development, investments and construction. Much growth isn’t expected in construction earnings, that business is primarily to preserve scale and construction expertise in support of Lendlease’s development business. The investments division houses a wide range of businesses including, military housing, property asset management and funds management. It is expected that the latter two business lines to grow substantially as Lendlease sells stakes in its development projects. This is a trade-off, relinquishing potential development profits in return for lower risk management fees, performance fees, and capital to accelerate its development pipeline. Lendlease’s history is in Australia and is is expected it to continue to pursue projects there, but it is expected earnings over the next two decades will rotate toward its offshore development pipeline in the United States, Europe, and to a lesser extent Asia

Risk and Uncertainty:

Despite selling its engineering and services businesses, Lendlease retains risks on the Melbourne Metro project. A base case is that existing provisions will cover future costs, but risk remains through to completion by circa 2026. Lendlease’s remaining business is opaque, but becoming more transparent. The bulk of the value of the company is in multi-decade urbanisation projects, where end values and margins cannot be accurately estimated until the projects are substantially completed. Even if Lendlease knew what revenues and margins are likely to be, contract terms are largely confidential. Projects face political, social and environmental risk, given they involve redeveloping large tracts of inner urban land, in collaboration with local municipalities, land owners and other stakeholders. These ESG issues contribute to a High Uncertainty Rating. Development risks include rising interest rates, a decline in secular demand for offices and apartments, or mis-pricing of contracts by Lendlease. A risk for the investment segment is that demand from institutions wanes, prompting outflows from Lendlease funds. Investors may fear rising rates, or limited upside with rates near the zero-bound. Changes to pension, tax or investment regulations could cause institutions to move away from illiquid assets. There was a taste of that risk in Australia in 2020 when the government allowed individuals in financial hardship to make superannuation withdrawals amid the COVID-19 crisis. That saw industry super funds saddled with illiquid property assets as they sold liquid assets to fund redemption requests. Lendlease experienced redemptions from its retail property funds due to headwinds for that asset class, and its possible that these headwinds could spread to office and apartment assets.

Bulls Say:

Lendlease has a huge development pipeline. Contract terms are confidential, but look to have been struck on attractive terms.
The balance sheet is in good shape, which should help Lendlease to accelerate its huge development pipeline.
Government balance sheets are strained, yet authorities appear to want to promote economic activity via construction. Lendlease is well positioned to participate, because of its near shovel-ready projects and capable management.

Company Description:

Lendlease’s ongoing business comprises three segments: development, investments, and construction. Development accounted for more than half of EBITDA in 2020, and the future pipeline is so large it cannot be funded from its own balance sheet. The group is selling projects stakes to its funds management clients. This sacrifices development profit, in return for management fees, reduced risk, and capital to accelerate its development pipeline. Construction generates large revenues but slim margins. This business is retained to preserve expertise and scale for the development business. Lendlease sold its engineering and services business during the pandemic, but retains some risks, notably the Melbourne Metro project which has years to run

(Source: Morningstar)

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