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Earnings wrap: Lendlease and BlueScope

Glenn Freeman and Lex Hall  |  20 Aug 2019Text size  Decrease  Increase  |  
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The future is a little brighter for Lendlease as a fire sale appears less likely, while clouds gather over BlueScope despite its US steel mill expansion.

Brighter outlook for Lendlease as fire sale less likely

Positive signs from Lendlease (ASX: LLC) around the offloading of its troubled engineering and services division have prompted a slight lift in Morningstar's fair value estimate.

The news came as the property and development company on Monday reported $467 million in net profit after tax for fiscal 2019, down from $793 million last year but ahead of Morningstar's expectations.

"Lendlease today confirmed that several potential buyers are undertaking detailed due diligence, which reassured us that the sale process will be somewhat competitive, rather than a fire sale," says Adam Fleck, Morningstar Australia's director of equity research.

This saw a jump in the trading price of Lend Lease securities, which hit a high of $15.82 on Tuesday, from $13.50 last week – roughly in line with the revised $15.60 fair value estimate, up from $15.20.

Lendlease management says it will sell its engineering and services units after taking a $500 million hit related to three disappointing roadworks projects that contributed to a 41.1 per cent drop in profit. These include:

  • Gateway Upgrade North, Brisbane
  • Kingsford Smith Drive highway widening, Brisbane
  • NorthConnex M1/M2 9km tunnel project in Sydney.

Once its "non-core" engineering and services units are sold, Lendlease will be left with its construction, development and investment divisions.

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Construction contributes about 20 per cent of group EBITDA, from its Bovis Lendlease Construction firm and three engineering construction entities Lendlease bought for $792 million in 2011, as part of its Valemus acquisition.

During the earnings announcement, Lendlease chief executive Steve McCann emphasised the firm's strong development pipeline of about $100 billion in projects, including $27 billion worth of urbanisation projects in four cities.

Fleck forecasts Europe to comprise a meaningful proportion of the firm's development earnings within the next decade, "surpassing Australia thanks to multiple large projects in Milan and London."

Some 45 per cent of future projects will be in Europe and 39 per cent in Australia, with the remaining 10 per cent and 7 per cent in the Americas and Asia, according to data from 30 June 2019.

But Fleck is critical of the "lumpy and long-dated earnings" characteristics of Lendlease's development business.

"We only include a portion of the group’s development pipeline in our explicit 10-year forecast period, given the incredibly long decade-plus timelines, and uncertain margins," he says.

"Many of these projects will be developed with future equity partners unknown even to Lendlease, let alone outside observers."

High business complexity adds to the difficulty of forecasting Lendlease’s future earnings.

"The timing of project progress, completion, and accounting treatment can have a large and lumpy effect on earnings," Fleck says.

He views the group's funds management arm as the most attractive part of the business. Contributing around one-third of group EBITDA, it has more than $35 billion under management across a range of property – office, industrial and retail – and infrastructure funds. This increased by 17 per cent in the financial year ended 30 June.

Morningstar expects growth to remain strong, though slightly slower, due to the strong development pipeline.

"Pairing a development and funds management business is an appealing combination as completed developments can be moved into funds.

"This frees capital that can be recycled into new developments, yet Lendlease still earns management fees on the assets," Fleck says.

Conceding Lendlease remains a "volatile business", he refers to its funds management operation as an anchor.

Fleck also applauds the low debt levels – with 9.9 per cent gearing falling at the lower end of the 10 to 20 per cent range targeted by management. This is especially important given that the sale of Lendlease's engineering assets hasn't yet completed, and the uncertain ebbs and flows of the firm's long-term project development earnings.

Prem Icon Full analyst report: Lendlease delivers a better second half; we slightly increase fair value estimate to $15.60

BlueScope’s outlook cloudy despite North Star expansion

BlueScope Steel delivered earnings in line forecasts but there are clouds on the horizon amid forecast weaker steel prices, warns Morningstar analyst Grant Slade.

Slade says steel prices and steelmaking spreads - the difference between the cost of raw materials and the cost of the finished product - benefitted from US tariffs.

However, he warns the near-term outlook is “less sunny” for BlueScope (ASX: BSL) because of a reversal in global steel prices and a glut of steel capacity.

Slade applauded the fiscal 2019 EBIT of $1.32 billion, which largely tracked his forecast. The operating margin of 10.7 per cent and free cash flow of $1,362 million were equally impressive and represent cyclical highs, he says.

Slade has lowered his near-term spread forecasts and his fiscal 2020 EBIT by 45 per cent to $728 million.

His fair value estimate has fallen by 10 per cent to $11.10. At 3.35pm, BlueScope was up 6.98 per cent at $11.99.

BlueScope announced it is pressing ahead with the $1 billion expansion of its North Star steel mill in the US, a move that would increase capacity by about 40 per cent.

The company held its final dividend despite a 35 per cent drop in full-year profit to $1.02 billion and the likelihood of lower earnings to come, saying the move would increase capacity at North Star by 850,000 metric tonnes a year when complete by the end of FY23.

Slade forecasts North Star’s steelmaking spreads to contract, saying he expects midcycle steel spreads at North Star of about US$250 per tonne, down from a cyclical peak of US$370 per tonne in fiscal 2019.

However, his long-term expectations remain intact with a largely unchanged midcycle spread of US$260 per tonne.

BlueScope's total sales for the 12 months to 30 June rose by 9 per cent to $12.53 billion but the bottom line was hit by increased raw material costs and the absence of last year's big one-off gains that included tax offsets.

Underlying earnings before interest and tax rose 6.2 per cent to meet June's downgraded guidance of $1.35 billion and BlueScope, which held its unfranked final dividend at 8 cents, tipped first-half underlying EBIT to be lower than each of the two previous periods.

Prem Icon Full analyst report: BlueScope makes hay while sun shines in 2019, but outlook is cloudier; North Star expansion approved

are editors at Morningstar Australia.

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