Lendlease undervalued despite dozing at the digger
The market has overreacted to the losses incurred by Lendlease, and as a result the global developer and builder is undervalued for the first time in three years, says Morningstar analyst Tony Sherlock.
The market has overreacted to the losses incurred by Lendlease (ASX: LLC), and as a result the global developer and builder is undervalued for the first time in three years, says Morningstar analyst Tony Sherlock.
A year ago, Lendlease flagged $200 million in post-tax losses linked to problems in four Australian engineering projects.
It reported last Friday that these losses had increased by a further $350 million because of flaws in project management, risk management and quality control, Sherlock says.
As a result, he has cut the company's fair value estimate from $18.50 to $17.20. It closed the week 17.3 per cent lower at $14.25, and today is trading at $13.50.
Despite the losses, however, Sherlock says the market has overreacted to the news.
"The losses on the engineering projects are definitely negative news for Lendlease," Sherlock said in a note on Friday.
"But we think the market has overreacted, shaving approximately 20 per cent or $1.8 billion off Lendlease’s market capitalisation.”
Lendlease has been a victim of its own strong earnings, prompting investors to ascribe it a high price earnings multiple, Sherlock said.
"The risk is whenever there is a major stumble - as is the case at present - the share price gets severely punished.”
At $13.50, the stock screens as undervalued, Sherlock said. "This is the first time we have viewed the firm as undervalued in at least three years."
Global builder and developer Lendlease is undervalued for the first time in three years
Sherlock says that while the company's pipeline of major projects has expanded, most are in their early stage of delivery and are yet to yield their full benefits.
The company also has a sound balance sheet, with low gearing of 5 to 15 per cent and negligible debt.
This will grow in appeal, Sherlock says, as cash-strapped governments will increasingly return to public-private partnerships to fund growth.
However, there are reasons to be bearish.
Lendlease could have elaborated on the reasons for its losses, Sherlock said, which were put down to lower productivity in the post-tunnelling phase of the NorthConnex motorway in Sydney, wet weather, access issues and remedial work from poor design on other projects.
A review of the company’s engineering division will force a substantial or near complete exit from higher-risk activities, Sherlock said.
As such Sherlock has cut revenue growth expectations for Lendlease from positive 2 per cent for the next four years to negative 2 per cent.
"We expect having had its fingers well and truly burnt, Lendlease will be bidding on and securing far less complicated engineering work than it has in recent years.
"The firm needs to improve the monitoring and managing costs, tracking project progress and identifying and managing risk."
Morningstar's $17.20 fair value estimate implies a fiscal 2019 P/E of 121.3 times and enterprise value/EBITDA of 13.4 times.
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Lex Hall is content editor for Morningstar Australia.
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