Capital Recycling And Construction Pipeline Will Shape Margins While Supporting A Fairly Valued Outlook

Catalysts

About Lendlease Group

Lendlease Group is an international property and infrastructure company focused on investments, development and construction, with a current emphasis on its Australian operations and global investment platform.

What are the underlying business or industry changes driving this perspective?

• Although Lendlease is concentrating on its Australian IDC operations, the group is still working through a large Capital Release Unit program that relies on completing around $3b of announced and active transactions. Any delay or repricing of these deals could restrain the planned reduction in net debt and interest costs, which may limit future earnings improvement.
• While the construction backlog revenue of about $8b in Australia and a preferred work book of around $6.9b provide long-dated work in areas such as hospitals, transport and data centers, execution risk on fixed price and complex projects could pressure EBITDA margins near the 3% to 4% target range and keep net margins volatile.
• Even though there is $48.7b of funds under management and more than 80 investors, fee margins in some Australian funds have already softened. Further margin pressure or slower deployment of the A$2.8b of available capital and A$4.7b being raised could limit growth in management fee revenue and Investment segment EBITDA.
• Despite a growing Australian development pipeline, including more than $4.7b of new projects secured in the half and targets of over $10b this year, many major residential and mixed use completions and settlements are weighted to FY '27 and FY '28. Slippage in timing or higher delivery costs may temper the conversion of presales into cash and constrain development ROIC and earnings.
• Although cost initiatives have reduced net overheads to a run rate below $400 million, with a targeted exit run rate of about $350 million by the end of FY '26, the CRU cost base and residual risks from exited international construction and communities land impairments may continue to absorb a meaningful share of operating cash flow and delay the improvement in group earnings and net margins.

Assumptions

This narrative explores a more pessimistic perspective on Lendlease Group compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts. How have these above catalysts been quantified?

• The bearish analysts are assuming Lendlease Group's revenue will decrease by 2.0% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from -2.3% today to 6.1% in 3 years time.
• The bearish analysts expect earnings to reach A$350.5 million (and earnings per share of A$0.53) by about February 2029, up from A$-141.0 million today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as A$592.0 million.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 12.0x on those 2029 earnings, up from -20.3x today. This future PE is lower than the current PE for the AU Real Estate industry at 12.9x.
• The bearish analysts expect the number of shares outstanding to grow by 0.12% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 11.63%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• If Lendlease completes the targeted A$3b of capital recycling across IDC and CRU and successfully brings underlying gearing down from 32.9% to the 15% target, lower net debt and interest costs could support higher earnings and improve market confidence, which may lift the share price and contradict the view that it stays flat by improving net margins and group earnings.
• The Australian Construction segment has A$8b of backlog revenue and a preferred work book of A$6.9b, with strong activity in hospitals, data centers and transport. If this circa A$15b pipeline converts into higher Construction revenues while maintaining EBITDA margins around the 3% to 4% target, the earnings contribution from IDC could rise and put upward pressure on the share price through stronger segment EBITDA and group revenue.
• Funds under management are A$48.7b with more than 80 investors, A$2.8b of capital available to deploy and A$4.7b being raised. If investor demand remains firm and fee margins stabilise or improve in core mandates, higher management fees and co investment returns from this global platform could support growth in Investment segment EBITDA and net margins, challenging the assumption that the share price will be unchanged.
• The development pipeline in Australia includes A$3.3b of apartment presales with around A$1b of settlements weighted to FY '27 and multi year projects such as One Circular Quay, Comcentre, One Darling Point and the Crown Estate joint venture. Successful delivery and settlement of these projects could materially increase cash inflows and Development segment ROIC, improving earnings and potentially leading to a re rating of the share price.
• Cost reduction plans target a group overhead exit run rate of about A$350m by the end of FY '26 from a current run rate below A$400m. If CRU costs fall as capital recycling completes, the combination of lower overheads and reduced CRU losses could move the group from an OPAT loss of A$200m toward a more profitable footing, which may support a higher valuation through stronger net margins and group earnings.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for Lendlease Group is A$4.42, which represents up to two standard deviations below the consensus price target of A$5.55. This valuation is based on what can be assumed as the expectations of Lendlease Group's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of A$6.5, and the most bearish reporting a price target of just A$4.42.
  
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2029, revenues will be A$5.7 billion, earnings will come to A$350.5 million, and it would be trading on a PE ratio of 12.0x, assuming you use a discount rate of 11.6%.
  
• Given the current share price of A$4.2, the analyst price target of A$4.42 is 5.0% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.