Prime Office And Retail Shifts Will Threaten Future Earnings Outlook

Catalysts

About Land Securities Group

Land Securities Group is a U.K. real estate owner and developer focused on prime offices, major retail destinations and selective residential projects.

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

• Concentration in prime London offices and top tier retail assets leaves earnings exposed if occupier preferences or workplace patterns shift more than expected. This risks softer reletting terms and slower like for like income growth that would cap future revenue and EPS expansion.
• Plans to rotate roughly GBP 1 billion into major retail over the next 12 to 18 months assume a finite window of attractive yields. However, intensifying competition for dominant centers and rising CapEx to keep assets experience led could erode acquisition spreads and compress net margins.
• Reliance on continued outperformance of destination retail, driven by higher footfall and retailer sales than the broader market, may be challenged if consumer spending downshifts or brands rationalize store networks again. This could reduce turnover linked rent and pressure net rental income growth.
• Current and future residential developments depend on policy driven improvements to yields and high 5 percent yield on cost targets. Any reversal in planning or affordable housing support, or higher build costs and exit cap rates, would lower project IRRs and dilute EPS accretion from the pipeline.
• The strategy to reduce development exposure and keep more capital in income producing assets improves balance sheet optics. If long duration projects lease up more slowly than assumed or at lower than expected ERVs, interest costs on non or low yielding capital could weigh on earnings and suppress net margins.

Assumptions

This narrative explores a more pessimistic perspective on Land Securities 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 Land Securities Group's revenue will decrease by 10.3% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 28.0% today to 95.0% in 3 years time.
• The bearish analysts expect earnings to reach £610.9 million (and earnings per share of £0.82) by about December 2028, up from £249.0 million today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as £914.8 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 8.1x on those 2028 earnings, down from 17.3x today. This future PE is lower than the current PE for the GB REITs industry at 9.0x.
• The bearish analysts expect the number of shares outstanding to grow by 0.15% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.5%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Sustained strong demand for best in class offices and major retail destinations, evidenced by decade high occupancy around 98 percent and like for like income growth above 5 percent, could keep rental values rising and support higher than expected revenue and earnings over the medium term.
• The strategy of rotating capital out of low or non returning assets into dominant retail centers that already show nearly 20 percent sales growth versus 3 percent in the wider market, together with accretive small CapEx projects, may structurally lift net rental income growth towards the 4.5 to 7 percent target range and bolster net margins and EPS.
• Ongoing overhead savings of more than 25 percent versus financial year 2023, plus a move to structurally lower development exposure and below 7 times net debt to EBITDA, may lead to a leaner cost base and lower financial risk, supporting resilient earnings growth and potentially a re rating of the share price on stronger net margins.
• Policy support for residential, including reduced affordable housing and infrastructure charges that could lift net yields on cost into the high 5 percent range, may unlock attractive long term build to rent projects, adding a new growth engine that enhances future revenue and EPS beyond financial year 2030.
• If capital recycling into high yielding retail and selective acquisitions continues to outperform original underwriting, while office leasing on new completions progresses broadly in line with assumptions, the company could deliver compound EPS growth around 4 to 4.5 percent and rising dividends, contradicting expectations of a sustained share price decline through stronger earnings and cash flow.

Valuation

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

• The assumed bearish price target for Land Securities Group is £5.16, which represents up to two standard deviations below the consensus price target of £6.96. This valuation is based on what can be assumed as the expectations of Land Securities 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 £9.17, and the most bearish reporting a price target of just £4.75.
  
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2028, revenues will be £643.1 million, earnings will come to £610.9 million, and it would be trading on a PE ratio of 8.1x, assuming you use a discount rate of 8.5%.
  
• Given the current share price of £5.81, the analyst price target of £5.16 is 12.7% lower. Despite analysts expecting the underlying business to improve, they seem to believe the market's expectations are too high.
  
• 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.