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Morningstar | Aveo Considers All Options to Unlock Value; FVE Unchanged at AUD 2.80

Aveo reported fiscal 2018 underlying earnings of AUD 22 cents per security, slightly above June guidance of AUD 21.4 cents per security. The business has yet to fully recover from negative press 14 months ago. Newly completed units are taking longer to sell, resulting in a large buildup of unsold inventory on balance sheet totalling AUD 347 million at June 2018, compared with AUD 135 million a year prior. The sales rate of units upon resident departure is 7.5%, well down on the long-term average of 10%-11%. This is behind the drop in portfolio occupancy over the past year to 90% from 93%. We think the firm has troughed and operations will improve from this point, but it’s likely to take some time. Aveo has introduced a variation on its standard contract that provides increased options for residents, but the deferred management fees, or DMF, are still viewed as elevated and may need to be revisited to accelerate sales.

We see Aveo taking a further two years to shake off the negative press and reposition to capitalise on the significant opportunity to provide high-quality housing for the elderly. Our fair value estimate for no-moat Aveo is unchanged at AUD 2.80. Aveo stock screens as undervalued, currently trading at AUD 2.40.

Positives from the result include the continued uptrend in deferred management fees and capital gains for each resold unit, which increased by 6.5% to AUD 104,400 from AUD 98,000 a year prior.

Aveo is soon to embark on a strategic review, with soon-to-be-appointed corporate advisors given an open remit to assess all options. Given the very favourable demographic tailwinds across Australia, Aveo regards a faster and high rate of development as the most accretive use of capital. Consequently, the advisors are likely to focus on avenues to introduce strategic investors in order to accelerate the number of units developed or potentially a share buyback.

Guidance is for fiscal 2019 earnings of AUD 20.4 cents per security, but our forecasts are slightly lower at AUD 20.0 cents per security. Major swing factors in the year ahead are the sales rate of legacy residential land lots and the time taken for incoming residents to settle. Resident settlement is currently taking about a month longer than previously, partly as a result of a lower auction clearance rate.