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Morningstar | Aveo Earnings Update Disappoints but Our Long-Term View is Intact, FVE Lowered 5% to AUD 2.00

No-moat Aveo Group’s downbeat earnings update highlighted ongoing challenges facing the retirement operator. Subdued residential property markets are slowing settlements, leading the firm to lower fiscal 2019 earnings guidance. Other highlights include guidance for full-year dividends of AUD 4.5 cents per security, the confirmation of an indicative takeover offer for Aveo, and a change towards more conservative revenue recognition. Adjusting for the weaker short-term outlook results in a decrease in our fair value estimate to AUD 2.00 per share from AUD 2.10. At current prices, the stock screens as fairly valued.

Tough operating conditions in the property market are pressuring sales and settlements, with Aveo now expecting fiscal 2019 underlying profit of around AUD 50 million, assuming 900 units settle. Weak house prices see prospective residents delaying settlement of existing properties, slowing moves into retirement units. Nonetheless, we think this is largely a cyclical factor and the long-term outlook for demand remains positive. Encouragingly, the firm cited some improvement since mid-May, with momentum strongest in the fourth quarter. Interest in Aveo’s residential products remains robust with 1,111 total written sales to June 21, equating to a 20% increase on last year.

We lower our forecast settlement volume to 890 units for fiscal 2019, after paring back near-term assumptions on the turnover rate for retirement assets and development units sales. Thereafter, we expect a step up in sales volumes of newly developed units by 2.8% per year through to 2023 (versus 2.0% previously), while our turnover rate assumptions post 2019 remain.

While the housing market is challenging, recent macro events such as APRA’s proposed changes to the mortgage serviceability benchmark and potential further RBA rate cuts suggest property prices should at least stabilise. We think the boost in sentiment, potentially improving credit affordability and availability, as well as the ageing demographic will continue to support sales volumes and turnover.

Adjusting for the above issues results in our forecast fiscal 2019 underlying net profit after tax falling 22% to AUD 50 million, or AUD 8.6 cents per security. Aveo flagged a change in revenue recognition from a delivery to settlement basis is due to take place effective July 1. While this may result in a slight drag to underlying profits, the change will: i) have no impact on underlying cash flows; and ii) help improve the quality of earnings. We forecast EPS to grow around 11% per year from AUD 8.6 cents in fiscal 2019 to AUD 22 cents in fiscal 2028. We also project dividends per security growth of 10% per year from AUD 4.5 cents to AUD 11 cents from fiscal 2019 to fiscal 2028, based on a payout ratio averaging 50%.

Aveo provided an update on its highly-publicised strategic review, confirming it has received a nonbinding and conditional indicative takeover proposal. A deadline is set for July 22. The sale will be called off if a scheme of arrangement cannot be agreed by then. We think a sale at a significant premium to our fair value estimate and the current share price is unlikely. The sheer (50%) difference between Aveo’s security price (AUD 1.93 at the time of writing) and net tangible assets (AUD 3.83) illustrates the uncertainty around long-term cash generation prospects of existing assets and pipeline initiatives.