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Morningstar | Mirvac’s Business Not Immune from Economic Pressures. FVE Reduced to AUD 2.10

Mirvac Group’s operational update for first-quarter fiscal 2019 highlighted moderation in retail sales for the year to June 2018 is continuing, but not at a rate that causes alarm. Retail sales are growing at 3% as compared with 4% a year ago. This level of growth is still above that of most listed peers, the difference accounted for in Mirvac’s focus on the economically strong Sydney market.

Even though the Reserve Bank of Australia is unlikely to raise the overnight cash rate above the current 1.5% in the near term, the upward trend in international bond yields will impact Mirvac and other property firms via gradually higher borrowing costs going forward. We’ve slightly raised our long-term cost of debt assumptions and Mirvac’s weighted average costs of capital, or WACC, increases to 8.5% from 8.4%. The higher WACC is the main reason for the reduction in our fair value estimate to AUD 2.10 per security from AUD 2.20 previously. At current levels, Mirvac screens as fairly valued with the guided fiscal 2019 distribution of AUD 11.6 cents per security representing a yield of 5.4%.

The residential division develops apartments and sells vacant land lots and is encountering a deterioration in trading conditions. Mirvac’s residential sales have slowed, mostly due to tightened bank lending standards, but also due to a huge fall in interest from offshore investors (particularly from China) who have been impacted by capital controls and higher taxes. The fact that Australian dwelling prices have been gradually declining over the past six-12 months is a good reason for first homebuyers to delay their purchase decisions until they feel the decline has run its course. Recent house price declines are causing some speculative housing investors to sell their properties to preserve capital. We expect more downside ahead.

Mirvac is guiding for 2,500 residential settlements in fiscal 2019, well down on the 3,400 in fiscal 2018. The sharp slowdown is partly market-related, but mostly due to the timing of multi-year apartment projects. Fiscal 2019 is a year of high apartment construction, but low delivery. The high number of apartment projects under construction is behind Mirvac’s guidance for a record number of apartment settlements in fiscal 2020. We are forecasting the selling price for the average Mirvac land lot to decline by a cumulative 12% over the three years to June 2021, then rise very slowly thereafter. However, should mortgage rates step up from the current very low levels (potentially due to repricing of risk in international credit markets), it is conceivable dwelling prices could to fall 20% to 25%, from top to bottom, (although this is not our base case) hurting Mirvac through lower development margins and higher land holding costs.

Mirvac’s current strategic focus is on the major office markets of Sydney and Melbourne. The firm is banking on its portfolio of modern buildings achieving superior occupancy and rents compared with market peers whose buildings have lower amenity. We concur with this view as the small incremental rental premium to operate from a modern building will often make a big difference to tenants operating efficiency. But we are less optimistic that office occupancy rates can hold in the 97%-98% range that has been the case for the past few years in Sydney and Melbourne. We forecast occupancy will gradually trend down towards 95%, which is more consistent with long-term industry trends. Downward pressure in occupancy and hence rents is expected to come from the completion of a series of offices that are currently under construction. Our current long-term forecasts are for rent growth over the coming decade is 2.9% for the combined office and industrial portfolios, with office forecast to average 3.5% and industrial average 1.8%.