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Morningstar | Stockland Pushes Forward With Revised Strategy Amidst Challenging Landscape

Narrow-moat-rated Stockland’s 2019 investor day highlighted the property conglomerate’s good progress in executing its revised business strategy. The focus is to revitalise the core retail malls, exit noncore assets and expand the industrial and office segment. The group also reaffirmed its fiscal 2019 funds from operations, or FFO, per share growth guidance of 5%. Stockland now expects settlement of its residential land lots to fall short of prior guidance (above 6,000 units) due to production delays, but this is to be offset by a skew in settlements towards higher margin projects in Sydney and Melbourne. We have adjusted some of our earnings forecasts in line with the updated guidance but our long-term view is intact. We retain our fair value estimate of AUD 3.90 per share.

Near-term risks persist including the loss of sales to online and tight bank lending standards. However, we believe Stockland’s initiatives are consistent with navigating these headwinds and driving longer-term value creation. Immediate priorities include further noncore asset divestments, upscaling the industrial development pipeline, executing the ongoing share buyback, and expanding strategic capital partnerships.

Weak discretionary spending and the rise of e-commerce are pressuring shopping centres with larger exposures to discretionary retailers. Stockland is seeing some price softness for new leases, which on average are being struck 3.5% below the prior rate. However, this is expected and factored into our view for rental growth of less than 2% in the near-term, rising to 2.1% by midcycle. Demand from franchisees has also reduced as a result of tightening credit availability and softer consumer spending. Retention currently sits around 68%. Stockland expects retail FFO to decline further in fiscal 2020 but trend upwards from thereon.

Moving forward, Stockland intends to reduce the number of core malls to 30 (down from around 35 currently) with a greater tilt towards nondiscretionary retailers. We think the strategy will help to maintain the portfolio’s defensiveness and appeal, but we’d need to see sustained improvement in the economy and consumer spending before lifting our rental growth forecasts. At present, we expect retail property rents to increase by 2.1% compound per year to 2028, and assume flat occupancy levels of 98% over the same period. This growth expectation is basically in line with inflation.

The retail divestment program is on track, with AUD 285 million of noncore malls sold. We assume the total planned divestments of AUD 1.0 billion will complete in fiscal 2020, but delays or price discounts would potentially see a minor downgrade to our fair value estimate.

Stockland continues to deploy capital to the industrial and office segments, in line with its target to increase the combined weighting to between 25% and 35% of total assets. The company highlighted a AUD 950 million industrial development pipeline. Industrial assets are attractive relative to retail given they should benefit from increased logistics from e-commerce. The shift to industrial is still in its early days. It will take at least three years for Stockland to grow share meaningfully relative to established industrial developers.

Progress in the residential segment is mildly disappointing. Stockland lowered its fiscal 2019 sales guidance to around 5,900 lots from more than 6,000 previously. The group attributed this to delays at Mt Atkinson with 200 lot settlements pushed out to fiscal 2020. An increase in the fourth quarter default rate to 5% (versus a long-term average of 3%) also disappointed, while sales over the quarter are expected to be around 700 lots (down from 963 in the previous quarter). There are signs of stress, with some buyers requesting settlement periods of four to five weeks. Management warned that lower sales in the second half of fiscal 2019 will adversely impact settlement volumes in fiscal 2020, to around the lower-end of a midcycle target of 5,000 to 6,000 lots. We adjust our forecast fiscal 2019 settlement volume to around 5,900, and around 5,300 for fiscal 2020. There may be some near-term, post-election housing improvement but this is uncertain.

Stockland maintains its fiscal 2019 FFO per share growth guidance of 5%, with high-margin settlements in Sydney and Melbourne expected to offset decline in volumes. Despite encouraging recent macro events, it is difficult to conclude credit availability will improve materially, given the move towards full verification of living expenses, attention on arrears, debt/income restrictions, and more recently APRA’s proposal for the banks to hold more capital for high-risk loans. We continue to expect relatively flat house prices and assume growth in the average price per lot of 0.7% a year over the next three years. We also assume an average 7% a year decline in the volume of lots settled to 2022, and growth of around 3% per year thereafter.