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Morningstar | Stockland’s Multi-Year Growth Engine Runs Low on Fuel. FVE Cut to AUD 4.00

Stockland’s first-half fiscal 2019 earnings on a funds from operations, or FFO, basis of AUD 16.8 cents per security, or cps, were down on the 18.0 cps in the previous corresponding period, or pcp, and consistent with expectations. The decline was mostly due to a decline in residential settlements to 2,096 lots compared with 3,159 in the pcp. Stockland is guiding for over 6,000 settlements for fiscal 2019, underpinning stronger second-half earnings. We continue to forecast fiscal 2019 FFO growth of 4.4%, below guidance that was lowered to growth of approximately 5% growth from 5%-7% previously. Guidance was reiterated for distributions of AUD 27.6 cps. After a five-year run of strong earnings growth, it is fair to say most of Stockland’s businesses are facing tougher operating conditions, the only solidly performing divisions are office and industrial which comprise 5% and 17%, respectively, of pre-overhead EBIT.

Overall, the retail performance weakened more than expected. Comparable retail sales deteriorated further growing just 1.4% in 12 months. This is impacting the rental growth trajectory, with rents up just 0.2% on renewed leases and falling 2.6% for new leases. Incentives paid to secure new tenants picked up to 14.5% from 13.1% and the tenant retention rate eased to 63% from 65% a year ago. These metrics are compelling arguments for Stockland to reduce its exposure to retail. We’ve trimmed retail rental growth expectations and factored in earnings dilution from selling more higher-yielding malls. Corresponding with weakness in Australian dwelling prices, we’ve also cut earnings growth expectation for the retirement living business. Our fair value estimate declines to AUD 4.00 from AUD 4.15. Narrow-moat-rated Stockland screens as slightly undervalued, currently trading around AUD 3.65.

We’d thought the previously planned sale of AUD 0.4 million of noncore malls was conservative, so upping malls on the block to AUD 1 billion was not a surprise. Execution of planned sales at book value will see investments in shopping malls fall from AUD 7.2 billion to AUD 6.3 billion, a decline from 69% to 66% of rent generating assets. Going forward, this will gradually reduce as most new capital deployments will be into office and industrial. Corresponding with the upped retail divestment programme, the retail development pipeline has been cut by 50%. This is a telling signal as it points to returns on mooted projects failing to hit Stockland risk and return hurdles. We still think there is ample scope to offload a further AUD 1 billion of malls, but it would be a challenge to execute in the near term given many others are trying to sell and the waning interest from wholesale investors in the shopping malls.

Stockland is far from immune to the decline in Australian house and apartment prices. However, we think the impact will be less than for many peers, especially smaller operators. First, Stockland has acquired much of its land bank of 82,000 lots under option, which means it isn’t as exposed to falling land values as those purchasing the land outright. Second, the firm's recent focus to sell completed houses (mostly townhouses) significantly broadens the customer base as many prospective buyers are turned off by the typical two-year lead time from putting a deposit on a lot to moving into a completed home. Profit per land lot also increases as Stockland makes a profit on the development of each dwelling. Third, Stockland’s scale as Australia’s largest developer of land lots permits savings in all aspects of the value chain from costs in site preparation selling to planning and marketing. Finally, Australia remains a very attractive place to live and we expect inbound migration to remain a strong driver of Australia’s population for the foreseeable future. This supports ongoing demand for Stockland’s more affordable housing product.