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Morningstar | Stockland's Stockpile of Cheap Land Continues to Deliver. FVE Unchanged at AUD 4.45

We've left our fair value estimate for narrow-moat-rated Stockland at AUD 4.45, with the stock screening slightly undervalued currently trading 6% below our valuation. Fiscal 2018 earnings on a funds from operations, or FFO, basis, were slightly ahead of forecast mainly due to a higher-than-expected number of residential settlements of 6,438 lots. Even though the housing market has demonstrably cooled, Stockland is guiding for fiscal 2019 settlements to remain above 6,000 lots. Residential margins look set to remain near peak 2018 levels of 18% for the next year and gradually tapering off thereafter. Margins are likely to hold up even through house prices have softened as many large projects have built up large contingencies over the past few years and these will be gradually released as the projects wind down.

We forecast fiscal 2019 earnings of AUD 37.5 cents per security, or cps, implying growth of 5.4% which is consistent with guidance for growth of 5% to 7%. Distribution guidance of AUD 27.6 cps puts the distribution payout ratio just below the bottom of the target range of 75%-85%. This seems prudent as we are forecasting a further cooling in the residential market, resulting in a fall in volumes in fiscal 2020 to under 6,000 lot settlements. Our assumption for a cooling in the Australian housing market--after all, who wants to catch a falling knife?--is the primary reason for our forecast FFO declines of circa 2% in each of fiscal 2020 and fiscal 2021. The other factors weighing on medium-term FFO are earnings dilution from planned asset sales and a gradual lift in borrowing costs.

Despite risks ahead for Australian housing, Stockland looks well placed to adapt. The firm is very much on the front foot, having a few years ago taken steps to build completed houses on its land subdivision sites. This vastly expands the addressable market as there is undoubtedly a large pool of prospective customers turned off by the typical lead time of two years. This is the typical time it takes from putting down a deposit for a land lot and getting the keys from the builder on the completed house.

We've long been fans of the retirement living sector. Demographic trends are both favourable and unlikely to reverse. Unsurprisingly, earnings were down following negative press on the sector a year ago, but the sentiment appears to have bottomed. Stockland's introduction of a greater variety of funding options to pay for retirement village accommodation will broaden the addressable market and get many around the negativity associated with deferred management fee contracts. We forecast a gradual recovery over the next two years in resales, but a big pickup in sales of new developments. Stockland is sticking with a partnering model for the provision of aged care services, but we see this as inferior to the integrated model common by New Zealand operators. The challenge for Stockland and the Australian incumbents is how to offer prospective residents whole-of-life care, without taking on the operational challenges in aged care.

The retail shopping centre portfolio is going through a challenging period as retail spending in pockets of Queensland slows due to weakness in the mining and agriculture markets. The new head of the commercial property division, Louise Mason has taken steps to address this, offloading 12 smaller malls totaling AUD 400 million. The disposal of these malls will see a gradual down-weighting to retail and a higher weighting to industrial as Stockland has AUD 100 million of developments under way and a further AUD 600 million in the development pipeline.