EUR 850.00 For Business Accounts Only

Morningstar | Transferring Coverage of Narrow-Moat-Rated Stockland, AUD 3.90 FVE Unchanged. See Updated Analyst Note from 27 May 2019

We reiterate our AUD 3.90 fair value estimate for property conglomerate Stockland following transfer of coverage to a new analyst. Our narrow moat, medium fair value uncertainty, and Standard stewardship ratings are retained. At AUD 4.45, shares screen as modestly overvalued. Key risks are tight lending standards, which may continue to depress the housing market and impact the volume and price of residential developments, and the erosion of the value of Stockland’s malls as sales are lost to online channels.

Around three quarters of Stockland’s operating income is rental income from the commercial property portfolio, split among retail (72%), industrial (20%), and office (8%). Looking ahead, we forecast low but stable rent growth from its retail properties. We expect industrywide sales leakage to online retailers to weigh on sales growth and tenant retention across the retail portfolio. We’re likely to see lower rent inflation in future. The planned sale of AUD 1 billion of noncore shopping centres may also be challenging to execute, given there is ample supply of shopping malls and weak buyer interest. Nevertheless, we like that Stockland has invested to revitalise its core shopping malls. This should help the portfolio’s defensiveness and maintain its appeal to consumers. Over the long term, risks associated with online sales leakage should be countered by increasing population density, which drives foot traffic. Population density is also likely to make alternative land parcels more inaccessible, which discourages prospective entrants from competing with Stockland in the same catchment area. We expect retail property rents to increase by 2.1% compound per year to 2028, slightly below inflation, and assume occupancy levels decline slightly to 98.5% from 99.4%.

Industrial and office are Stockland’s preferred growth segments. The company wants to increase the combined weighting to between 25% and 35% of total assets from 21% at end 2018. In line with the retail divestment program, capital will now be redeployed towards industrial and office assets. Stockland boasts an impressive industrial portfolio, of which 70% is premium quality. Industrial assets are attractive given they are immune to the shift to online retail, and should actually benefit from increased logistics. However, the shift to industrial is in its early days and it will take at least three years for Stockland to grow share meaningfully relative to established industrial developers. On the office side, the portfolio is lower-quality and we think this could expose the firm to valuation downside if office demand slows. We forecast industrial rents to grow by 1.6% compound per year to 2028 and office by 2.7%.

Residential and retirement living comprise the remaining 25% of Stockland’s operating earnings. In its third-quarter fiscal 2019 operational update, the firm confirmed trading conditions remain challenging for residential land sales and development, with net residential deposits down 28% on the previous corresponding period. Recent macro events, such as the Coalition’s surprise election victory, APRA’s proposed changes to the interest rate stress test and a likely RBA rate cut reduces downside risks for Stockland’s residential assets.

We have not incorporated a housing market improvement in our forecasts. Despite encouraging signs, it is difficult to conclude credit availability will improve materially, given the move towards full verification of living expenses, near-term attention on arrears and debt/income restrictions. 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 6.6% a year decline in the volume of lots settled to 2022, and growth of around 3% per year thereafter.