Investment view
Mirvac is an integrated property manager and developer. Key investment property assets are held across office, retail, and industrial sites. MGR also develops medium-density apartments in urban infill locations, and house land packages typically on the suburban fringe (broadly 50/50 revenue mix). MGR has recently begun the process of introducing third-party capital, in a bid to lift the Group’s Return on Assets (ROA) which has averaged 5.3% over the last decade.
MGR’s residential development business remains the key focal point of investors as it contributes ~30% of group earnings and remains a key swing factor in earnings. MGR housing volumes should lift across 2023-25 as new product comes to market. Investors have marked down the MGR share by >30% since mid-2021 on fears of rising rates and the potential impact on residential volumes.
Balance sheet write-down risk is low. In the two most recent periods of falling house prices; the GFC and 2012/13, MGR and peer residential developer Stockland Group (SGP) both took balance sheet write-downs ~15% of housing inventory. Whilst each cycle is different, the level of inventory replenishment is materially less in 2022/23 vs prior periods reducing the risk of write-downs.
Will office towers become ghost towers? 47% of MGR’s income comes from office assets. In addition, office exposure represents close to half the book value. MGR assets are generally not the flagship trophy-style assets found in Dexus (DXS) or General Property Trust (GPT), which opens the investor debate around the potential for valuation impacts if the office buildings see valuations fall.
MGR valuation: 14x FY23E earnings, 0.7x book value, 5.0% dividend yield suggests that value is on offer in MGR, which is unsurprising given the >30% share price fall since 4Q2021. On price-to-book measures, MGR looks compelling. The cheapest large-cap A-REIT, even if you assume a 15% write-down in asset values.
Rising interest rates create a headwind for earnings, property valuations, and investor sentiment. In our view, rising interest rates will keep pressure on the MGR share price, particularly as housing finance and house prices fall. Without a near-term catalyst to change investor perceptions, and with earnings risk skewed to the downside for FY24E, we rate MGR a Hold.
Risks to investment view
MGR’s key areas of focus – residential, office, and construction all face headwinds in a higher interest rate environment. Whilst MGR has a strong level of housing pre-sales heading into FY23, earnings headwinds exist across rising debt and construction costs. The Trust assets are unlikely to see earnings accelerate in this environment.
MGR is seen by investors as one of the most sensitive companies to residential housing activity. We expect both housing credit and house prices to continue to fall though 2022/early 2023. This is likely to continue to provide a headwind for the MGR share price.
Conversely, a slowing of interest rate hikes or falling house prices would likely be seen as a positive catalyst for MGR. MGR is currently trading well below book value, so any change in sentiment towards housing and interest rates would likely be well received. Stronger than expected results from MGR’s asset divestment program ($1.3bn) could see MGR undertake a share buyback (2H23). The 2018 buy-back saw the share price strong outperform the market in the following 12-months.
Investment view
MGR has a strong product offer across well-located high-quality office/retail and industrial assets. The Group is a large residential development business that targets urban infill and master-planned communities. The market views MGR as a housing proxy, which results in the share price being more volatile than the A-REIT index.
MGR currently screens attractively for value, with share price trading at ~20% discount to NTA, whilst earnings multiples are currently at multi-year lows. The market is implying that asset values will come under pressure as higher interest rates weigh on the real estate valuations and residential volumes.
We resist the temptation to be more positive on MGR. In our view, negative sentiment towards residential developers means the share price is unlikely to be rerated over the next +6-12 months.
3 Key investor issues
- Do residential earnings and settlements fall in 2023/24?
Residential earnings remain a key swing factor into 2023/24 as the residential property market is expected to cool following a period of above-average credit growth and housing activity post COVID.
Falling house prices in response to rises in the RBA cash rate are likely to temper volume growth. In this environment, we expect a tempering of volumes, with downside pressure on developer margins likely to emerge.
At this stage, we don’t expect MGR to see a collapse in residential volumes and earnings in 2023 given. This is due to;
- Underbuild of homes across Australia relative to demand.
- Real interest rates are likely to still be negative even as the RBA cash rate peaks in 2023. We expect the RBA cash rate to peak 2.75-3.00% in early 2023.
- Net migration levels are likely to accelerate across 2023/24 providing incremental demand for new residential builds (migrant intake cap of 180k could be lifted to 200k pa).
- Whilst raw materials costs are rising, MGR’s scale should see margins largely hold in 2023. MGR upgraded margin guidance in August for FY23.
- MGR has a significant lot release program and apartment release program in 2023/24 as new product comes online. The housing product is in key growth areas and should help insulate MGR from seeing housing volumes go backward.
In our view, investors will find it difficult to look through risks to MGR’s housing earnings until the RBA has stopped lifting interest rates or national house prices stop falling.
Investors also recall that in the last major housing downcycle, SGP residential margins fell from 16% to 7%. Management has guided to an FY23 residential margin of ~18%, in-line with the long-term average. Risks for FY24 margin decline are more pronounced given the combination of raw material prices, higher interest rates and the potential for lower house prices. Inquiry levels in 2QCY22 showed a significant slowdown in terms of conversion rates into sales which further raises risks of lower margins into 2HCY23
- how is mgr’s balance sheet looking?
Balance sheet gearing for MGR remains comfortable at 21.3%, although the hedge profile lags the sector at 55%. There remains the potential for asset sales (+$1.3bn) through 2023, where we expect proceeds to be deployed in development opportunities rather than debt deduction.
MGR’s book value increased ~1% to $2.79 to June 30, 2022 driven by an 8bps compression in the cap rate over 2H22. In other words, the MGR valuation is full relative to where prices in both office and housing markets are likely to go over 2023-24.
The most significant risks on the balance sheet are in the office and residential development assets. Office makes up 47% of MGR earnings and 62% of Trust assets. We remain concerned that MGR’s office income is vulnerable to the negative demand drivers in office space, which could threaten both earnings and balance sheet carrying values.
The prospect of share buyback? In 2017/18 undertook on-market share buyback equating to ~3% of shares on issue. This saw the share rise +30% (market +14%) over the period of the buyback, taking the price back to NTA. Post-flagged asset sales, the prospect of share buy-back increases.
FIGURE 1: RESIDENTIAL SETTLEMENTS, FLAT in FY23. DOWNSIDE RISKS EXIST FOR FY24.
FIGURE 2: MGR HAS MODEST GEARING, WITH ONE OF THE LOWEST HEDGING PROFILES INTO 2025.
3. MGR valuation considerations.
- Book value: the share price is currently trading at a ~25% discount to book value of $2.79. Excluding the GFC and Covid-19 periods, the MGR share price in prior housing downcycles bottomed at a 40% discount to book value.
- Previous housing cycles 2008/09 GFC and 2012/13 housing slowdown, saw inventory write-downs of 23% and 18% respectively. Given the much lower replenishment rates of inventory in this cycle, we believe it is unlikely MGR will be forced to write down inventory (outside of a recession scenario for Australia).
- Earnings multiple: MGR PER is currently 14x P/FFO, the equal lowest earnings multiple over the last decade (excluding COVID-19). This represents a 20% discount to the 10-year average, or almost 1.5 standard deviations away from the long-term average.
- Earnings expectations: MGR has guided to 2.6% EPS growth in FY23E, which does contain a lot of moving parts across resi, office/industrial, and interest costs. Growth into FY24E is expected to be flat on FY23. Any slippage in residential, or office-related earnings could see earnings growth slip into negative territory.
- MGR’s share price has fallen >30% from the September 2021 highs, which makes MGR the worst performing A-REIT in the S&P/ASX 100 over that time. Across most valuation measures, multiples are approaching prior cycle lows.
- In our view, the clear risk over the coming 6-12 months is further slippage in MGR’s share price as the housing market further slows in response to higher interest rates.
FIGURE 4: MGR WROTE DOWN RESIDENTIAL ASSETS BY ~20% IN EACH OF THE PRIOR HOUSING DOWNTURNS.
FIGURE 5: OFFICE AND RESIDENTIAL DEVELOPMENT COUNT FOR 65% OF EARNINGS
FIGURE 6: MGR CHANGE IN PER VALUATION VS CHANGE HOUSE PRICES
FIGURE 7: MGER PER 14x WHICH IS -1 STANDARD DEVIATION AWAY FROM THE LONG TERM AVERAGE
FIGURE 8: P/NTA IS APPROACHING PRIOR CYCLE LOWS. A SHARE BUYBACK WOULD PUT A FLOOR UNDER THE PRICE
FIGURE 9: MGR REMAINS A LOW ROE BUSINESS DESPITE THE STRTAEGIC PUSH TO BECOME MORE CAPITAL LIGHT
FIGURE 10: DIVIDEND YIELD NOW AT 5%, WITH LIMITED DPUE GROWTH EXPECTED OVER FY22 -25E.
