Investment implications
Stockland is an integrated property manager and developer that focuses on retail, office, and industrial assets. SGP is the largest residential lot developer in the country. The group operates a more capital-intensive model vs more asset management-focused peers Charter Hall (CHC) and Goodman Group (GMG). SGP has started to introduce capital partners in a bid to lower the capital intensity of the Group. Return on Assets (ROA) has averaged 4.5% over the last decade.
Residential development is the key focal point of investors (a third of group earnings). Adverse weather and pandemic-related delays lowered both settlements, and completions of housing lots in FY22. Guidance was lowered from 6,400 to 6,000 in February. SGP’s annual productive capacity is capped at ~6,500 lots. In prior down cycles, SGP’s residential volumes have fallen ~15%.
SGP share price has fallen ~25% since June 2021, and now trades at 10% discount to book value. In the two prior housing downturns (2008/09 and 2012/13) SGP wrote off ~15% and ~12% of housing inventory. Whilst the market is fearful that this could again occur in the current housing downturn, we view this as unlikely given a much closer relationship between inventory and sales in this cycle.
“New Stockland Strategy” aims to lift ROA. Under CEO Tarun Gupta (June 2021) SGP is looking to refocus the Group on its core areas of property expertise and lift SGP’s ROA. Divestment of the retirement division for $1bn (in-line with NTA) in July, sees gearing fall from 23% to 17%. This opens the door for a share buyback, something SGP has done before when the share price is below book value.
Rising interest rates create a headwind for earnings, property valuations, and investor sentiment. In our view, rising interest rates will keep pressure on the SGP share price, particularly as housing finance and house prices fall. We remain comfortable that SGP’s balance sheet is in good shape (gearing 23%). Under supply of housing and the likelihood of migration picking up 2023/24 limits the risk of balance sheet/inventory overhang that prior cycles have had.
11x FY23E earnings, 0.9x book value, 7.0% dividend yield suggests value is on offer in SGP, notwithstanding flat 3yr EPS CAGR. With earnings risks skewed to the downside through FY23/24E, we rate SGP a HOLD. Peer housing developer Mirvac Group (MGR) trades at 0.75x book with low single-digit EPS CAGR.
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 margins likely to emerge.
At this stage, we don’t expect SGP 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, SGP’s scale should see margins largely hold in 2023. Developer peer MGR upgraded margin guidance in August for FY23.
- SGP downgraded FY22 settlement volumes from 6,400 to 6,000 lots in February, primarily due to wet weather and supply chain issues. We expect most of these missed settlements will move into FY23. Our base case scenario is that SGP will deliver ~6,000 lots in FY23E.
In our view, investors will find it difficult to look through risks to SGP’s housing earnings this until the RBA has stopped lifting interest rates or 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.
2024 volumes and margins contain more risk at this juncture. Unless the RBA takes cash rates well above the neutral setting, restricting domestic growth – 2024 volumes will likely hold around 6,000.
- Will the newly appointed CEO’s strategy point to a stronger growth outlook?
Recently appointed CEO Tarun Gupta (June 2021) continues with implementing the “New Stockland Strategy”. So far, the strategy has included; 1) accelerating the development pipeline, 2) introducing capital partners; and 3) selling the retirement business. The core objective of the strategy is to lift SGP’s return on assets (ROA) which has averaged <5% last 10 years.
- Sale of Retirement business - completed in July 2022, for $1bn (2% discount to book). As a result of the sale, SGP will return to an income tax-paying position for FY23E. The income tax expense is guided to be 5-10% of Funds from Operations (FFO). In our view, the retirement business sale is a strategic positive. It lacked scale vs the rest of the group and was unlikely to be additive to lifting SGP’s return on assets.
- The move to a tax-paying position is neutral for most investors. The business will build franking credits that will offset the tax implications, leaving grossed-up distribution in-line with the prior distribution amounts. Non-resident shareholders will be disadvantaged, given the inability to use franking credits. The SGP share register remains largely domestic investors, so we expect minimal impact on share price from this change.
- Balance sheet, interest rate hedge profile: gearing currently stands ~23% with a look-through of <35%. Gearing should fall to ~18%, as proceeds from the retirement business sale are used to repay debt. Interest rate exposure is hedged at ~65% with an average debt maturity of 4.8yr, which should dampen the earnings impact from higher rates. Further, de-gearing could occur if SGP moves to sell $1bn of retail assets into a JV with capital partners.
- Capital management options – the sale of the retirement business opens the prospects of capital management for SGP. Gearing is ~18%, below the bottom end of the 20-30% target range. With the share price trading ~15% below book value, a $500m buyback would reduce shares on issue by ~6%, whilst being +2.5%-3% EPS accretive at current prices.
- Previous share buybacks (2011, 2019) were initiated when the share price was trading below NTA. This produced significant results, removing the valuation discount, and saw the SGP share price significantly outperform the market whilst the buyback was active.
In our view, SGP is more likely to preserve capital, rather than undertake a buyback at this point in the housing cycle.
Figure 1: SGP’s previous buybacks removed the discount to book value. Share price outperformed strongly during the buyback
3. SGP valuation considerations.
- Book value: the share price is currently trading at a ~15% discount to book. In prior cycles without balance sheet write-downs, the share price bottomed at a 40% discount to book value.
- Previous housing cycles 2008/09 GFC and 2012/13 housing slowdown saw inventory write-downs of 15% and 12% respectively. Given much lower replenishment rates of inventory in this cycle, we believe it is unlikely SGP will be forced to write down inventory (outside of a recession scenario for Australia).
- Earnings multiple: SGP PER is currently 11x 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: SGP has guided to 2-5% FFO growth in FY23E. The market is forecasting flat EPS growth over 2022-24E as softer residential markets bite. This is the equal lowest of any of the ASX 100 A-REITs. Any slippage in residential, or retail-related earnings could see earnings growth slip into negative territory.
- SGP’s share price has fallen >20% from the June 2021 highs, which makes SGP the third worst performing A-REIT in the S&P/ASX 100 over that time. The market is pricing in an aggressive fall in earnings/valuation, which in our view, is unlikely to occur in 2023E.
Figure 2: SGP and MGR write-downs of residential inventory in previous housing downturns.
Risks to investment view
Key risks to SGP are: 1). residential slowdown and falling residential margins; 2). low earnings growth vs peers could see SGP continue to underperform peers; 3). write-downs to residential inventory. This occurred in previous housing downturns, suppressing the share price, 4). SGP’s office and retail assets continue to deliver soft earnings contributions and or face lower valuations, 5). cost inflation headwinds via development operations in residential and commercial, and 6). SGP undertakes a share buy-back.
Investment view
The shift in SGP’s model to accelerate development earnings has the potential to lift both earnings and ROA, which we are supportive of from a strategic standpoint. Whilst development earnings may not carry the same earnings multiple as Trust earnings, this is not an issue when the share price is trading at a 15% discount to book value.
The market is looking for flat EPS growth into FY24E, with any benefits from the strategic reset offset by headwinds in residential and soft recovery in Retail and Office Trust assets.
In our view, the market will continue to price SGP at a discount to book value until the cash rate stops going up, house prices stabilise, or Stockland announces a capital management initiative. With earnings risk-neutral to down over 2023/24, we rate SGP a Hold.
Figure 3: SGP FY23E earnings mix. Residential earnings are expected to make up 36%.
Figure 4: Residential sales are flat in 2023, with flat margins despite inflation pressures.
Figure 5: SGP share price relative to home lending growth, which is likely to go negative as the RBA lift interest rates in 2023.
Figure 6: SGP PER relative to changes in house prices. Share price has moved well in advance of prior house prices in this cycle.
Figure 7: SGP PER 11x, ex COVID, in-line with the lowest level over the last 10 years.
Figure 8: SGP trading at a ~15% discount to NTA, a level where buybacks have been announced previously.
Figure 9: ROE trading at the top end range – Forecasts suggest it rolls over into FY24.
Figure 10: Highest dividend yield of the ASX100 AREITs with a payout ratio of 75%.
