Fitch Assigns First Time 'BBB-' to Lendlease; Outlook Stable
OREANDA-NEWS. Fitch Ratings has assigned a Long-Term Issuer Default Rating (IDR) of 'BBB-' and a senior unsecured debt rating of 'BBB-' to Lendlease Corporation Limited (Lendlease). The Outlook is Stable.
The rating reflects Lendlease's inherently cyclical core property development and construction businesses in Australia, the UK, US and Asia as the company rotates between its investment and cash-generation phases, and the impact property cycles have on the businesses in the countries in which it operates. Fitch expects visibility around cash generation from its AUD5.2bn in apartment pre-sales and construction backlog revenue of AUD17.3bn at 30 June 2015 (end-FY15) to remain high over the next three to four years, when its completes a number of projects.
However, the rating reflects the continued investment required by Lendlease to maintain the strength of its order book as projects are completed and the risk of mismatches of investment cash outflows and cash receipts at project completion, which typically is more than one year.
Lendlease benefits from its diversification into investment management, retirement villages and provision of US military housing, which generate stable and predictable revenues and provide considerable headroom to the rating.
KEY RATING DRIVERS
Market Leadership: Lendlease has a market leading position in most of its businesses, including urban regeneration projects in Australia and the UK and urban apartment construction in the US. At end-FY15, it had 12 major urban regeneration projects, 25 major apartment buildings and five commercial buildings in delivery, including Barangaroo South and Darling Harbour Live in Sydney, and Elephant & Castle and The International Quarter in London. Lendlease's scale - with a development pipeline of AUD44.9bn and construction and infrastructure backlog of AUD17.3bn - supports its rating. Lendlease also has the largest senior living and retirement business in Australia by units and is a leading provider of privatised military housing in the US.
Well-Diversified Business: Lendlease's business includes residential and infrastructure development, construction and investment management, with its main operations in Australia, the UK, the US and Asia. The strength of the Australian property market has underpinned Lendlease's opportunities since 2008, with Australian operations accounting for about 71% of FY15 segment profit before tax. Fitch expects Lendlease's international operations to partially offset any negative trend in Australia as the economy transitions away from dependence on resources and global markets improve. In 2015, Lendlease's international development pipeline continued to expand with around AUD8bn of new major urban regeneration projects.
In addition, Lendlease's retirement village, US military housing and investment management segments generate stable and predictable revenues compared to the inherently cyclical and volatile revenues from its core property development and construction businesses. In FY15, these businesses accounted for around AUD380m in EBITDA, and their contribution is likely to continue to account for about 40% of EBITDA.
Project Concentration in Sydney: Lendlease benefits from geographical and sector diversification, but its current project portfolio is somewhat concentrated as it delivers large Sydney developments, Barangaroo and Darling Harbour Live. The size of these projects means that Lendlease will continue to have high exposure to the Sydney residential and commercial real estate markets until 2018.
Strong Order Book; Earnings Visibility: At end-FY15, Lendlease disclosed a development pipeline of AUD44.9bn (including joint-venture share of AUD6.5bn), construction backlog revenue of AUD17.3bn and funds under management (FUM) of AUD21.3bn. Completion of these projects and increasing FUM will drive Lendlease's revenue generation from 2016 to 2019, which Fitch expects to peak in 2018 and 2019. Lendlease has an apartment backlog (or landbank) of 17,806 zoned apartments - around a 16-year supply - and is focusing on urban regeneration projects globally and a pick-up in infrastructure spending in Australia to maintain the strength of its order book.
Long Project Lead Time: Lendlease's development and construction projects are large scale and multi-year. In 2012, Lendlease entered its investment phase as it embarked on a number of apartment and commercial tower projects at urban regeneration sites, with development inventories increasing from AUD2.3bn at end-FY12 to AUD3.2bn at end-FY15. As these projects near completion, Fitch expects Lendlease to begin to realise the value of the investments over the next three to four years, including AUD5.2bn in pre-sold apartment revenue and AUD17.3bn in construction backlog revenue. However, the mismatching of investment cash outflows and the receipt of cash at project completion presents a significant risk for Lendlease.
Derisking of Apartment Settlements: Lendlease reported record pre-sold apartment revenue of AUD5.2bn in FY15, which it expects to realise over the next three to four years. Factoring in a 10% pre-sales default rate, Lendlease still meets its rating guidelines. Its highest default rate was 13% for a single project immediately following the global financial crisis of 2007. However, to manage its settlement risk exposure, Lendlease has developed a product called Pre-Sold Lendlease Apartment Cash Flows (PLLACes), which transfers Lendlease's rights to payments on the purchase prices of pre-sold apartments for a cash payment. The company first sold the product in FY15 and by end-FY15 has removed the risk of settlement for around AUD0.6bn of its pre-sold apartment revenue.
Fitch's key assumptions within the rating case for Lendlease include:
- Development and construction revenue is based on expected completion of pre-sold apartments and construction projects until 2019, respectively;
- FUM to increase by around 5% per annum;
- Investment cash outflows to peak in FY16 and FY17 as Lendlease completes its current portfolio of major projects;
- Investment in land bank to recommence in FY18;
- Dividend payout ratio to be at the higher end of 40%-60% of net profit after tax guidance.
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- Recurring EBITDA to gross interest expense increasing to above 3.0x on a sustained basis (FY15: 2.65x); or
- Adjusted net debt to operating EBITDAR improving to below 2.5x on a sustained basis (FY15: 2.22x).
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- Recurring EBITDA to gross interest expense declining to below 1.5x on a sustained basis; or
- Adjusted net debt to operating EBITDAR increasing to above 4.0x on a sustained basis.