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The Octopus And The Turtle

Published 04/10/2017, 02:51 pm
Updated 10/03/2019, 12:30 am

Originally published by UBS Asset Management

This week I'll cover two stocks that screen relatively attractive. One is a complex, cyclical business that has had strong performance, while the other is a simple long term business with minimal newsflow.

Lend Lease (AX:LLC) – the octopus

Lend Lease create places where you live, work, shop, play or travel. That's a simple way to say that they are engaged in designing, developing, constructing, funding, owning, co-investing in, operating and managing property and infrastructure assets. They have a $50bn development pipeline, a $21bn construction book and FUM of $26bn and have been responsible for completing world class projects such as:

  • Barangaroo South in Sydney Australia, the largest urban renewal project since the 2000 Olympics, creating a new waterfront financial district, with a mix of office space, premium residential buildings, as well as vibrant shopping, dining, hotel, hospitality and public spaces.

  • Melbourne Quarter, which is the largest new mixed-use urban regeneration development in central Melbourne in over a decade.

  • Bluewater shopping centre in Kent the UK, completed in 1999 on a derelict 240 acre, former chalk quarry.

  • The Athlete's Village at Stratford in the UK, completed
    in 2012.

  • US Military Housing, having been awarded their first project in 2000. They’ve now grown the military housing portfolio to a total of 40,605 homes and 12,500 lodging units across 50 facilities.

  • Project Riverline, an urban regeneration of an area of Chicago, IL.

  • Plus they’ve been engaged on roads, rail, airports, dams, fibre networks and much more.

Lend Lease is a near term play on a strong Australian and UK property market as well as growth in infrastructure spending. EBITDA contributions are 40% development (apartments, land, commercial, retail, retirement), 25% construction (engineering, building) and 35% investments (funds management, co-investments). The multiple business lines means there are more moving arms than an octopus, and when things are going well then multiple divisions contribute meaningfully to earnings. This is such a time in the cycle. The balance sheet is in great shape, with $1.2bn of cash and $2.2bn in undrawn debt, interest coverage of 10.3x and headline gearing of 5.0%.

The risks of such a complex business are immense, with sizeable bid costs involved to secure work and if they miss out that's expensed. Management has done a fantastic job of managing the risks to date and while not cheap relative to it's past, it has the benefit of earnings momentum and a solid outlook. Their competitive advantage is their longevity with a strong list of achievements and a strong balance sheet. While we factor in a sizeable cyclical downturn in the medium term, we do expect earnings upgrades short term and solid deal flow. It offers a dividend yield ~4% and the expectation of ~8% pa earnings growth in FY18/19.

Viva Energy Reit (AX:VVR) – the turtle

If Lend Lease is the octopus, then Viva is the turtle, with steady earnings growth and no fanfare. It offers a 6.2% distribution yield with ~4% pa growth and trades ~6% premium to NTA (breakup value). The NTA does appear conservative with VVR using a 5.9% capitalisation rate, given recent sales have been much sharper; eg. a service station at Laverton North VIC sold for 3.9% yield, and one at Springvale South VIC sold at a 5.3% yield.

VVR is the owner of 437 petrol station sites across Australia, leased to Viva Energy with a weighted lease term (WALE) of 14.2 years. Viva Energy Australia is the exclusive supplier of fuel and other oil products in Australia under the Shell (LON:RDSa) brand, and they have an Alliance with Coles Express (owned by WES), who runs the fuel and convenience retail services across all locations. It provides one of the most secure earnings streams in our coverage universe given:

  • The duration and certainty: The portfolio is 100% occupied with lease terms ranging from 10-18 years, and a 14.2 year WALE. In addition, there are 7 x 10yr options for extensions in each agreement.

  • The fixed bumps for current and future leases: There is secure contracted rental growth of 3% per annum and no market rent-reviews until 2026.

  • A strong tenant: Viva Energy is the operator of an integrated downstream energy business.

  • Triple net leases: All property outgoings are the responsibility of the tenant, lowering exposure to external cost factors.

  • Reasonable fee structure: Management expense ratio is expected to be ~30bps, but expenditures are booked on a cost recovery basis only.

  • Some growth potential: We anticipate that Viva Energy could add 20 sites per annum to its network, which
    may be offered to VVR where the properties are freehold in nature.

We find the long WALE with fixed rental increases very attractive in the current low growth/inflation environment. We estimate that holding all else constant, VVR can deliver ~4% earnings growth over the next three years given the 3% fixed rent growth and 34% gearing level. Operational risks are limited for investors given all leases are triple-net.

Those against the stock argue that service stations will be negatively impacted by the penetration of electric vehicles (EV) that would result in lower fuel sales, as well as a decline in convenience retailing, and this in turn leads to downward rental reversion upon rent reviews. We contend that firstly, penetration is slower than anticipated, with EV sales estimated to less than 0.2% of total new sales in Australia in June 2017*. Secondly, given the prime corner locations, these sites would be perfect for last mile distribution or alternatively high density residential.

* Source: Wheels Magazine - July 2017

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