Fitch Affirms Lendlease at 'BBB-'; Outlook Stable

(The following statement was released by the rating agency) Fitch Ratings-Sydney-February 07: Fitch Ratings has affirmed Australia-based Lendlease Corporation Limited's Long-Term Issuer Default Rating at 'BBB-'. The Outlook is Stable. A full list of rating actions follows at the end of this commentary. The company's credit metrics remain strong for its rating, notwithstanding the impact of the announced write downs in its engineering business in the financial year ended June 2019 (FY19). We now expect coverage, as measured by recurring EBITDA/gross interest expense, to fall to just below 3.0x and leverage, as measured by adjusted net debt/operating EBITDAR, to peak at 2.3x over the period to FY22, as Lendlease absorbs the write downs and embarks on its next investment phase; levels well within the guidelines for its current rating level. The Stable Outlook reflects the expansion in the company's international business, particularly in Europe, which now comprises 52% of its AUD56 billion urbanisation development pipeline following major project wins in the UK and Italy and is balancing the effects from Australia's cooling real-estate market. The Outlook also reflects the company's investment business, which has seen funds under management (FUM) rise to AUD30 billion - with a further AUD4 billion of secured future FUM - and investments of AUD3.4 billion at FYE18. KEY RATING DRIVERS Strong Financial Profile: Lendlease's company-defined gearing of 8% at FY18 was below its 10%-20% publicly announced target as it nears the end of its development cycle, which is typically highly cash generative. Following the write downs in the engineering business announced in November 2018 - which we expect to cause a temporary rise in leverage in 1H19 - Fitch expects the company to ensure the strength of its balance sheet is maintained as it looks to redeploy this capital through investments and move gearing back to within the target range. We do not expect capital to be allocated to a share buyback or special dividend as part of this process. Leadership, Diversification, Scale Drive Ratings: Lendlease has a market-leading position in most of its businesses, which include residential, commercial, retail and infrastructure development, construction and investment management in Australia, the UK, the US and Asia. Recent project wins, particularly in its European development business, have seen the company's development exposure to Australia decline, as it focuses on increasing its pipeline in target global gateway cities. This large and increasing scale - with a development pipeline of AUD71 billion and construction backlog revenue of AUD21 billion at FYE18 - supports the company's rating. Reduced Risk of Apartment Settlements: Lendlease's pre-sold residential property revenue fell to AUD4 billion in FY18, from AUD5 billion in FY17, as the company completed projects in its development inventory - particularly in Australia, where the real estate market has been weakening. Settlements in Sydney comprised 40% of pre-sold property revenue at FYE18. However, we see settlement risk as low, since it relates solely to the Darling Square (NYSE:SQ) complex where properties are planned for completion by FYE19 and remain "in the money"; that is, there is price growth since launch. Although tighter underwriting standards among financial institutions increase settlement risk, supportive valuations decrease this risk. Furthermore, Lendlease is working to accommodate bona fide purchasers who are taking longer to obtain financing than originally anticipated. We believe there is higher settlement risk in Melbourne over the next one to two years, as these properties could be "out of the money". However, they represent a small contribution to earnings, with 8% of pre-sales due to settle in FY19. Lendlease continues to meet its rating guidelines even when factoring in a 10% pre-sales default rate. The default rate in FY18 on around 3,000 apartment settlements was less than the company's long-term average of around 3%. Issues in Engineering: Lendlease announced that it will take a AUD350 million after-tax provision in its engineering business in 1H19 - recognising further deterioration in a small number of previously identified underperforming projects. The company aims to take additional action to mitigate the impact of these losses, consistent with its normally strong oversight, and has already initiated a review of the business. Fitch will continue to monitor the effect the write-offs and review will have on the company's risk management and overall business profile. Cash Generation to Support Investment: Fitch expects underlying cash generation to be supported until FYE21 by the continued realisation of its pre-sold residential property revenue of AUD4 billion, which peaked at AUD6 billion at FY16, and construction backlog revenue of AUD21 billion at FYE18. We believe this will allow Lendlease to invest in its next development cycle while maintaining credit metrics within its current rating guidelines. However, the timing of cash realisation can be lumpy, as it depends on project completion and can impact metrics in a given year. The global trend towards urbanisation, demonstrated by recent project wins in Europe, continues to underpin demand for the company's services. This should help offset any negative trend in the Australian property market, which has supported the company's growth since 2008. Stable Recurring Earnings: The company's Australian retirement villages, US military housing and investment management business generate stable and predictable revenue, which underpins its credit profile and provides considerable headroom to the rating. These businesses accounted for around AUD669 million in EBITDA in FYE18 and are likely to represent around 30%-40% of annual EBITDA going forward. Fitch expects the company's revenue sources to become more diversified as it manages the capital allocation to its investment segment to include telecommunications infrastructure and built-to-rent apartments, in which it has already announced investments. Strong Order Book, Earning Visibility: Apart from the strong development pipeline and construction backlog revenue, Lendlease also had FUM of AUD30 billion and investments above AUD3 billion at FYE18. Fitch expects project completion and rising FUM to drive revenue over the next 12 months. Lendlease has a pipeline of around 26,000 zoned apartments not yet in delivery - more than a 10-year supply - and is focusing on urban regeneration projects globally to maintain order-book strength. DERIVATION SUMMARY Lendlease's rating is driven by its exposure to the cyclical home-building and construction sectors and the associated mismatch between investment outflows and cash receipt on its projects, which typically lasts longer than one year. This balances the benefits from the company's recurring revenue stream in its investment business, which provided interest coverage of 5.5x in FYE18. Lendlease's recurring EBITDA interest coverage is higher than that of its peer, Hong Kong-based Nan Fung International Holdings Limited (BBB/Stable). However, Nan Fung has large financial assets and low leverage, defined as total adjusted net debt/operating EBITDAR, of (0.7x) as at the financial year ended March 2017, while Lendlease's leverage of 1.4x benefited from cash generation following settlements in its development business, despite around AUD190 million in share buybacks undertaken in FY18. However, we expect Lendlease's leverage to increase as the company redeploys its capital and invests in its development pipeline. Lendlease's adjusted net cash/operating EBITDAR leverage and recurring EBITDA interest coverage are comparable with that of Australian peer, Downer EDI Limited (BBB/Stable). However, Downer has lower exposure to cyclical cash flow as recurring maintenance-style projects have increased as a proportion of its project portfolio. However, we note that Lendlease's recurring EBITDA is likely to rise as capital allocated to its investment business continues to increase. KEY ASSUMPTIONS Fitch's Key Assumptions Within Our Rating Case for the Issuer - FUM to increase by around 5% per year from FY19 to FY22 (FY18: 15%). - Reported pre-sold apartment revenue of AUD4 billion to be realised in FY19 and FY20, in line with company guidance. - Apartment settlements to decline to the lower end of the publicly announced target of 1,000 to 2,000 per year. Communities settlements to decline to the lower end of the publicly announced target of 3,000 to 4,000 per year. - Dividend payout ratio to be at the higher end of 40%-60% of net profit after tax guidance. RATING SENSITIVITIES Developments that May, Individually or Collectively, Lead to Positive Rating Action - Recurring EBITDA (defined as EBITDA from the investment segment per Lendlease's financial reports)/gross interest expense increasing to above 3.0x (FY18: 5.5x) on a sustained basis. - Adjusted net debt/operating EBITDAR falling below 2.5x (FY18: 1.4x) on a sustained basis. Developments that May, Individually or Collectively, Lead to Negative Rating Action - Recurring EBITDA/gross interest expense falling below 1.5x on a sustained basis. - Adjusted net debt/operating EBITDAR increasing to above 4.0x on a sustained basis. LIQUIDITY Adequate Access to Capital Markets: Lendlease has capital-market issuance in every region in which it operates; Australia, the UK, the US and Singapore. It also establishes bank debt and bank guarantee facilities as required. It had undrawn facilities of AUD1.8 billion at FYE18, including a AUD1.5 billion syndicated multi-option facility (AUD0.6 billion maturing in June 2019 and AUD0.9 billion in June 2020) and a GBP400 million club bank facility (maturing March 2022), drawn to GBP160 million. FULL LIST OF RATING ACTIONS Lendlease Corporation Limited - Long-Term Issuer Default Rating affirmed at 'BBB-'; Outlook Stable - Senior unsecured rating affirmed at 'BBB-' Lendlease Finance Limited - Senior unsecured rating affirmed at 'BBB-' Lendlease Europe Finance plc - Senior unsecured rating affirmed at 'BBB-' Lendlease (US) Capital Inc. - Senior unsecured rating affirmed at 'BBB-' Contact: Primary Analyst Kelly Amato, CFA Director +61 2 8256 0348 Fitch Australia Pty Ltd Level 15, 77 King Street, Sydney, NSW, 2000, Australia Secondary Analyst Leo Park Associate Director +61 2 8256 0323 Committee Chairperson Vicky Melbourne Senior Director +61 2 8256 0325 Media Relations: Peter Hoflich, Singapore, Tel: +65 6796 7229, Email: peter.hoflich@thefitchgroup.com; Leslie Tan, Singapore, Tel: +65 6796 7234, Email: leslie.tan@thefitchgroup.com. 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