Lend Lease's Growth Story

Background by Eureka Report editor James Kirby: Along with arch-rivals Westfield and Mirvac, the Lend Lease group remains one of the biggest property companies on the ASX, with a market capitalisation of about $6 billion.

After recovering from some severe management difficulties in 2005 '” including the botched takeover of the GPT Group '” Lend Lease has now moved to reduce its dependence on construction income that currently underpins about 35% of total earnings.

Since the group released a solid annual result showing a 13.5% increase in underlying profit of $281.6 million in 2005, investors have cautiously returned to the company. Lend Lease is trading around $14.29 '” down from highs of $15 but dramatically above its 12-month low of $11.

Investors like the strong diversity of earnings at Lend Lease and the fully franked dividends, however. Clarke is still spending much of his time trying to persuade the market he has found the right formula for earnings growth at the company. Pinning his hope on a “partnership” growth model, Clarke tells Robert Gottliebsen* how he plans a strong increase in earnings from outsourced property management for the US army and also from British shopping centres.

Robert Gottliebsen: What are the Lend Lease businesses that excite you most over the next five years?

Greg Clarke: I think we’ve got some very exciting offshore businesses. We’ve got the Crosby Communities business in the UK; the major retail centre opportunities in the UK, which we’ve got a good pipeline of; and the military housing, PFI [private finance initiatives] businesses, in the US under Actus '” there’s some great international growth opportunities there.

What’s happening in the UK housing market?

Well, our businesses are trading well. The UK housing market is showing high single-digit growth in prices this year. Looks like they’ve achieved a soft landing with gentle interest rate increases, and the pundits over there are predicting more of the same over the next three years. So that business is trading extremely well.

Are you seeing a change in the demography over there?

Yes. What’s happening in the UK is what’s been happening in Australia but for longer, in that people are moving back into inner cities. Inner urban developments such as Victoria Harbour [Melbourne] and Rouse Hill [Sydney], which are happening over here in Australia, are now happening in the UK. We’re major players in Greenwich and, with the acquisition of Crosby, we’re now well positioned in the other major metropolitan centres outside of London such as Leeds, Manchester and Birmingham.

How big can that housing business be?

Well as a normalised EBIT number it turns over about $80 million profit a year. That bleeds through over three years because of new IFRS [international financial reporting standards] accounting rules, but that’s the base number, which we see growing substantially over the next five years. We’re big business.

Lend Lease has a lot of shopping centre assets in the UK. How does your operation differ from, say, Westfield?

The Westfield model '” largely they own and control major shopping centres. We’re more of a partner. We tend to partner with people such as major insurance companies who wanted to redevelop shopping centres but don’t want to sell them. So we’re partnered with people like Liverpool Victoria and Legal & General, which are major friendly associations, provident associations, and we take an equity stake in a small shopping centre, redevelop it with them and end up as a major owner and manager of a much larger shopping centre.

Is there a lot of potential for this?

Huge potential. There’s more than 100 shopping centres in the UK that fit that spec. We hope to win one, two or three a year for the next four or five years.

What about defence in the US? What’s the US Defense Department doing that gives you an opportunity?

Well the US Defense Department has decided to spend its tax dollars on smart weapons and technology so it’s outsourcing what it sees as non-core requirements such as the development and management of the military camps. We’ve won 25% of that market since we founded that business over there five years ago and we see that as a huge opportunity not only for military family accommodation, but also the barracks privatisation project, which is coming up, and then military housing, which is also coming up.

Lend Lease currently earns about $20 million in the US. What could happen to profits over there?

That business could see its profits going up by a factor of five over the next five to 10 years. It could be an extremely large business with a profitability of over $100 million.

Do you have enough capital to fund this?

Yes, we have very low level of gearing. We could probably sustain an extra $1 billion to $1.5 billion of debt, but we won’t need to do that because we have lots of capital being recycled from developments which are being finished where we’ll get the capital back to reinvest.

What about the Australian housing market? Do you think it’s going to be flat for a while?

We see the Australian market as flat for a while. Whether 'a while’ is 12 months, 18 months, 24 months '” who knows? But we do know that affordability of Australian housing is at an all-time low and until the economy and wages catch up and makes the people at the bottom of the housing layer able to afford those houses, we think the market is going to moribund for the foreseeable future.

How does the Lend Lease Australian housing model differ from, say, Stockland or Mirvac.

Well we’ve got a model, they’ve got a model. Our model is slightly different and we use third-party capital. Most of our residential opportunities in Australia use land owned by other people so we partner with them, market our product and share the lots which are sold. The profitability goes to the land owner and ourselves. Stockland, for example, bought Lensworth, which is a very high quality business, but that’s based on land ownership. They’re both good business models. Ours is just less capital-intensive than theirs.

The analysts have Lend Lease earning about $350 million a year. How do you see them moving in the years ahead?

Well we have an aspiration to maintain double-digit earnings growth over time. And from what I see today, we’re well placed to achieve that. I think the majority of that growth over the short to medium term will come from outside Australia, principally in the UK and the US, where our businesses are growing very, very well.

How does your P/E [price/earnings multiple] compare with similar businesses overseas?

Well we have quite a low P/E versus similar businesses which have high quality community retail and PFI businesses, so as our business delivers on the growth we’ve been talking about and as people become more confident that we can deliver and execute, I think we’ll see hopefully an increase in P/E over time.

Perhaps they’re nervous about the construction business?

Well, I think the construction business is a good business. We like it. It’s got a great footprint around the world but it needs to be a lower proportion of the group over time. So we want that proportion of the group to grow, but we want to see our residential business, our communities business and our PFI investment management businesses growing faster than our construction business, so the percentage of business as construction diminishes over time.

* Robert Gottliebsen is a business commentator for The Australian.