Lend Lease Group (ASX: LLC) is an international property and infrastructure company with a market capitalisation of $9.7 billion. Here are five things you should consider before buying its shares.
- Lend Lease is a complicated business spanning four continents with operations from managing retirement villages through to constructing railways. Such diversification spreads geographical and industry risk, but can also lead to inefficiency. In 2014, the Group Services division reported a loss before tax of $218 million, compared to $179 million in 2013, a significant drag on overall profits.
- Lend Lease carries out projects that take several years and sometimes decades to complete. Therefore yearly profit numbers are based on estimates and cash flows are extremely lumpy. Similarly, it is difficult to know what its assets are really worth since they largely consist of partially completed projects, construction materials and investment properties.
- Development and construction companies are capital intensive businesses, which are unable to grow quickly and produce little spare cash for shareholder returns. Lend Lease manages to pay a healthy 4.7% dividend yield, but I notice its debt has grown significantly over the past five years.
- There is a tendency for developers to borrow too much given their high funding requirements. Lend Lease is comfortable in this regard since its debt-to-equity ratio is around 13% based on 2014 financials. The problem is that we are currently experiencing an upswing in the property cycle. Should things turn sour, some of Lend Lease's assets may shrink in value, whilst its lenders simultaneously demand their money back.
- Given the complexity of Lend Lease and difficulties in measuring its profits and assets, I would require a large margin of safety before buying its shares. However, based on its 2015 guidance, it trades on a high enterprise value to earnings ratio (EV/E) of around 18. It is also trading at a huge 170% premium to its net tangible assets.
A better alternative?
United Overseas Australia Limited (ASX: UOS) is another property developer, but with a far simpler business model. The company's operations are based solely in Malaysia where it develops and invests in commercial and residential property. The group structure is quite complex though, with a 68% ownership interest in developer, UOA Development BHD, and a 46% stake in the UOA Real Estate Investment Trust.
Over the past 10 years, United Overseas Australia's earning per share have risen from 3.1 cents to 7.6 cents. I estimate its share of group net cash is $176 million and profits attributable to shareholders were $87 million in 2014. The company is dual listed in Australia and Singapore, with a total market capitalisation of $627 million. Therefore, its EV/E is just over 5 at current prices, which is incredible value.
The stellar track record of the company, the high level of management ownership and its low price make United Overseas Australia one of the best value stocks around. The only drawbacks are the convoluted ownership structure, its low liquidity and its exposure to the booms and busts of a developing country's property market.
