Top broker upgrades this blue-chip to a “conviction buy” as it still has a 20% upside

If you thought you couldn’t find value among the large cap outperformers, think again! The strong run in the share price of Lendlease Group (ASX: LLC) may have further to go after Goldman Sachs upgraded the stock and added it to its “conviction list”.

The stock has rallied 30% over the past year when the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index is up 9%, but even then the stock still looks cheap, according to the broker.

Lendlease’s share price performance and valuation stands in contrast to other construction and property development groups like Cimic Group Ltd (ASX: CIM), Mirvac Group (ASX: MGR) and Stockland Corporation Ltd (ASX: SGP) with their share prices trailing far behind.

“LLC continues to trade at a PE rel [price-earnings relative] (vs ASX 200 Industrial ex Fins) of just 0.68x, vs a long-run average of 0.82x,” said Goldman Sachs.

“With consensus (FactSet) estimates, in our view, 3% and 7% too low for FY19E and FY20E, respectively, and LLC’s earnings quality set to improve on multiple fronts.”

The broker has raised its price target on the stock to $25.20 per share and is tipping a total return of around 20% for the stock over the next 12 months. This was enough for Goldman Sachs to add the stock to its conviction buy list as it upgraded its recommendation to “buy” from “neutral”.

The diversified group is tipped to grow its earnings per share by 12% on average over the next three years that is driven by the completion of Lendlease’s $500 million share buyback, a progressive roll-out of its $70 billion plus development pipeline, average funds under management (FUM) growth of 9% a year till FY23, and a normalisation of construction margins to the bottom-end of the group’s 3%-4% global target range, added Goldman Sachs.

The construction division is the Achilles heel of Lendlease but conditions are expected to improve. Goldman Sachs points out that even based on a reasonably conservative assumption, the business is looking good with the broker forecasting earnings before interest, tax, depreciation and amortisation (EBITDA) growing by 52% a year for the next three years for this division.

But it isn’t all plain sailing for Lendlease as a number of risk factors could drag on the stock. These include a harder-than-expected fall in our residential market, further construction write-downs, budget blowouts on development projects and a significant drop in global commercial property values.

In spite of the risks, Lendlease is probably better placed than most of its peers to deal with the macro uncertainties thanks to its diversified businesses that span across industries, as well as geographies.

The group will also benefit from the increased spending on public infrastructure – a sector that inspires a high level of earnings confidence given the billions that the federal and state governments have already committed to spending.

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Motley Fool contributor Brendon Lau has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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