Fitch Ratings has affirmed Australia-based Lendlease Corporation Limited's Long-Term Issuer Default Rating (IDR) at 'BBB-'.
The Outlook is Stable. A full list of rating actions follows at the end of this commentary.
The affirmation is based on the company's market leadership across key businesses and globally diversified cash flow, as well as the strength of its financial position and financial flexibility.
The Stable Outlook reflects Lendlease's ability to deliver on capital recycling initiatives following the sale of its Australian Communities business after several delays to flagged initiatives amid the Covid-19 pandemic and market uncertainty. This saw EBITDA net leverage rise to 4.1x in the financial year ended June 2023 (FYE23), above the level where we may take negative rating action. However, the company's demonstrated ability, alongside capital partnering and flexible investment timing, should allow it to manage leverage within its target range, despite higher gross debt to boost production and expand its investment segment.
Key Rating Drivers
Capital Recycling Supports Financial Profile: Lendlease aims to use capital recycling to maintain its strong financial profile as it moves towards its target development work in progress levels and funds around AUD900 million in provisions taken over the past couple of years. The cash inflow in 2HFY24 from the AUD1.3 billion sale of the Communities business, alongside net proceeds of around AUD900 million at One Sydney Harbour, should see leverage improve to below 3.0x by FYE24.
Lendlease has plans for additional capital recycling initiatives, including the sale of its retirement living businesses in China and Australia. The company is able to stage and pause investments and is increasingly partnering with investors on large-scale projects to maintain its financial flexibility. Nevertheless, we expect management of leverage to be lumpy, due to the size and timing of each investment and capital management action and hence expect leverage to remain elevated at 1HFY24 before the flagged cash inflow in 2HFY24.
Joint Venture Structures Bring Complexity: Lendlease uses joint ventures to reduce risk on its balance sheet from large development projects, with the company targeting 25% to 50% equity interest. Lendlease and its partners provide equity contributions, with project financing performed at the joint-venture level on a non-recourse basis. Lendlease also has the ability to sell down its stake and monitors the performance of the projects closely. However, there is a risk that Lendlease may need to provide additional support for underperforming projects, especially given the projects' high profile nature.
Recurring Earnings Offset Development Risk: Lendlease's credit profile is supported by the stable and predictable revenue from its investment portfolio, which stood at AUD3.9 billion at FYE23, and its asset and investment management businesses.
We expect earnings from these businesses to rise over the medium term, as the company increases its capital allocation to the investments segment to over 50% (FYE23: 40%). This should help it manage its higher-risk exposure from its development business as delivers its development pipeline of over AUD100 billion. The company expects its secured projects to create over AUD60 billion in funds under management.
Diversification Mitigates US Weakness: Lendlease has market-leading positions in most of its businesses in Australia, Europe, the US and Asia. These include residential, commercial, retail and infrastructure development; construction; and investment management. This, alongside its scale, with a development pipeline of over AUD120 billion as at FYE23, provides flexibility to absorb and adapt to weaknesses in some markets - such as the pause of its Hayes Point project and cancellation of its San Francisco Bay Area project alongside its pivot towards growth opportunities in Australia and Asia.
Global Urbanisation Supports Growth: We believe Lendlease's global urbanisation business will drive demand for the company's services. International urbanisation project wins were the main contributor to the growth in the development pipeline, which by FYE20 was 2.5x the size of that in FYE15 and has remained relatively stable since. International projects now make up around 70% of the development pipeline. We believe that delivering this pipeline and the rising number of funds under management and co-investments will provide strong earnings visibility over the next few years.
Derivation Summary
Lendlease's rating is driven by its exposure to the cyclical residential and construction sectors, and the associated mismatch between investment outflows and cash receipts on its projects, which typically last longer than a year. The company's recurring cash flow generation from its investment business helps to balance the cyclicality, providing recurring EBITDA interest coverage of 1.9x in FY23. The company also uses investment partnerships and various capital recycling opportunities to support its balance sheet strength over the cycle. However, the scale and timing of Lendlease's development pipeline and capital recycling measures can lead to short-term fluctuations in its EBITDA net leverage, as it moves through various production phases and cycles. Thus, we expect leverage to remain elevated over the next few years, as the company expands its invested capital and accelerates the delivery of its global development pipeline.
This contrasts with Australian peer, Downer EDI Limited (BBB/Negative), which has lower exposure to cyclical cash flow, with a focus on less capital intensive, recurring maintenance-style projects. This allows the company to maintain a more stable and conservative balance sheet and stronger interest coverage over the cycle. These factors more than offset Lendlease's stronger business profile, which benefits from greater geographical and product diversification, and explain the one-notch rating differential. The Negative Outlook on Downer's IDR, however, reflects ongoing labour challenges that continue to delay its ability to return its margin to above 5%, notwithstanding its ability to maintain a conservative balance sheet.
Key Assumptions
Fitch's Key Assumptions Within Our Rating Case for the Issuer:
Funds under management to increase by around 10% a year from FY24 to FY27 (FY23: 10%) and co-investments to increase by around 20% a year over the same period.
Development completions to increase steadily towards AUD8 billion a year, with increased capital requirements supported by higher third-party investments.
Core construction EBITDA margin to return to the 2%-3% guidance from FY24, following the sale of the engineering and services business.
Dividend payout ratio to be at the lower end of the 30%-50% of net profit after tax guidance from FY24 to FY26, and at the upper end from FY27.
Cash outflows relating to provisions within the non-core segment of around AUD900 million to be realised over FY24-FY27.
Proceeds of AUD650 million from the sale of the Communities business to be received in each of FY24 and FY25.
RATING SENSITIVITIES
Factors that could, Individually or Collectively, Lead to Positive Rating Action/Upgrade:
Recurring EBITDA coverage, defined as EBITDA less gains on sales from the investments segment per Lendlease's financial reports/gross interest expense, exceeding 3.0x for a sustained period (FY23: 1.9x).
EBITDA net leverage falling below 2.0x for a sustained period (FY23: 4.1x).
Factors that could, Individually or collectively, lead to negative rating action/downgrade:
Recurring EBITDA coverage falling below 1.5x for a sustained period.
EBITDA net leverage increasing to above 3.5x for a sustained period
Liquidity and Debt Structure
Strong Liquidity: Lendlease has debt capital market issuance in the currencies of each of its regional headquarters: Australia, UK, US and Singapore. This allows it to match funding currency with operations. It consistently demonstrates good access to various capital markets, including during the initial phases of the pandemic and with the successful creation of Presold Lendlease Apartment Cash Flows transactions to reduce settlement risk on residential developments.
Liquidity was AUD2.6 billion at FYE23, comprising AUD900 million in cash and AUD1.7 billion in undrawn and committed facilities. This was more than sufficient to fund our forecast of around AUD900 million in negative free cash flow across FY24 and FY25 amid the planned increase in development and investment activity. Lendlease has also demonstrated its ability to recycle capital through asset sales to fund new investments.
Issuer Profile
Lendlease is a leading international real estate and investment group, with operations in Australia, Asia, Europe and the US. It focuses on delivering urban projects in global gateway cities and investments that generate social, environmental and economic value.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/topics/esg/products#esg-relevance-scores
LENDLEASE GROUP 
