We recently reviewed the fundamentals for Mirvac Group (ASX:MGR) after the Company reported results for the 12 months to 30 June 2022 (FY22). As an A-REIT, MGR shares have suffered as a result of the outlook for higher interest rates and a slowing domestic economy. Accordingly, we consider whether there are any catalysts for a rebound in the shares, which are currently hovering around 2-year lows.
About Mirvac Group
Mirvac Group is a fully integrated property company with internalised management. Its investment portfolio is diversified across office, retail and industrial assets in capital cities across Australia. These operations are supplemented by high and medium density apartment and house & land development operations and commercial development.
Key Fundamental Drivers
Portfolio Quality Highlighted by Rental Growth Across All Asset Classes
Overall Net Operating Income (NOI) (i.e. rental income) grew by 1.5% on a Life-for Like basis in FY22 and was positive for all asset classes, with Office reporting NOI growth of 1.9%, Industrial +3.3% and Retail +0.2%. Leasing spreads were positive for Office and Industrial and improved for retail. MGR continues to improve its portfolio quality by selling lower quality assets, and reinvesting into its $12.4b development pipeline.
The growth in Office NOI highlighted the resilience of the higher quality office space, as MGR saw positive leasing spreads for its portfolio. Market rents for Industrial continue to rise and MGR’s 100% Sydney industrial portfolio should benefit. However, rental growth in the short term is hampered by a low level of lease expiries in FY23 (~6%). Retail sales continue to rebound, from COVID-related impacts. The only area of weakness highlighted by management being CBD retail.
Development Pipeline the Key Driver of Medium-Term Earnings Growth
EBIT for the Development division is comprised of Residential (68% of divisional EBIT) and Commercial & Mixed Use (32% of divisional EBIT). The Residential segment reported a 16% increase in EBIT for FY22. This was on the back of a contribution from higher-value project settlements (2,523 settlements were completed; broadly in line with guidance of 2,500). The Commercial & Mixed Use segment reported a 173% increase in EBIT, following completion of Locomotive Workshop, Sydney and 80 Ann Street, Brisbane.
Within the Residential segment sales rates have slowed but price growth has been strong and high pre-sales provide good earnings visibility. As such, despite the Company guiding for flat growth in settlements (2,500 in FY23, as was the case in FY22), higher prices due to apartment contribution are expected to support earnings growth for Residential.
The latter is likely to occur despite a moderation in the margin relative to FY22. This was 25% and above the target range of 18-22% on a ‘through-the-cycle’ basis. It was mainly due to the large contribution from the Master Planned Community (MPC) operations. This accounts for ~85% and which reported price growth of 20-30% across the different projects. While the Residential margin is expected to remain above the target range, it is expected to decline in FY23 to just above its target range of 18-22%, as more apartment sales are recognised in FY23.
Gearing Expected to Reduce Further
Gearing (defined as net debt/[total tangible assets less cash] basis) reduced by 100 basis points from 31 December 2021 (22.3%) to 21.3% as at 30 June 2022. Gearing is at the low end of the Company’s 20-30% target range. The reduction in gearing was primarily driven by higher valuations and proceeds from asset sales. The asset sale program is continuing and coupled with the potential introduction of capital partners, may lower the gearing level even further, notwithstanding that the timing of these asset sales and the deployment creates uncertainties around income impacts in FY23.
MGR is planning to divest a further $1.3b of assets, with the proceeds to be deployed into the development pipeline,
In addition to the $1.3b of asset sales, MGR should receive cash from the introduction of a capital partner in Build-To-Rent. In total, it is estimated that this could result in a further $1.7b of capital (in addition to the expected asset sale proceeds). This would reduce gearing to 11%. It also provides $2.6b of capacity in the event that the Company utilises its balance sheet up to 25% (i.e. the midpoint of the 20-30% target range).
The shares are currently trading at a significant discount to its NTA of $2.79 per share (which is higher than normal). It is also at the lower end of its long-term P/E trading multiples. This is given that there is a higher degree of uncertainty around FY23 earnings. In particular, FY23 earnings contain more moving parts than usual. Notwithstanding, we consider that there are several catalysts for the shares over the short term:
i. Company guidance for FY23 Operating EPS is likely conservative.
ii. An attractive outlook for development and/or announcements on securing tenant commitment for the development pipeline, despite potential for a declining asset value backdrop.
iii. MGR’s exposure to apartments, which is a favourable part of the residential market near term, given that apartments are seen as more defensive.
iv. A strong balance sheet and the potential for gearing to decline further.
v. Further clarity/announcements on the timing of asset sales and the deployment of sale proceeds.
After spending nearly 12 months in a downtrend, MGR now appears to be forming a base. It looked to be breaking out a few days ago, but is now back into the range. A push back above $2.20 would be a positive sign and we would consider that to be the buy trigger. Any weakness from here needs to see the share price stay above $2.
Michael Gable is managing director of Fairmont Equities.
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