At its recent interim results release (1H24), Lifestyle Communities (ASX:LIC) announced an equity raising. Subsequently, the share fell sharply. This was despite the equity raising easing balance sheet pressure.
We recently researched the Company in The Dynamic Investor to assess the implications from the equity raising. Are gearing levels likely to increase again? Is the Company in a better position to invest for growth? We also consider other fundamental indicators to assess whether current levels present an entry opportunity.
About Lifestyle Communities
Lifestyle Communities owns, operates and develops resort-style retirement communities in Victoria. The majority of these land-leased manufactured housing estates are located close to the outskirts of Melbourne and Geelong. LIC has 15 fully complete communities (3,673 occupied sites), with a further 15 (2,709 sites) at various stages of development.
The annuity revenue stream is made up of two components: i) A Site Rental Fee after a buyer acquires the house ($212 per single and $245 per couple, per week, per home indexed at greater of CPI or 3.5% p.a.) and ii) A Deferred Management Fee (DMF), whereby upon resale, the Company would typically retain 20% of the retail price. DMF income streams tend of ramp up over the course of a project, as more mature residents move on.
Key Fundamental Drivers
Revenue Growth Outlook Supported by Improved Settlements
LIC’s 1H24 results were negatively impacted by lower settlements. The latter reflects low consumer confidence in building and customers wanting to see their completed homes before they list their existing homes for sale.
Settlement rates are expected to remain subdued in 2H24, with Company guidance pointing to the number of settlements in FY24 being similar to FY23. Importantly, LIC has retained 3-year volume guidance of 1,400-1,700 homes, meaning the shortfall this year is likely to be made up over the next couple of years.
In context, inquiries remain strong and cancellations are low. Importantly, the slower settlement growth profile likely reflecting a softer market backdrop rather than any structural demand issue. In particular, the expected ramp-up in settlements in FY25 & FY26 is likely to be driven by two factors. Firstly, an improvement in the macro backdrop (possibly catalysed by lower interest rates). The second is continued execution on LIC’s development pipeline to drive a significant ramp-up in settlements.
Another factor supporting a resumption in settlement growth over the medium term is that lower developer confidence has improved liquidity of land parcels. In turn, this is creating the opportunity for LIC to acquire high-quality land sites. Five opportunities have been identified, with Company commentary suggesting an increase from building ~3 communities per year to 4-5.
Equity Raising Alleviates Balance Sheet Pressure
In February 2024, the Company completed an equity raising to lower debt levels. In context, significant growth in LIC’s active sites resulted in gearing rising to ~40% as at 31 December 2023. The equity raising is expected to lower the gearing level to ~18% as at 31 December 2023. It was also undertaken to fund growth initiatives, including land acquisition and associated development CAPEX.
Looking forward, gearing is not expected to rise significantly over the FY24-26 period as the Company acquires new development sites. This is because the fair value uplift from each settlement is typically larger than the cash cost of the land. Overall, growth in the number of settlements is expected to have a relatively benign impact on gearing following the equity raising.
Does the Equity Raising Provide Upside Risk to the Medium-Term Earnings Growth Profile?
The earnings impact of the equity raising is expected to be broadly neutral to slightly earnings accretive. This is because the equity raising is initially being used to pay down debt at higher cost.
Notwithstanding investor concerns about the equity raising, there is upside risk to the earnings growth profile over the medium term. This is primarily due to the ramp-up in the pipeline following recent land acquisitions.
To this end, the Company have flagged that challenging market conditions have enabled the availability of a number of attractive englobo* land acquisition opportunities. LIC acquired four new sites in 1H24 and plan to use the capital raised via the entitlement offer to acquire a further five sites.
* Englobo refers to an undeveloped lot, group of lots or parcel of land that is zoned to allow for, and capable of significant subdivision into smaller parcels under existing land use provisions.
Fundamental View
LIC shares are trading on a 1-year forward P/E multiple of ~16.5x. This multiple is at the bottom end of the 5-year average of ~20x and considered undemanding in the context of an EPS growth profile of ~19% over FY23-26 on a CAGR basis. Importantly, the medium-term earnings profile is supported by a growing development pipeline to drive significant growth in settlements, development profits, rental income and DMF income. Each of these metrics are strongly leveraged to a supportive structural (macro) growth outlook.
Charting View
LIC has formed a support level near $14 over the past 18 months. It is back at that level again, so any weakness is a buying opportunity and investors can then place their initial stop just under $14. Major resistance is up near $19. However, if it cannot hold this $14 area, then the next line of support is back near $12.
Michael Gable is managing director of Fairmont Equities.
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