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 the commentary.
Lendlease's IDR reflects its market leadership across key businesses and globally diversified cash flow, as well as the strength of the company's financial position and its financial flexibility. Fitch expects gross debt to rise over the next one to two years. However, we expect EBITDA net leverage to remain below 3.5x, the level at which we may take negative rating action, which underpins the Stable Outlook.
The rising leverage reflects planned increases in development production and growth in the investments segment. However, the peak will be lower than our previous forecasts after Lendlease reduced its dividend payout range. The company wants to increase the equity funding of its strategic initiatives to fund growth, and together with its capital recycling approach, planned increase in capital partnering and ability to exercise flexibility over the timing of key investments, we expect the company can manage its leverage within its target range.
Key Rating Drivers
Rising Debt on Strategic Initiatives: Fitch expects Lendlease's leverage to rise over the next two years as it seeks to increase its development activity and capital allocation to investments, and funds the realisation of around AUD800 million remaining in non-core segment provisions taken over the past couple of years. We believe Lendlease's strong financial profile and financial flexibility, as well as its ability to stage its investments and recycle capital, will enable the company to manage leverage within its target range, and within our rating sensitivities.
Leverage Peak Below Previous Forecast: We now expect leverage to peak at 3.4x in the financial year ending 30 June 2023 (FY23) and FY24, before improving towards 3.0x from FY25 as Lendlease nears its target development production levels. The peak is lower than our previous expectation following the company's decision to increase the planned equity contribution to fund the initiatives. Flagged capital recycling initiatives not included in our forecast, including introducing a capital partner in the communities business, could also see leverage peak at a level lower than forecast.
However, the build-up and management of leverage is likely to be lumpy due to the size and timing of each of its investment and capital management actions.
Strong Financial Profile Absorbs Delays: Lendlease's strong balance sheet, divestments, actions at the start of the pandemic to boost financial flexibility, and its disciplined capital management have enabled it to manage supply-chain issues, labour shortages and delays in planned development starts as investors take longer to reach final investment decisions in volatile markets. Its company-defined gearing - net debt/total tangible assets less cash - of 7.3% at FYE22 was well below its 10%-20% target, while Fitch-calculated EBITDA net leverage was well below the negative guidelines for the rating at 2.3x.
Recurring Earnings Offset Development Risk: Lendlease's co-investments of around AUD3.5 billion at FYE22, and the Australian retirement living, US Communities (military housing) and investment management businesses generate stable and predictable revenue, which supports Lendlease's credit profile. Fitch expects earnings from these businesses to rise over the medium term as the company increases its capital allocation to the investments segment to over 50% (FYE22: 46%).
The increase in stable earnings will help Lendlease manage higher-risk exposure in its development business as it starts delivery of its record development pipeline. The company expects secured projects to create over AUD50 billion in funds under management.
Leadership, Diversification, Scale Drive Ratings: Lendlease has a market-leading position in most of its businesses, which include residential, commercial, retail and infrastructure development, construction and investment management in Australia, Europe, the US and Asia. Project wins in recent years, particularly in Europe and the US, pushed its development pipeline to almost AUD120 billion. Delivering this pipeline and the rising funds under management and co-investments provide strong earnings visibility over the next few years.
Global Urbanisation Supports Growth: Fitch believes Lendlease's successful expansion of the urbanisation business globally will drive demand for the company's services. International urbanisation project wins were the main contributor to the growth in the development pipeline, which was 2.5x the size of that in FYE15 by FYE20, and has remained relatively stable since. International projects now make up over 80% of the development pipeline.
Capital Measures Reduce Investment: Lendlease's ability to use various capital management tools reduces the upfront cash required for its business expansion, particularly large urbanisation projects. These include land-payment models limiting upfront land payments, capital recycling within its investments business and partnering with investors on large-scale projects. Fitch believes this reduces the cyclicality of Lendlease's cash generation - which has historically been lumpy due to project commencements and completions - enabling the company to win and fund larger projects globally.
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 receipt on its projects, which typically last longer than a year. This balances the benefits from the company's recurring revenue from its investments business, which provided recurring EBITDA interest coverage of 2.9x in FY22, including the impact of the pandemic.
Lendlease's EBITDA net leverage is comparable with that of Australian peer Downer EDI Limited (BBB/Negative). Compared with Downer, Lendlease's business profile benefits from greater geographical and product diversification. However, Downer has lower exposure to cyclical cash flow, with its focus on recurring maintenance-style projects. This is highlighted by Lendlease's recurring EBITDA interest cover being weaker than Downer's interest coverage and explains the one-notch rating differential. Downer's Negative Outlook relates to governance issues.
We expect Lendlease's leverage to rise over the next few years as it expands it invested capital and accelerates delivery of its global development pipeline. However, the company's core business, use of investment partnerships and various capital-recycling opportunities will support its balance-sheet strength.
Key Assumptions
Fitch's Key Assumptions Within Our Rating Case for the Issuer:
Funds under management to increase by around 10% a year from FY23 to FY26 (FY22: 12%) and co-investments to increase by around 20% a year over the same period.
Development production 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 in FY23 and FY24, and at the upper end from FY25
Cash outflows relating to provisions within the non-core segment of around AUD800 million to be realised over FY23-FY26.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Recurring EBITDA coverage (defined as EBITDA less gains on sale from the investments segment per Lendlease's financial reports/gross interest expense) increasing to above 3.0x for a sustained period (FY22: 2.9x).
EBITDA net leverage falling below 2.0x for a sustained period (FY22: 2.3x).
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.
Best/Worst Case Rating Scenario
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
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, allowing 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 its Presold Lendlease Apartment Cash Flows (PLLACeS) transactions to reduce settlement risk on residential developments.
Liquidity was AUD3.9 billion at FYE22, made up of AUD1.3 billion in cash and AUD2.6 billion in undrawn and committed facilities. This is more than sufficient to fund around AUD2.2 billion in negative free cash flow that Fitch forecasts for FY23 and FY24, which is driven by the planned increase in development and investment activity.
Issuer Profile
Lendlease is a leading international real estate and investments 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
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This 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. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg
LENDLEASE GROUP 
