I. Sector Landscape and Outlook
The construction and real estate sector encompasses residential and non-residential construction, building structure services, heavy and civil engineering, land development, installation services, and site preparation activities.
The sector has been growing at a healthy pace in the past ten years with 3.8% per annum, exceeding the All-Industry growth rate of 3.2% as per the data by the Australian Trade and Investment Commission. Rapid urbanization, rising young generation, increasing homeownership and affordability, and industrialization are some of the key drivers for growth. Capital cities like Melbourne and Sydney are at the top for residential property price growth. Perth and Brisbane are favoured destinations for commercial office space. The property market once exhibited a bubble, is undergoing a correction phase as property prices have begun to ease.
The construction sector accounted for 6.9% of the overall GDP in September 2020 quarter. Australia’s commercial rental market continues to serve as an attractive destination for offshore funds. The sector garnered ~$18.1 billion of overseas investments in 2019 as the data by the Australian Trade and Investment Commission.
Key Trends:
Building approvals showed a strong recovery aided by demand from first-time home buyers and various government support programs such as The HomeBuilder scheme and the record low-interest rates. Total dwelling units approved surged 22.8% in December 2020 over the prior year according to the data by the Australian Bureau of Statistics. Australians continued to show increased buying for detached dwellings which had reported a record growth during the second half of 2020. Demand for high-density apartments remained low due to uncertain rental income and the absence of foreign buyers. Approvals for private houses in Victoria, South Australia, and Western Australia touched record high in December 2020. The value of total buildings approved rose 4.9% in December 2020 over the preceding month led by non-residential buildings as per the data released by the Australian Bureau of Statistics. In a separate report by Commonwealth Bank, Tasmania showed strong growth in dwelling starts driven by population growth and home prices which had stayed low compared with the mainland.
Figure 1. Building Approvals Showed Strong Recovery in December 2020:
Data from Australian Bureau of Statistics, Chart Created by Kalkine Group
Home prices improved by 3.0% at the National level in 2019-20 over last year as per data by the Reserve Bank of Australia. Stage 4 lockdown affected housing prices in Melbourne. Prices at Regional Australia outgrew capital cities during the second half as a large part of the working population moved out to natives and regional cities in the wake of pandemic and stay-at-home protocol. Home prices showed recovery recently with +0.8% at the national level – almost all states showed an increase in price in January 2021 but lower than pre-COVID levels. As per data by the Australian Bureau of Statistics, the mean prices of New South Wales stood the highest with $888,900 in September 2020 quarter. This was followed by Victoria (at $738,600) and the Australian Capital Territory ($721,000).
Figure 2. Housing Price Changes in Selected States:
Data from Reserve Bank of Australia, Chart Created by Kalkine Group
The Australian commercial vacancy rate reached the highest level since 1997 with an 11.7% increase in January 2021 over pcp according to The Property Council of Australia. This was driven by an increase in supply and lack of demand from tenants. Perth, Darwin, Adelaide, and Brisbane posted a double-digit growth exceeding the nation-wide growth. A significant number of offices were completed during the lockdown which had pushed Melbourne vacancy rates to the highest level since 2015. The report mentioned that about 1.1 million sqm of office space will be supplied to the Australian commercial office market in the next two years.
Figure 3. Office Vacancy Rates Surged 11.7% in January 2021:
Data from The Property Council of Australia, Chart Created by Kalkine Group
The value of housing loan commitments reached a record high in December 2020 to $26.01 billion according to the Australian Bureau of Statistics. Over half of the increase in loan commitments was led by existing dwellings. Various stimulus programs by federal and state governments such as the HomeBuilder scheme, stamp duty concessions, and record low mortgage rates are the key drivers for growth. Property investors are returning to the market with the loan commitments for the investor housing segment increased by 8.2% in December 2020 (on a YoY basis). First-time borrowers rushed to avail the grant for new loans at the end of the year.
Figure 4. Home Loan Commitments Touched Record High in December 2020:
Data from Australian Bureau of Statistics, Chart Created by Kalkine Group
Index Performance:
The ASX 200 Real Estate (Industry Group) generated returns of ~+49.42% in the last ten years as compared to ~42.37% by the ASX 200 Index. Increasing affordability, declining housing inventory, upward moving prices across states, and increasing office vacancy rates are some of the growth contributors.
Figure 5: The ASX 200 Real Estate (Industry Group) outperformed ASX 200 Index by 7.05% over the last ten years
Source: Refinitiv (Thomson Reuters) as on the close of 18 February 2021
Key Risks and Challenges:
With bleak sentiments lingering around, businesses largely kept their capex plans on hold including spend on office buildings. Private capex data by the Australian Bureau of Statistics showed capex spend on buildings and structures decline by 15.0% in September 2020 quarter over last year. Corporate subleasing remained high particularly in Melbourne driven by lower tenant demand and this may invariably affect vacancy rates and commercial rentals. A surge in home loan commitments primarily led by government grants and stimulus schemes. Roll-back of such programs may affect the housing market demand. Increasing supply of homes coupled with low mortgage rates may lead to a property bubble. And with a high unemployment rate, it may bring catastrophic effects to the economy.
Figure 6. Key Risks in The Construction and Real Estate Sector:
Sources: Analysis by Kalkine Group
Outlook:
As building approvals are showing upward movement and home prices are recovering, The Commonwealth Bank is optimistic about the growth in the housing market. The Nation-wide dwelling price is expected to rise 8% in 2021 and 6% in 2022 as projected by the Bank. The current momentum is leading to strong price rises. Double-digit property auction clearances and a surge in turnover in most capital cities may bring price gains. The federal budget cleared $14 billion budget spend over the next four years which will boost the infrastructure and construction market. There are several projects lined-up such as Western Sydney Airport, Dungowan Dam project, Bruce Highway Upgrade. These may bring traction to the engineering activity and influence the rentals and vacancy rates for the commercial property market.
II. Investment theme and stocks under discussion (MGR, MND, SRV, WGN)
After understanding the sector, let us now look at four companies listed on the ASX. The price potential of the companies under discussion has been analysed based on the ‘EV/EBITDA’ method.
1. ASX: MGR (Mirvac Group)
(Recommendation: Buy, Potential Upside: Low Double Digit, Mcap: A$8.74 Billion)
Mirvac Group is an integrated, diversified Australian property group comprising an investment portfolio and a development business.
Valuation
Our illustrative valuation model suggests that stock has a potential upside of 26.52% on 18 February 2021. We believe that the stock might trade at a slight discount compared to its peer median EV/EBITDA (NTM Trading multiple) as the management projected EPS growth of 0.13 cents per share in FY21, lower than FY20. As per H1 FY21 results, the rental collection is yet to reach pre-COVID levels. For the said purposes, we have taken peers such as Carindale Property Trust (ASX: CDP), BWP Trust (ASX: BWP), ALE Property Group (ASX: LEP). The stock delivered an annualized yield of 3.51%.
2. ASX: MND (Monadelphous Group Limited)
(Recommendation: Buy, Potential Upside: Low Double-Digit, Mcap: A$1.13 Billion)
Monadelphous Group Limited provides engineering and construction services to the resources and petrochemical industries.
Valuation
Our illustrative valuation model suggests that stock has a potential upside of 29.46% on 18 February 2021. We believe that the stock might trade at a slight discount as compared to its peer average EV/EBITDA (NTM Trading multiple) given the sizeable exposure to resources sector. Engineering construction is yet to show nation-wide revival which may put pressure on earnings. For the said purposes, we have taken peers such as Reliance Worldwide Corporation Ltd. (ASX: RWC), GWA Group Ltd. (ASX: GWA), MAAS Group Holdings Ltd. (ASX: MGH). The stock delivered an annualized yield of 2.91%.
3. ASX: SRV (Servcorp Limited)
(Recommendation: Speculative Buy, Potential Upside: Low Double-Digit, Mcap: A$280.77 Million)
Servcorp Limited provides contracted serviced offices and virtual office services to clients throughout Australia, New Zealand, Asia, and Europe.
Valuation
Our illustrative valuation model suggests that stock has a potential upside of 25.76% on 18 February 2021. We believe that the stock might trade at a slight premium as compared to its peer median EV/EBITDA (NTM Trading multiple) as the assets are well-diversified in varied geographies which had lifted the overall revenues in FY20. For the said purposes, we have taken peers such as LendLease Group (ASX: LLC), Victory Offices Ltd. (ASX: VOL), Lycopodium Ltd. (ASX: LYL). The stock delivered an annualized yield of 6.89%.
4. ASX: WGN (Wagners Holding Company Limited)
(Recommendation: Hold, Potential Upside: Low Double-Digit, Mcap: A$342.57 Million)
Wagners Holding Company Ltd provides construction of roads and tunnels, bridges, airports, mining and gas plants, dams, and other infrastructure projects.
Valuation
Our illustrative valuation model suggests that stock has a potential upside of 19.13% on 18 February 2021. We believe that the stock might trade at a slight premium as compared to its peer median EV/EBITDA (NTM Trading multiple) considering the robust portlio in public infrastrucure which are expected to benefit from the government’s ambitious $14.0 billion budgetary spend for the next four years. For the said purposes, we have taken peers such as EVZ Ltd (ASX: EVZ), Johns Lyng Group Ltd. (ASX: JLG), Brickworks Ltd. (ASX: BKW).
Note: All the recommendations and the calculations are based on the closing price of 18 February 2021. The financial information has been retrieved from the respective company’s website and Refinitiv (Thomson Reuters).
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