Property developer Stockland booked a 6.7 per cent drop in funds from operations for the half due to flagging house prices and a sub-par retail performance but bright spots remain, says Morningstar.

Total revenue from its residential property segment, which generates around one-third of group profit, fell to $658 million for the half, from $870 million last year.

The developer's preferred profit measure, funds from operations, slipped to $407 million in the half-year ended 31 December, largely due to falling residential property prices in the western Sydney and Melbourne land markets.

In response, Morningstar analyst Tony Sherlock has cut his fair value estimate by 3 per cent, to $4 from $4.15, as management warns of further troubles ahead. Stockland shares were trading at $3.65 at market close Wednesday.

"We expect further price declines in residential land of about 5 per cent in this calendar year, concentrated in Sydney and Melbourne," Stockland said on Wednesday.

Sherlock attributes the decline to a fall in residential settlements to 2,096 lots compared with 3,159 in the prior corresponding period.

While acknowledging Stockland is highly exposed to falling Australian house and apartment prices, he thinks the impact will be less than for many peers, especially smaller operators.
He gives four key reasons:

  • Stockland has acquired much of its land bank of 82,000 lots under option, which means it isn’t as exposed to falling land values as those purchasing the land outright
  • The firm's recent focus on selling completed houses (mostly townhouses) significantly broadens the customer base, as many prospective buyers are discouraged by the typical two-year lag between leaving a deposit and move-in date
  • As Australia’s largest developer of land lots, Stockland has scaled benefits across all parts of the value chain, from site preparation costs through to planning and marketing
  • Australia remains appealing to prospective migrants, and ongoing population growth supports ongoing demand for Stockland’s more affordable housing packages.

Retail, aged care weigh on profits

Sherlock also calls out a weaker-than-expected retail result, as sales grew just 1.4 per cent in 12 months.

This also impacts its rental of retail units, where rents grew just 0.2 per cent for renewals of existing leases, and dropped 2.6 per cent for new leases.

"These metrics are compelling arguments for Stockland to reduce its exposure to retail," he says, while trimming his retail rental growth expectations.

Sherlock cut earnings growth expectation for the retirement living business, also on the back of weakness in Australian dwelling prices.

Citing deterioration in the housing market, reduced credit availability and weak consumer sentiment, Stockland management expects around 5 per cent growth in funds from operation per security for the full year - at the lower end of its 5 per cent to 7 per cent guidance range.

Sherlock continues to forecast fiscal 2019 funds from operations growth below company guidance of 4.4 per cent.

"After a five-year run of strong earnings growth, it is fair to say most of Stockland’s businesses are facing tougher operating conditions," he says.

"The only solidly performing divisions are office and industrial which comprise 5 per cent and 17 per cent, respectively, of pre-overhead earnings before interest and taxes."

The company is guiding for over 6,000 settlements for fiscal 2019, underpinning stronger second-half earnings.

Australia's property downturn has also driven recent earnings downgrades at building suppliers including Boral (ASX: BLD) and Fletcher Building (ASX: FBU), builder AV Jennings (ASX: AVJ) and property classifieds firm REA Group (ASX: REA).