CWK - Jones Lang LaSalle: Cautiously Optimistic Medium-Term Prospects Appears Baked In

2023-10-09 12:46:11 ET

Summary

• 1H 2023: revenues, profits and margins decline due to real estate industry downturn.
• Near term prospects likely to remain challenging.
• Medium term prospects are supported by growth drivers such as demand for real estate management services and building sustainability solutions.
• Risks include an extended real estate downturn.

Real estate firm Jones Lang LaSalle's (JLL) near term prospects are likely to remain challenging but medium term prospects are more optimistic. Their prospects however appear baked into the stock.

Company Overview

Jones Lang LaSalle offers real estate and investment management services covering a variety of property types (including residential, commercial, industrial, retail, infrastructure, hospitality, educational, data centers, and healthcare) and serves clients in over 80 countries.

The company has five operating segments:

Markets Advisory is engaged in advisory services covering a number of areas including leasing, property management, and other real estate-related consulting services. This is their biggest profit generator but the segment's share of overall profit is impacted by cyclical factors.

Capital Markets is engaged in capital market solutions including debt advisory, equity advisory, investment sales and advisory, loan servicing, and valuation advisory. This segment too is subject to cyclical volatility with its share of earnings rising and falling in tandem with capital market activity.

Work Dynamics offers facilities management, project management, and portfolio services. This is their biggest revenue generator and their second biggest profit generator as of 1H 2023.

JLL Technologies offers property technology solutions such as cloud-based data analytics software, facilities management systems, and building operation management software, as well as an online marketplace platform - JLL Marketplace - which retails facilities management supplies. The segment's contribution to earnings is negligible.

LaSalle is engaged in real estate and securities investment activities.

1H 2023 performance

Q2 2023 revenues dropped 4% YoY (declining for the third consecutive quarter) and fee revenues dropped 14% YoY driven by falling revenues in their biggest segments due to continued weakness in real estate markets. For 1H 2023 revenues are down 3% YoY and fee revenues fell 15% YoY.

• Capital Markets continued to be impacted by falling transaction volumes due to interest rate uncertainties (leading to a 35% YoY decline in segment revenue for Q2 2023). Fee revenues sank 34% YoY during the quarter.

• Markets Advisory was hit by lower leasing activity in both Europe and the U.S. their top two markets by revenues (the U.S., U.K., France and Germany together account for around 70% of revenues) leading to an 8% YoY decline in segment revenue during the quarter. Fee revenues meanwhile dropped 13% YoY.

Sagging revenues in these two segments offset strong performance in LaSalle (which grew revenues 26% YoY in Q2 2023 despite falling real estate asset values, driven by 27% fee revenue growth), Work Dynamics (2% YoY revenue growth), and JLL Technologies (20% YoY revenues growth) during the quarter.

Profitability declined sharply, with operating profits down 37% YoY in Q2 2023 and operating margin dropped to 7.9% in Q2 2023 from 11% the prior year quarter. YTD operating income sank 60% YoY and operating margin fell to 4.6% compared with 10.2% the prior year period. Profitability was impacted by a number of factors including lower transaction volume, lower leasing activity, a decline in asset valuations, and moderating equity valuations which saw two of JLL Technologies' portfolio companies raise capital in down rounds.

Q2 2023 free cash flow improved significantly to over $200 million compared with $137 million the prior year quarter. The improvement was largely driven by a cash flow benefit from receivables, which helped offset the decline in earnings. 1H 2023 free cash flow of negative $567 million was an improvement from negative $625 million the prior year period.

Prospects - challenging near term, cautiously optimistic medium term

Near term prospects are likely to remain challenging; U.S. inflation is still above the Fed's 2% target ( 3.7% according to latest data) so lending conditions are likely to remain tight, impacting leasing activity and transaction volumes, and thereby crimping near term earnings for JLL's Capital Markets and Markets Advisory segments, both of which are significant earnings drivers. Additionally, LaSalle's near term profitability may be impacted by further declines in asset valuations. Work Dynamics, whose revenues are more contractual and therefore not as impacted by cyclical factors, could maintain a positive trajectory. Management noted in their Q2 2023 earnings call that they continue to see strong contract renewal and expansion rates and are optimistic about the segment's growth prospects on the back of growing demand for real estate management services. However, this segment's performance is likely to be outweighed by weakness in other segments. Weak near term earnings prospects could lead to another year of negative free cash flow (FY2022 free cash flow amounted to negative $5.9 million before accounting for $85.8 million stock based compensation). Liquidity is solid however with $400 million in the bank and a $1.5 billion undrawn credit facility.

Medium term prospects are cautiously optimistic. Transaction volumes and leasing activity should rebound when lending conditions improve and the company is positioned to benefit from a number of growth drivers including continued demand for real estate management services (70% of corporations manage real estate in-house according to the company reflecting meaningful runway for growth), Industry 4.0 trends (requiring transformation of existing operational facilities or relocate or build new ones), and demand for building sustainability solutions (buildings account for about 40% of energy-related carbon emissions and JLL has expertise across the entire life cycle of a building enabling them to offer clients end-to-end solutions to help companies decarbonize their built environments and thereby achieve ESG targets). The company's proprietary technology differentiates itself from smaller players and positions them to capture market share and drive top line growth. Management is confident about expanding the company's market share and achieving top-line growth above global GDP growth (the IMF projects global GDP growth of 3% in both 2023 and 2024).

Medium term profitability prospects are cautiously optimistic as well, helped by a reduced cost base thanks to cost savings initiatives, market share gains, as well as enhanced efficiency thanks to technology (such as JLL GPT, their new AI-powered tool to improve productivity ).

Financials

CAPEX needs are not expected to change materially. A debt to equity of 67 is on par with rivals like CBRE (CBRE) (61) but management is focused on deleveraging near term, which should better position them to make future acquisitions to support growth and expand market share.

The company's current ratio is adequate.

Risks

Extended real estate downturn

It is assumed that the current real estate downturn is temporary and real estate activity is assumed to recover within the next few years. If the industry remains weak for longer than anticipated, the company's financial and stock returns could be materially affected.

Conclusion

JLL has a moderate buy analyst consensus rating.

JLL's price/cash flow is nearly 25 , considerably higher than the sector median of 10.7

Taking the following assumptions suggests JLL is valued at under $5 billion, lower than their current market value of $6.4 billion. The company's prospects appear baked into the stock and could be viewed as a hold for investors willing to tolerate the risks.

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