By Chris Shaw

Last month Citi initiated coverage on property syndicate and development group Peet Limited ((PPC)) with a Buy rating (see: Value In Peet As It Scales Up Operations, FNArena, 18/6/2010) and since then interest in the company has grown, to the extent BA Merrill Lynch has now also initiated coverage with a similar Buy rating.

For BA-ML, Peet offers a number of attractions including the highly fragmented nature of the residential development market the company operates in, as this offers scope for the group to take market share from weaker competitors.

Another attraction is Peet has a dominant position in the residential land syndication market, with its solid track record given access to a captive retail investment base. In BA-ML's view, this gives Peet a sustainable competitive advantage and assists in securing high fee streams. Upside potential comes from new large wholesale syndicates, which BA-ML has not factored into its model.

Peet has an extensive land bank, which BA-ML notes is on average six years old. Over the last six years residential prices weighted by Peet's state exposures, which are primarily Western Australia, Victoria and Queensland, have risen by 59% compared to a national average increase of 22%.

In BA-ML's view this increase in value sets the company up well, as on the broker's numbers the value of Peet's inventory is now at a 32% premium to book value. This is a positive for future development margins.

In coming years BA-ML sees sold earnings growth for the group, forecasting capital annualised earnings growth in earnings per share (EPS) terms of 5.4% for FY10-FY15. This growth should be driven by a combination of factors, one being a stabilising in margins.

As well, BA-ML expects volumes to improve given Peet has four new project launches set for this year and is expected to launch additional new syndicates in coming years. Acquisitions should also help, the broker noting management at Peet are currently assessing three possible deals. This should result in a further new syndicate launch in the next six months.

Management quality is good, BA-ML pointing out Peet's historical return on equity is higher than developer peers thanks to high fees and a capital efficient land syndication model. As funds management also generates high margins for the group, the broker estimates an overall EBITDA (earnings before interest, tax, depreciation and amortisation) margin of 38% for the first half of FY10.

With respect to earnings, BA-ML is forecasting EPS of 14.1c this year, increasing to 14.6c in FY11 and 15.3c in FY12. By way of comparison, when Citi initiated coverage last month it was forecasting EPS of 14.2c, 15.5c and 17.1c respectively for FY10 to FY12. The FNArena database shows consensus EPS forecasts of 14.1c for FY10 and 15.3c for FY11.

For BA-ML the major risk to earnings comes from volumes, with the level of interest rates a major variable in this regard. Further rate hikes could impact on development activity, though the fact Peet is a 'middle market' price point operation and has a low cost landbank somewhat insulates it from adverse rate movements in the broker's view.

Based on its forecasts BA-ML has a discounted cash flow valuation for Peet of $2.48, while the stockbroker sets its price target on the stock at $2.45. This is in line with the average price target according to the FNArena database.

BA-ML's Buy rating means Peet is now rated as Buy four times and Hold once. Macquarie earlier this month downgraded to a neutral view on relative valuation grounds, at the same time cutting its price target to $2.04 from $2.50. Deutsche Bank has the highest price target according to the database at $2.65.

Shares in Peet today are weaker in line with the broader market and as at 10.50am the stock was 6c lower at $1.94. This compares to a trading range over the past year of $1.60 to $2.42 and implies upside of better than 24% to the average price target indicated by the FNArena database.

FN Arena is building the future of financial news reporting at www.fnarena.com . Our daily news reports can be trialed at no cost and with no obligations. Simply sign up and get a feel for what we are trying to achieve.

Subscribers and trialists should read our terms and conditions, available on the website.

All material published by FN Arena is the copyright of the publisher, unless otherwise stated. Reproduction in whole or in part is not permitted without written permission of the publisher.