Still a little more to go. Earnings and target price revision

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1 AUSTRALIA FKP AU Price (at CLOSE#, 27 Aug 2012) Neutral A$0.38 Volatility index Medium 12-month target A$ month TSR % -6.6 Valuation - Sum of Parts A$ GICS sector Real Estate Market cap A$m day avg turnover A$m 0.9 Number shares on issue m 1,212 Investment fundamentals Year end 30 Jun 2012A 2013E 2014E 2015E Revenue m EBIT m Reported profit m Adjusted profit m Gross cashflow m CFPS CFPS growth % PGCFPS x PGCFPS rel x EPS adj EPS adj growth % PER adj x PER rel x Total DPS Total div yield % Franking % ROA % ROE % EV/EBITDA x Net debt/equity % P/BV x FKP AU vs Small Ordinaries, & rec history Note: Recommendation timeline - if not a continuous line, then there was no Macquarie coverage at the time or there was an embargo period. Source: FactSet, Macquarie Research, August 2012 (all figures in AUD unless noted) 29 August 2012 Macquarie Securities (Australia) Limited Still a little more to go Event FKP has launched an underwritten 6 for 7 non renounceable pro rata entitlement offer at $0.20ps, a 47.4% discount to the last share price close to raise ~$208m. The entitlement offer has been released in conjunction with the group's FY12 result and the announcement of material write downs. Impact Balance sheet repair. We have expressed concern over FKP's balance sheet for some time now, particularly noting aggressive asset valuations, low cash EBITDA to interest paid and a retirement ICR within close proximity to its covenant. We have previously estimated that all else constant, ~$300m of equity would be needed to deliver credit metrics more in line with REIT peers (cash ICR >2.5x and gearing <30%) and thus are not surprised by the fact that the $208m equity raising is being accompanied with a strategy to further de-gear via asset sales. Need to execute on asset sales. Indeed FKP expect to receive ~$175m of proceeds from the sale of two commercial developments at Gasworks and three property trust assets which in aggregate are expected to realise gross proceeds of ~$330m. Whilst FKP s cash EBIT to interest paid ratio increases to ~2.4x on the sale of the 3 property trust assets and up to ~3.4x if the Gasworks developments are also sold, we also note that beyond FY13, FKP are expected to spend ~$150m on construction at Milton and Albion which would again begin to depress the metrics if undertaken by FKP. Big discount to NTA but need to get comfortable on retirement and market will price inventory at a discount. NTA post write downs and the equity raising falls to $0.58ps. Ordinarily we subtract the capitalised value of corporate/overhead costs when valuing groups on a going concern basis, which in the case of FKP amounts to ~$0.10ps, thus resulting in an NAV of $0.48ps. However we continue to highlight the assumptions used by FKP in determining the valuation of their retirement assets. In particular a long run price growth assumption of 4.5% and a turnover rate assumption on ILU s of 10 years (equating to 10%). If we assumed a turnover rate of 9% and long run price growth of 4%, the gross retirement valuation would fall ~10% and our $0.48ps NAV would fall to $0.44ps. In addition we do not expect the listed market to pay book value for the development assets whose book value imply a trailing EBITDA multiple of ~40x. Earnings and target price revision EPS FY13-43%, FY14-51%, FY15-15%. Target price reduced from $0.40ps to $0.34ps Price catalyst 12-month price target: A$0.34 based on a Sum of parts methodology. Catalyst: Execution of asset sales over FY13 Action and recommendation Participation in the entitlement offer at $0.20cps offers value, however we note that FKP still need to de-gear further and thus the stock will continue to trade below fair value in our view. Neutral retained. Please refer to the important disclosures and analyst certification on inside back cover of this document, or on our website

2 Fig 1 FKP FY12 result overshadowed by balance sheet reset and equity raising The good The not so good The interesting Balance sheet takes a hiding. The raising comes after substantial write downs were taken on the carrying value of several of the groups assets which have driven a 26% fall in NTA from $1.22ps to $0.90ps: i) A $289m (24%) reduction in the value of the groups on balance sheet retirement portfolio; ii) a $48m (71%) reduction in the value of Currumbin in Brisbane, one of the group s resi projects on the back of a deferral in expected delivery dates; iii) a $49m (42%) reduction in the carrying value of the group s investment in RVG as a reduced asset carrying value is compounded by high gearing in the fund; and iv) A $42m (37%) reduction in the carrying value of the group s Mulpha FKP Norwest JV Pushing gearing to uncomfortable levels. The write downs drove an 8ppt increase in the groups gearing to 39%- well above the groups target 25-30% gearing range, necessitating the equity raising. NTA down 53%. After also taking the equity raising into account, pro forma NTA of $0.58ps is 53% below the $1.22ps reported at 31 December Interest cash coverage <1x. For FY12, Group EBITDA of $140.3m includes $79.9m of non cash retirement earnings which when excluded (as well as the RVG contribution) and adding back interest in COGS, equates to a proxy for cash EBITDA of only ~$63m, relative to ~ $69m of net interest payments in the half. Even after equity raise, cash coverage only just >2x without asset sales. On our current base case estimates the group cash ICR in FY13 would be just over 2x, a number we would like to see >2.5-3x. Resi los sales tumble. Resi land lot sales were down 25% in the year although the slowdown was even more pronounced in 2H12 which was down ~28% on 2H11. Built product sales down 81% on the pcp, although we note that this is largely a function of project timing. Margins maintained but for how long? FKP s resi margins for the full year improved relative to the half year although we note commentary from management stating that FKP are holding prices despite competitor discounting. This raises the obvious concern that at some point FKP too will need to meet the market. With annual resi lot sale targets slashed. FKP have substantially reduced their target annual lot sales across its resi projects: i) Saltwater Coast from pa to (- 50%); ii) Peregian Springs to (- 20% to -33%); and iii) Rochedale from to (~-35%). Retirement ICR improves. The ICR on the retirement syndicate improved from 1.8x at Dec 11 to 2.0x at June 12 although remains within reasonable proximity to the >1.75x covenant Reduction in corporate costs expected to continue. FKP have reduced corporate overheads by 20% in FY12 with additional initiatives being pursued to further reduce the extent of corporate costs in the business. FKP are targeting overhead savings of 5-10% on a like for like basis. Retirement resale volumes rebound in 2H12. After reporting a disappointing 205 retirement sales (new and resales) in 1H12, representing a 7% turnover rates, resales in 2H12 rebounded 46% to 299 in 2H12 resulting in sale volume for the full year of 504 and representing an 8% turnover ratio. The 2H12 annualised turnover rate was 10% - consistent with the assumption underpinning FKP s retirement valuation. However we expect that a significant quantum of these purchases were undertaken by FKP. Getting nearer to cashflow. With the average resident age in FKP s retirement portfolio creeping higher (now 82.7 years vs 82.6 years at Dec 11 and 82.4 years at June 11), FKP are undoubtedly getting closer to cash crystallisation from their retirement business. Interested party in DD on Gasometer 1. FKP have advised that negotiations with several parties regarding a sale and fund through transaction at Gasometer 1 continue. And HOA with BOQ at Gasometer 2. Translation of this HOA into a signed lease agreement will assist in the ability of FKP to sell this development. Source: Macquarie Research, August 2012 Equity raising not enough, still need to de-gear through asset sales. FKP expect to sell two commercial developments at Gasworks and three property trust assets. In aggregate the gross proceeds from the realisation of these assets are expected to be ~$330m. But watch out for Albion and Milton. FKP s cash EBIT to interest paid ratio increase to ~2.4x on the sale of the 3 property trust assets and up to 3.4x if the Gasworks developments are also sold. However beyond FY13, FKP are expected to spend ~$150m on construction at Milton and Albion which would again begin to depress the metrics if undertaken by FKP Retirement valuation metrics. We continue to highlight the assumptions used by FKP in determining the valuation of their retirement assets. In particular a long run price growth assumption (from year 6) of 4.5% and a turnover rate assumption on ILU s of 10 years (equating to 10%). Over the last six years, 10% is the highest turnover rate FKP have been able to achieve and whilst there is an argument to suggest that the increase in the average age of the residents in the portfolio supports a move to 10% we question its sustainability given eventual replenishment with younger residents, who on average are expected to live longer. Compared to SGP. Whilst there are clear differences in FKP s portfolio relative to SGP s, in particular the average age of residents is ~2 yeas higher in FKP s portfolio and the contract terms are more lucrative we note that SGP use long run price growth of +3.9%, 9% turnover and a 12.8% discount rate (relative to FKP at 12.5%). SGP participation in equity raising. In light of comments made by Matthew Quinn at a recent sell side analyst briefing, we expect SGP to take up their ~14% pro rata entitlement in the FKP equity raising. Demerger/separation continues to be explored. However this may simply take the form of a sell down of all the development/property trust assets to be left with a standalone retirement entity. 29 August

3 Balance sheet repair Equity raising hardly a surprise FKP has launched an underwritten 6 for 7 non renounceable pro rata entitlement offer at $0.20ps, a 47.4% discount to the last share price close to raise ~$208m. The raising comes after substantial write downs were taken on the carrying value of several of the groups assets which have driven a 26% fall in NTA from $1.22ps to $0.90ps and an 8ppt increase in the groups gearing to 39%(well above the group s target 25-30% gearing range). A $289m (24%) reduction in the value of the group s on balance sheet retirement portfolio. A $48m (71%) reduction in the value of Currumbin in Brisbane, one of the group s resi projects on the back of a deferral in expected delivery dates A $49m (42%) reduction in the carrying value of the group s investment in RVG as a reduced asset carrying value is compounded by high gearing in the fund A $42m (37%) reduction in the carrying value of the group s Mulpha FKP Norwest JV We have expressed concern over FKP's balance sheet for some time now, particularly noting aggressive valuations, low cash EBITDA to interest paid and a retirement ICR within close proximity to its covenant. Indeed at 30 June 2012 these metrics were as follows: For FY12, Group EBITDA of $140.3m includes $79.9m of non cash retirement earnings which when excluded (as well as the RVG contribution), and adding back interest in COGS, equates to a proxy for cash EBITDA of only ~$63m, relative to ~ $69m of net interest payments in the half. The ICR on the retirement syndicate improved from 1.8x at Dec 11 to 2.0x at June 12 although remains within reasonable proximity to the >1.75x covenant But still needs to further de-gear We have previously estimated that all else constant, ~$300m of equity would be needed to deliver credit metrics more in line with REIT peers (cash ICR >2.5x and gearing <30%) and thus are not surprised by the fact that the $208m equity raising is being accompanied with a strategy to further de-gear via asset sales. Indeed, whilst the equity raising results in pro forma credit metrics in compliance with all covenants except the Net debt/underlying EBITDA covenant which has been waived and which FKP is expected to be in compliance with post the equity raising, the pro forma FY12 credit metrics provided by FKP are not quite rock solid in our view. The ICR on the retirement syndicate facility of 2.0x remains close to the 1.75x covenant with the pro forma LVR of 43% still within reach of the 50% covenant given the potential for further write down. Although we note that FKP will have sufficient liquidity to pay down the retirement debt facility in the event of a covenant breach. On our current base case estimates the group cash ICR in FY13 would be just over 2x, a number we would like to see >2.5-3x. 29 August

4 Fig 2 FKP key banking covenants Source: FKP, August 2012 However we note that planned sales are expected to rectify this situation. Indeed FKP expect to receive ~$330m of gross sale proceeds from the sale of two commercial developments at Gasworks and three property trust assets detailed below. The weighted average cap rate on the property trust assets is 9.4%. Fig 3 ~$330m of targeted asset sales Asset sales A$m (approx.) Comment Gasometer 1, Gasworks 125 Party currently in DD. Retail component let to Woolworths. Construction currently underway Gasometer 2, Gasworks 50 Office asset under HOA with BOQ 339 Lonsdale St, Melbourne 31 Has been classified as asset for sale on b/sheet Brown Plains, Brisbane 50 Has been classified as asset for sale on b/sheet 465 Victoria Rd, Chatswood 82 Has been classified as asset for sale on b/sheet Less assumed costs and provision for discount -8 Provides ~5% buffer to book values of property trust assets Total 330 Source: FKP, Macquarie Research, August 2012 On our estimates, FKP s cash EBIT to interest paid ratio increases to ~2.4x on the sale of the 3 property trust assets and up to 3.4x if the Gasworks developments are also sold as can be seen in the table below. We note that this compares to a ratio of only 0.9x in FY12. Fig 4 ICR will head the right way as asset sales are executed A$m FY13 pro forma Base case + sale of property trust assets + Gasometer 1 & 2 EBITDA ex retirement revaluation Pro forma cash interest paid EBIT (cash proxy) : Interest (cash) Source: Macquarie Research, August 2012 However we also note that beyond FY13, FKP are expected to spend ~$150m on construction at Milton and Albion which would again begin to depress the metrics if undertaken by FKP. 29 August

5 Taking a look at the value proposition NTA post the above mentioned write downs and the equity raising falls to $0.58ps as depicted in the chart below. Ordinarily however when we value groups on a going concern basis we subtract the capitalised value of corporate/overhead costs which in the case of FKP amounts to ~$0.10ps, thus resulting in an NAV of $0.48ps. Fig 5 Pro forma NTA $0.58ps Source: Macquarie Research, August 2012 However we continue to highlight the assumptions used by FKP in determining the valuation of their retirement assets. In particular a long run price growth assumption (from year 6) of 4.5% and a turnover rate assumption on ILU s of 10 years (equating to 10%). Over the last six years, 10% is the highest turnover rate FKP have been able to achieve and whilst there is an argument to suggest that the increase in the average age of the residents in the portfolio supports a move to 10% we question its sustainability given eventual replenishment with younger residents, who on average are expected to live longer. Fig 6 10% turnover rate the best it has been 12% 10% 8% 6% 4% 2% 0% FKP turnover rate FKP average age (years) FY06 FY07 FY08 FY09 FY10 FY11 FY Source: Company data, Macquarie Research, August 2012 Indeed, if we assumed a turnover rate of 9% and long run price growth of 4%, the gross retirement valuation would fall ~10% and applying a similar reduction to all retirement would reduce our $0.48ps NAV to $0.44ps. 29 August

6 Fig 7 Sensitivity of valuation to retirement assumptions A$m % of valuation ILU turnover from 10 to 11 years -41-4% L/run price growth from 4.5% to 4% -47-5% Total % Reduction in DTL 26 Net reduction in NTA -62 Same discount across other retirement assets -30 Total reduction in NTA % Acps % Source: FKP, Macquarie Research, August 2012 Whilst there are clear differences in FKP s portfolio relative to SGP s, in particular the average age of residents is ~2 years higher in FKP s portfolio and the contract terms are more lucrative, we note that SGP use long run price growth of +3.9%, 9% turnover and a 12.8% discount rate (relative to FKP at 12.5%). In addition we note that in the listed environment the market is more likely to place a greater emphasis on earnings and cashflow than asset value. In this regard we note that FKP have ~$1.1bn of gross residential and apartments and commercial and industrial assets on balance sheet which in FY12 only delivered EBITDA of $28.2m, implying a trailing EBITDA multiple of ~40x on current book value. Fig 8 ~40x EBITDA multiple implied by resi and C&I book values Inventory book value A$m FY12 EBITDA A$m Multiple (x) Residential communities + apartments Commercial and industrial Total 1, Source: FKP, Macquarie Research, August 2012 Whilst this will improve following the expected asset sales above and an improvement in EBITDA (particularly from the resi business), we expect the market will continue to ascribe a value below book value for this business in light of the poor earnings. That said upside clearly exists if FKP sell down their development inventory which is not currently generating any earnings/cashflow. Forward earnings highly variable In light of the many moving parts and targeted asset sales, FKP s earnings remain highly variable. We also note that given typically over three quarters of interest paid is capitalised to the balance sheet, material changes to this ratio following the equity raising can move the earnings substantially. Indeed the reclassification of Currumbin from an active development project to inactive in itself increases P&L interest by ~$6m, representing >6% of FY12 underlying profit. We have adjusted our forecasts to reflect the result and equity raising however have not yet assumed the asset sales in our base case forecasts. On this basis we are currently forecasting FY13 underlying earnings of ~$112m, equating to EPS of ~5.5cps. FY12 result ahead of our expectation but driven by non cash retirement revaluation FKP reported a FY12 statutory net loss of $359.9m driven by write downs and asset devaluations. Operating profit after tax of $94.7m was well ahead of our $85.0m forecast, however the key difference was the non cash revaluation of the retirement business which was ~$8m ahead of our forecast whereby we had assumed a slowdown in capital growth rates. We provide a snapshot of the result below. 29 August

7 Fig 9 FY12 operating EPS down 23.3% on the pcp FY11 ($m) 1H12 ($m) 2H12 ($m) FY12 ($m) FY12 vs FY11 (%) Retirement $m (10.2%) Residential Communities $m (48.1%) Commercial & Industrial $m (68.5%) Funds & Investments $m (12.0%) Unallocated overhead $m (17.3) (7.9) (7.0) (14.9) (13.9%) EBITDA $m (26.3%) Depreciation & amortisation $m (3.0) (1.6) (1.3) (2.9) -% EBIT $m (26.6%) Interest expense $m (26.5) (7.3) (5.2) (12.5) (52.8%) Profit before tax $m (22.3%) Tax expense $m (34.1) (7.8) (17.2) (25.0) (26.7%) Profit after tax $m (21.2%) Outside equity interests $m (5.7) (2.7) (2.5) (5.2) (8.8%) Net operating profit $m (21.7%) Mark-to-market of interest rate swaps $m 7.2 (14.9) (14.0) (28.9) FKP Property Trust write-downs $m (12.6) (4.9) (22.9) (27.8) Non-operating gains/(write-downs) in retirement portfolio $m (1.1) - (224.9) (224.9) Non-operating gains/(write-downs) on equity investments $m (22.6) (5.5) (89.2) (94.7) Development inventory impairment $m (0.9) (4.9) (37.4) (42.3) Intangible impairment $m (5.5) - - Other (including bad debts recovered) $m (3.2) (0.3) (26.1) (26.4) Statutory profit/(loss) after tax $m (362.9) (350.3) (525.6%) Operating EPS cps (23.3%) Statutory EPS cps (30.3) (29.2) (517.1%) DPS cps (6.7%) Source: FKP, Macquarie Research, August August

8 A$m FY11a FY12a FY13e FY14e FY15e Profit and loss EBITDA: Property investment Development (including land subdivision) Retirement Other EBITDA D&A EBIT Net interest Profit before tax Tax OEI Adjusted NPAT Adjustments (incl. Asset revals, swap revals, etc) Reported NPAT Adjusted EPS cps Adjusted EPS growth 6.1% -23.1% -31.0% -14.4% 7.0% DPS cps DPS Growth 100.0% -6.7% -46.4% 3.0% 3.0% Balance sheet Cash and other liquid assets Other current assets Total current assets Property investments 2, , , , ,427.5 Other non current assets Total non current assets 3, , , , ,238.3 Total assets 4, , , , ,747.6 Current debt Other current liabilities 1, , , , ,472.3 Total current liabilities 1, , , , ,763.9 Non current debt Other non current liabilities Total non current liabilities Total liabilities 2, , , , ,195.4 Total equity 1, , , , ,552.3 Source: Company data, Macquarie Research, August August

9 Important disclosures: Recommendation definitions Macquarie - Australia/New Zealand Outperform return >3% in excess of benchmark return Neutral return within 3% of benchmark return Underperform return >3% below benchmark return Benchmark return is determined by long term nominal GDP growth plus 12 month forward market dividend yield Macquarie Asia/Europe Outperform expected return >+10% Neutral expected return from -10% to +10% Underperform expected return <-10% Macquarie First South - South Africa Outperform expected return >+10% Neutral expected return from -10% to +10% Underperform expected return <-10% Macquarie - Canada Outperform return >5% in excess of benchmark return Neutral return within 5% of benchmark return Underperform return >5% below benchmark return Macquarie - USA Outperform (Buy) return >5% in excess of Russell 3000 index return Neutral (Hold) return within 5% of Russell 3000 index return Underperform (Sell) return >5% below Russell 3000 index return Volatility index definition* This is calculated from the volatility of historical price movements. Very high highest risk Stock should be expected to move up or down % in a year investors should be aware this stock is highly speculative. High stock should be expected to move up or down at least 40 60% in a year investors should be aware this stock could be speculative. Medium stock should be expected to move up or down at least 30 40% in a year. Low medium stock should be expected to move up or down at least 25 30% in a year. Low stock should be expected to move up or down at least 15 25% in a year. * Applicable to Australian/NZ/Canada stocks only Recommendations 12 months Note: Quant recommendations may differ from Fundamental Analyst recommendations Financial definitions All "Adjusted" data items have had the following adjustments made: Added back: goodwill amortisation, provision for catastrophe reserves, IFRS derivatives & hedging, IFRS impairments & IFRS interest expense Excluded: non recurring items, asset revals, property revals, appraisal value uplift, preference dividends & minority interests EPS = adjusted net profit / efpowa* ROA = adjusted ebit / average total assets ROA Banks/Insurance = adjusted net profit /average total assets ROE = adjusted net profit / average shareholders funds Gross cashflow = adjusted net profit + depreciation *equivalent fully paid ordinary weighted average number of shares All Reported numbers for Australian/NZ listed stocks are modelled under IFRS (International Financial Reporting Standards). Recommendation proportions For quarter ending 30 June 2012 AU/NZ Asia RSA USA CA EUR Outperform 55.67% 61.00% 53.43% 42.58% 69.23% 46.60% (for US coverage by MCUSA, 9.05% of stocks followed are investment banking clients) Neutral 30.50% 22.11% 36.99% 52.41% 28.02% 33.69% (for US coverage by MCUSA, 8.14% of stocks followed are investment banking clients) Underperform 13.83% 16.89% 9.59% 5.01% 2.75% 19.71% (for US coverage by MCUSA, 0.45% of stocks covered are investment banking clients) Company Specific Disclosures: Macquarie and its affiliates collectively and beneficially own or control 1% or more of any class of 's equity securities. Important disclosure information regarding the subject companies covered in this report is available at Analyst Certification: The views expressed in this research reflect the personal views of the analyst(s) about the subject securities or issuers and no part of the compensation of the analyst(s) was, is, or will be directly or indirectly related to the inclusion of specific recommendations or views in this research. The analyst principally responsible for the preparation of this research receives compensation based on overall revenues of Macquarie Group Ltd (ABN , AFSL No ) ( MGL ) and its related entities (the Macquarie Group ) and has taken reasonable care to achieve and maintain independence and objectivity in making any recommendations. General Disclosure: This research has been issued by Macquarie Securities (Australia) Limited (ABN , AFSL No ) a Participant of the Australian Securities Exchange (ASX) and Chi-X Australia Pty Limited. 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