This story features GOODMAN GROUP. For more info SHARE ANALYSIS: GMG
Global demand for industrial property is likely to support Goodman Group for the next few years, leading to robust earnings, but is there an issue with the valuation?
-Development earnings significantly above the previous peak
-Is Goodman Group’s self-funding ability underappreciated?
-Minimal loss of rent throughout 2020
By Eva Brocklehurst
Development projects continue apace for Goodman Group ((GMG)), as tenant demand for logistics/warehousing has accelerated, underpinned by the pandemic. As a result, the business appears well-placed for continued growth in earnings over the next 2-3 years amid a strong balance sheet and a self-funding model.
The group is benefiting from exceptionally strong demand in industrial property and the US is likely to be a strong driver of that business in 2021. First half operating earnings of $614.9m reflected 16% growth. All metrics grew from a high base. Operating earnings growth guidance has been been upgraded to 12% in FY21 from 9% previously.
Work in hand has increased to $8.4bn and the company expects this to exceed $9bn in the second half. Citi suspects guidance may even be conservative, noting slower investment income growth may still be offset by strength in the management business and lauding the long-term growth prospects and a clearly-defined strategy.
The main news was development earnings, significantly above the previous peak, and the fact 44% of operating earnings now emanate from Europe. Yet income from funds was a disappointment for brokers.
Management income was flat while investment income was down -8%. Credit Suisse believes these results must be taken in the context of the asset growth that has occurred over the past year and expects development margins will remain elevated.
While acknowledging Goodman Group is not the cheapest stock around, the broker retains a preference and upgrades to Outperform. On the other hand, UBS believes, while the business can capitalise on structural tailwinds, the price reflects this.
Morgan Stanley acknowledges bond yields are a challenge, noting the share price has underperformed the sector index by around -2% this year, which has likely been driven by the sharp uplift in Australian 10-year bond yields. If this continues there could be additional pressure on the stock.
Nevertheless, as the broker points out, there is a portfolio of “enviable” land which can be re-purposed. Distributions are not expected to increase in FY22-23, which Morgan Stanley believes is sensible, as there are plenty of deployment opportunities.
The self-funding ability of Goodman Group is underappreciated, in the broker’s view. Ord Minnett, too, likes the flexibility, noting development metrics are strong and margins should remain elevated at least until FY23.
Development
Demand for warehouse space is accelerating, as evident in data accrued by UBS. Moreover, as the company focuses on land-constrained markets and high-value warehousing its workload is growing.
Goodman has signalled that the increase in development volumes over the next few years means more capital will be allocated to this segment. Looking ahead, Goodman will target a 40-50% pay-out ratio that should allow the business to self-fund its share of development activity.
Credit Suisse believes it’s worth highlighting that the Australian land bank were acquired relatively cheaply compared to the prices paid more recently by some of the company’s peers. The business also continues to target higher and better-use re-zoning opportunities and multi-level warehousing. In this way, Credit Suisse believes high margins can be retained.
Goldman Sachs puts a dampener on enthusiasm and flags development earnings as the lowest quality item within the earnings mix, now accounting for almost half group earnings (EBIT). Reinvestment and management contributions were well below forecasts and the group also benefited from a lower tax rate.
Performance Fees
Credit Suisse acknowledges the performance fee outlook is more modest in FY21 with total returns for partnerships expected in the mid teens. Goodman has previously guided to a -$20-30m decline in performance fees in FY21 and the broker suspects these may be affected further by timing issues.
Macquarie points out the funds management platform has sustained a similar level of returns for the past five years and expects it to be no different in FY22-23. Goodman achieved minimal loss of rent throughout 2020 and was able to maintain occupancy at 97.9%.
There were 45 developments completed throughout the year. Gearing is expected to increase slightly as development capital is deployed and fewer asset sales occur but will remain under 10% over the short term.
Value?
Despite a predictably strong performance, there were plenty of rating upgrades, from Macquarie, Credit Suisse and Ord Minnett. Macquarie believes Goodman Group is now undervalued.
Goldman Sachs, not one of the seven stockbrokers monitored on the FNArena database, is unmoved and retains a Sell rating with a $12.24 target. The database has five Buy ratings and one Hold (UBS). The consensus target is $20.10 suggesting 16.4% upside to the last share price.
Jarden, also not one of the seven, is in the Goldman Sachs camp, with an Underweight rating and $19 target. The broker likes the globally dominant position in logistics and concedes the opportunity for modern distribution centres is significant, upgrading forecasts to reflect the expected annual growth in earnings over FY21-23.
The broker also does not believe the shift to more development income from management fees is a problem. The main obstacle for Jarden is the rating has been upgraded significantly in the last 12 months and there appears better value elsewhere in the sector.
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