Goodman Group (ASX:GMG) shares have failed to gain significant ground since the start of the year, mainly due to investor rotation into cyclicals.
After the Company recently reported its results for the first quarter of Financial Year 2021 (1Q21), we reviewed to see whether the weakness in the share price from recent highs presents an opportunity.
About Goodman Group
Goodman Group is an integrated property group. They have operations throughout Australia, NZ, Asia, Europe, UK, US and Brazil. The Company is one of the largest specialist fund managers of industrial property globally. They derive revenue from four sources: Property rent, developments, investments, and funds management.
The Management division is the main driver of group earnings. Earnings from the Management division comprise investment management, including portfolio performance fees and property service fees.
Key Fundamentals Drivers
1. Development margins are expected to remain elevated over the medium term. Development Work In Progress (WIP) has increased from $6.5b as at 30 June 2020 to $7.3b as at 1Q21. It is slightly ahead of the Company’s guidance of >$7.0b in 1H21. GMG expects WIP to increase further through the rest of the year and now expects WIP to exceed $8b by 30 June 2021.
The driver of the growth in WIP is Asia, which accounts for 80% of WIP. In a broader sense, GMG are seeing an acceleration of demand from major customers, in particular those exposed to the digital economy.
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In the event that WIP reaches $8b, then with a forecast yield on cost of 6.7% (as at 1Q21) well above GMG’s last stated portfolio cap rate of 4.9% (with the Company commenting at the 1Q21 update that further cap rate compression is likely in the near term), Development margins are expected to remain elevated over the medium term. Further, the ramp-up in WIP has a positive flow-on effect to revenue expectations for the Funds Management and Investment divisions.
2. Actual rental growth rate likely higher than reported figure. Like‐for‐like net operating income (NOI) growth moderated slightly to +2.9% in 1Q21, from +3.0% in 4Q20. It has been supported by high occupancy rates, which increased slightly to 97.8%, from 97.5% as at 30 June 2020. The moderation in NOI growth – both in an absolute sense and in the context of GMG’s indicative NOI growth of 3.3-3.5% – reflects that fact that some geographies have low inflation rates. This in turn impacts the extent to which annual rental increases can be passed through.
However, GMG noted market rental growth is trending higher (~4%) in many markets in which it operates. Given the acceleration of tenant demand and GMG’s concentration of specific infill locations, NOI growth is expected to remain solid albeit unlikely to accelerate significantly.
Importantly, the strong life-for-like NOI growth, coupled with expectations for further positive revaluation gains in FY21 and a slowdown in the quantum of asset disposals are key factors in offsetting the expected slowdown in Management earnings growth in FY21.
3. Low level of gearing is likely to be maintained into the medium term. GMG continues to maintain low gearing and high levels of liquidity on both its own balance sheet and those of its Partnerships. In turn, this allows the Company to pursue organic growth opportunities (GMG’s preferred strategy) as well as acquisition opportunities.
Over the medium term, look-through gearing (which has typically been low) is likely to increase from 20.3% as at 30 June 2020 to <25% in order to fund the development pipeline. The implication here is that a gearing level of ~25% may curtail the avenues available to GMG to generate earnings growth in the absence of a higher equity contribution.
To this end, GMG has indicated it would review the capital management strategy into the medium term, which may involve the Company reducing its equity stakes. A lesser-preferred option would be for GMG to leverage its balance sheet in order to fund the equity co-investments.
4. GMG has a track record of upgrading EPS growth guidance. A key catalyst for a recovery in the share price is the potential for an upgrade to EPS guidance at the 1H21 results release (due 19 February). To this end, the Company has maintained guidance for 9% EPS growth in FY21.
GMG is one of the better-placed REITs to benefit from bond yields settling/reversing from currently high levels, given that GMG is considered a growth + defensive investment. The upcoming interim results may just be the catalyst that the shares need.
Since early November, GMG has seen its share price soften slightly, leading to some short-term underperformance against the broader market. The decline in the share price during the last few months has been fairly shallow compared to the rally in the middle of 2020, so it doesn’t look too bearish at the moment. We can also see it sitting on top of the February peak, which is a good sign. This means that at the moment the short-term weakness appears to be a consolidation against a longer-term uptrend. Any strong bounce around these levels near $17 would indicate that the consolidation is over and that would be a buying opportunity. However, any sharp movements down from these levels would be viewed as a negative.
Michael Gable is managing director of Fairmont Equities.
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