Why Goodman Group remains sanguine about looming headwinds
The share price of Goodman Group (ASX: GMG) has plunged around 27 per cent since the start of the year as some investors began to price in headwinds for the commercial and industrial property business. Nick Vrondas, Group CFO, addressed these issues at the recent Macquarie Group investment conference, and explained why he is confident that growth remains on track.
Last week I was fortunate enough to attend the annual Macquarie Conference, Australia’s largest investment conference. It was the first time since 2019 the conference was held in person, although offshore investors were again absent given some lingering challenges on international travel. Aside from the usual attractive line-up of Australian corporate presentations, the conference also provided a good opportunity to catch up with the investor community for the first time in three years.
One of the companies that presented at the conference was, Goodman Group (ASX:GMG). The company’s share price has been under significant pressure in the past two weeks, with the sell-off triggered by comments from Amazon regarding an overbuild of capacity as a result of extremely elevated demand conditions arising from the pandemic (i.e. the “stay-at-home” e-commerce boom), leading to significant price declines in global peers Prologis (PLD US) and Segro (SGRO LN). Concerns around higher rates haven’t helped either, as fears over a broader industry overbuild raise concerns around the certainty on future rent increases.
Nick Vrondas, Goodman Group CFO, addressed some of these issues at the Macquarie conference. Below are some key points he made at the conference.
GMG being aware of the Amazon’s reduced need for space, and its impact on future development
The CFO suggested this was not the first time Amazon has flagged excess capacity, with a similar comment in 2017.
GMG’s exposure to Amazon (ex AWS) is 5-6 per cent of rent and around 10 per cent including AWS. In terms of global lease space, Goodman represents around 2.5 per cent of Amazon’s global lease space, which they believe is essential and core to Amazon’s business given its infill locations.
In terms of the development book, GMG is currently working on three projects for Amazon (out of 85 projects globally) or about 5 per cent of WIP.
The CFO believes peripheral space was taken up in anticipation of volume growth. While he expects Amazon to grow into this capacity over time, he believes imminent needs may not be required.
Outside of Amazon, the CFO believes there are a whole raft of industries and businesses that are still trying to play catch up for their supply chain and delivery capability to the consumer.
Recent changes and disruptions to supply chains and the changing origin of goods is likely to lead to significant levels of activity in the sector, with GMG continuing to see demand. The company continues to focus on good locations and quality assets that are generic and adaptable and appeal to a wide audience.
In short, the CFO was aware of the comments – this is unsurprisingly given share price moves and likely investor enquiries – but remains comfortable with the company’s position and does not change what the company is doing.
Tenant demand – and depth of the market on a development asset
Dependant on market and location, he cited one of GMG’s new developments in the Orange County area in California, where there were five-to-six interested parties, and the company recently closed its first pre-lease with an unnamed grocer. GMG sees grocers and general merchandising remaining active, while 3PL providers are also very active.
Level of development WIP
CFO re-iterated previous comments that depending on conditions, GMG can move higher (circa $13bn) but will not try and pre-empt, and instead focus on profitability and quality. The CFO also commented on potential volume for margin trade-offs, and that WIP is not the entire earnings story.
GMG’s growth in net operating income rent was 3.4 per cent in the 1H FY2022. However, market rent growth is running well ahead of this at the moment, especially in certain regions (LA, London). For example, GMG’s closest peer Prologis recently reported around 20 per cent growth in infill rents, after 20 per cent growth in calendar year 2021.
The CFO has suggested there is catch up and embedded growth the company has yet to enunciate to the market, as rent is indexed over the life of contract and access to reversion will be a few years away on market review. However, market conditions will be reflected in the value of its portfolio.
The CFO also cited the possibility of providing some guidance over the rental growth in upcoming disclosures.
Impact from interest rates and asset allocation
GMG has been focused on total return, with its co-investors focused on longer-term asset and liability matching.
Investor appetite remains broadly unchanged, as there has been increasing recognition of the industrial asset class being core. For example, asset managers would have circa 10 per cent of assets in Global Estate (REITs), of which 10 per cent was Industrial. There has been broader recognition this will need to increase over time.
Return expectations are very much about total return – i.e. yield + growth. For long-term investors, the CFO believes 4 per cent rent (cap rate) + 4 per cent growth on unlevered basis remain attractive for long-term ownership.
Investors may have benchmarked at 6 per cent under easy monetary policy settings, but the CFO believes this is closer now to 8 per cent.
Construction costs + inflation, and offsetting factors?
The CFO suggested construction costs were up 15 per cent on average over the past 12-18 months. He anticipates the rate of escalation may diminish, but will still escalate from here.
Supply chain impacts on material costs will need to be monitored.
However, in terms of total project value and Work in Progress (WIP), construction represents one third of the amount, with the remainder being land value + margin.
GMG believes cost escalation remains manageable for their portfolio, and that rental growth can offset and pass this on.
The Montgomery Funds owns shares in Goodman Group. This article was prepared 9 May 2022 with the information we have today, and our view may change. It does not constitute formal advice or professional investment advice. If you wish to trade Goodman Group you should seek financial advice.