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Morningstar | Search for Yield Remains a Powerful Tailwind for Goodman. FVE Increases 7% to AUD 12. See Updated Analyst Note from 15 May 2019

After raising fiscal 2019 earnings guidance to growth of 9.5% from 7% in February, we weren’t expecting any further upgrades as part of the third-quarter update. That said, narrow-moat-rated Goodman provided a mini-upgrade, advising assets under management, or AUM, will exceed AUD 45 billion by June 2019, up by at least AUD 2.1 billion or 4.9% since December 2018 when AUM was AUD 42.9 billion. Part of the uplift will be due to movement of development assets to completed assets, with the balance attributable to further asset value appreciation driven by rent growth and potentially a further reduction in market yields.

The most interesting takeaway was management advising it was possible for the overall industrial market to go through a period of contraction in outer years. CEO, Mr Goodman stated the possible catalyst was consolidation in the automotive industry and increased use of car sharing would hurt the logistics industry. Goodman believed it was well insulated from this given its focus on strategically important sites, rather than sites in commoditised locations where rents were low and very sensitive to volatility in demand and occupancy.

We’ve slightly increased our forecast for developments. This flows into a higher rate of growth in external assets under management and the associated fee income. We’ve also reduced the firm's weighted average cost of capital to 8.0% from 8.2% to capture the benefit to the firm of locking in ultra-low-cost debt for an extended period. The firm has a weighted average cost of debt (inclusive of derivatives and facility costs) of just 2.4%, with a weighted term of 6.5 years. Incorporating these revisions sees our fair value estimate increase to AUD 12.00 from AUD 11.20. At current level, the stock continues to screen as overvalued currently trading in the range of around AUD 13.30.

Separately, it was positive to hear Goodman expects in the next 12 months to commence site works at the recently acquired ultra-high-value site in Hong Kong to develop a multilevel logistics building. The end use of the site isn’t known, but we expect it will become a data centre as this appears to be the highest and best use for the site. Accordingly, Goodman expects in the next 12 months for work-in-progress, or WIP, to jump from the current AUD 3.7 billion to close to AUD 5 billion.

Our long-term assumptions are unchanged, which is for WIP to grow at a 10-year CAGR of 3.2%. Major drivers include a focus on in-fill sites that have very high end values. The focus on strategic infill sites supports superior rent growth and we forecast a 10-year rent CAGR of 2.2%, being a combination of current rent growth of 3.3% that falls away to 2% a decade from now.

We expect external AUM growth to significantly exceed WIP growth, with a forecast 10-year CAGR of 9% supported by a gradual increase in the value of new buildings completed each year. This level of forecast AUM growth is arguably high, but for context is 30% lower than the 13.1% CAGR in external AUM for the five years to June 2018.