Our Thoughts Post The FY23 Result.
Operating conditions continue to be strong for Goodman Group. Like-for-like NPI growth seen during the period suggests that logistics and industrials continue to outperform. Structural tailwinds will continue to provide Goodman with a strong growth outlook.
Guidance is as viewed conservative, with the market putting through EPS upgrades of ~3% post-result. GMG typically takes a conservative approach to its guidance so it’s not uncommon that the market would position itself 2-3% above guidance. Management's short-term incentives (STI) are driven by the Group meeting guidance, so it’s not unsurprising that they tend to set guidance with a degree of conservatism.
The reporting of unrealised performance fees for 2H23 has been pushed back ~6 months into 1H24 to better reflect the timing of when they are likely to be realised. GMG indicated that this is strictly a timing decision. Given GMG had comfortably met guidance ex the recognition of performance fees, the timing makes sense in our view.
Looking ahead, consensus estimates factor in a material slowing of earnings growth. EPS growth is expected to average ~16% p.a 2019-24E. Consensus has FY25-26E EPS growth halving to 8%, a level GMG achieved over the 2014-19 period.
Development earnings (60% of Group in FY23) are the key culprit, with growth expected to slow materially from +35% in FY23 to low single digit in FY24-26E.
Neither Investment earnings, mid to high single earnings growth, nor greater performance fee realisation from the pool of A$1.3bn unrealised performance fees will be able to fully offset the slowing of Development earnings in our view.
The evolving DC opportunity could play a useful role in supporting higher earnings growth for longer.
Why DCs Could Be x4 Better Than Industrial Sheds?
Goodman Group is well on its way to becoming one of the larger providers of data warehousing globally. The scale of GMG has taken the market by surprise. A$4bn (~30%) of its A$13bn work-in-progress (WIP) has been identified as data warehouse (or Data Centre) opportunities. These projects are expected to be funded ~50% on the balance sheet and 50% in partnerships.
95% are expected to be brownfield projects (across the Group and via GMG’s partnerships). GMG has indicated DC demand is being driven by existing customers, particularly the global hyper-scalers which are looking to build out their capacity into the end of the decade. Hyper-scalers are large-scale data operators typically found in cloud service providers. e.g., Amazon Web Services (AWS), Microsoft Azure, Google Cloud Platform.
GMG estimate that ~3-4 gigawatts (GW) of potential capacity is currently within the work-in-progress (WIP) pipeline. ~2GW of the 3-4GW is secured, with the balance being in the process of various development approval/power acquisition processes. Having access to the right amount of electrical power is as strategically important has having well located land.
Data capacity of this size would make Goodman Group a significant player in the global data warehousing space. The scale of this opportunity is yet to be completely understood, but with the recent boom in AI and increasing in demand for data storage, we expect the current data capacity forecast may need to be upgraded over coming years. The DC market is forecast to grow at a five-year CAGR of ~11.3% from 2021 to 2026 and at a ~20% CAGR for hyper-scalers (JLL).
The DC opportunity for GMG is significant, because of the materially larger pool of gross profit dollars, and higher margins that can be collected from a data warehouse development (over traditional logistics centre). Our analysis of industry estimates points to a 3-4x uplift in the total value created of developing an operating DC vs. traditional logistics centres on the same site.
This represents the total available monetisation opportunity. The actual returns for GMG will be lower – given the higher capital and construction costs of DC vs. a traditional warehouse.
GMG's 4GW DC Pipeline Is Significant.
3-4GW of data capacity is significant for GMG, as it represents a similar scale to that of a current hyper-scaler’s self-built capacity. The total capacity of the global third-party market is ~14GW, with ~4.1GW under construction. Total global third-party GW under construction increased ~260% over the past year and is expected to continue to keep growing. We expect that this trend will continue to expand as the demand for data skyrockets due to generative AI.
Hyper-scalers' self-built capacity reached 13.1GW at the end of 2022 with ~78% of the capacity being for Amazon Web Services, Google Cloud, Meta, and Microsoft Azure. These hyper-scalers remain a key opportunity for GMG. Amazon already represents ~10% of Group earnings. We expect the 3-4GW of capacity GMG speak too may increase over time as GMG works through the work-in-progress pipeline. The re-development/repurposing of existing industrial sites into DCs may become a significant opportunity.
Figure 1: Estimated global DC capacity verses GMG's DC development pipeline.
Is The Current Share Price Capturing The Opportunity?
The equity market currently values Australian/US DC operators some 35% higher than GMG’s current EV/EBITDA multiple (or >45% higher than where GMG was trading at the end of July 2023).
Assuming a data centre multiple of 27x on ~20-30% of GMG earnings that could potentially be DC-derived, this would imply a 10-15% point uplift in GMG's current EV/EBITDA multiple of 20x. Ultimately the economics of DCs for GMG is yet to be fully understood and quantified by the company.
Goodman As A Data Centre Operator.
GMG see data as a significant growth opportunity and is looking to explore what avenues the Group could explore in the future. One of these avenues could be operating the data centres. Currently, there is no defined pathway toward this, so no earnings and capital associated are being factored into market estimates, but GMG believes the group would be in a good position to do so. This decision will ultimately be dependent on whether power constraints continue, and demand continues to increase.
Goodman group’s shift to data warehousing outlines the structural growth of the business. Not only does it provide exposure to expanding growth opportunities, but it also highlights opportunities for margin expansion. Goodman group has done a great job of being exposed to legacy and emerging industries. The ecommerce exposure and partnership with Amazon became a strong competitive advantage for the business in ~2017 and has continued to provide growth opportunities for the group.
Figure 2: Goodman Group Forward 12 Month EV/EBITDA below global data centre operators
Can GMG Apply Its Competitive Advantage To DCs?
We see five key elements which underpin GMG's competitive advantage.
- Highly prized property portfolio and land bank in urban centres
- Global real estate enterprise and global client relationships of Fortune 500 companies.
- Deep experience with governments and councils on development/rezoning
- Developer skillset. GMG has a well-established track record of being able to handle all aspects of the development process from design, construction, completion, and ongoing management of the asset.
- Access to large capital pools via a variety of sources and partnerships across global markets.
In our view, these are transferable into the DC industry. Core DC knowledge can be further developed internally over time, or by bringing in external partners.
The Requirement For Power
The availability of land is a key advantage for GMG as it’s difficult to obtain high-quality sites in jurisdictions that fit the requirements of clients. An example of this is the availability of power, which is required to operate. To obtain these requirements, it can take a significant amount of work with power companies, and requires not only the right piece of land but also council requirements.
The Rise Of AI
Generative AI has become one of the fastest growing trends year-to-date and it poses a significant opportunity to operators like Goodman Group. The data intensity of projects is rapidly increasing, and the user base is now relevant for almost all industries. Generative AI requires a mass capacity of storage for raw (base) data to train its model and for newly generated data that is created. Gartner expects Generative AI will increase from >1% of global to ~10% of data worldwide by 2025.
Whilst the discussion of AI has entered the mainstream, data from McKinsey's 'The State of AI in 2023' survey would suggest that it’s still early days. The average adoption per industry is currently at ~0-10%. The possibilities for AI to be implemented into business operations are largely endless and it’s expected that a majority of businesses will be using AI to improve operations by ~2030. The World Economic Forum suggests that advances in natural language processes could increase global GPD by ~7% on the expectations that three-quarters of companies will adopt AI technologies over the next 7 years.
AI Euphoria
There is a clear degree of scepticism that remains when industries grow at the rate at which AI has been growing. Ultimately there will always be a degree of euphoria that encompasses these industry trends. The tougher part is determining what is, or isn't, actually relative to the AI boom.
For Goodman Group, the DC opportunity is a significant deal. Not only to the earnings base but to the growth prospects for the business. We view this as legitimate exposure to AI and expect the market will reward its validity.
A concern within the AI-exposed industries is the storage of data and the ability to scale it at the same rate of data creation Goodman is seeing this, with global hyper-scalers interest has gone vertical over the past 6 months and there is an urgency to obtain data centres for 2027-29. For customers to take full advantage of AI (particularly on-the-fly AI), it will require AI-specific hardware and optimised DCs. AI is only one element of these customers needing well-located land and proven ability to develop industrial-like assets
Risks to Investment View
Investment View
Industrial assets continue to be some of the best-performing in the AREITs. Rental growth is strong, supply is constrained, and demand is continuing to expand. In our view, Goodman Group is well-positioned to benefit from these industry tailwinds.
The development pipeline remains robust, with new areas of growth such as data and residential providing multi-year optionally. Datacentres are becoming a more meaningful part of the business (30% of the A$13bn WIP workbook), with 3-4GW of potential power identified within the portfolio.
Goodman Group remain conservatively geared at the lower end of the AREIT sector, and significantly below global peers. We expect GMG to continue to run its conservative leverage model as it has proven beneficial through the current rate hike cycle.
GMG remains well-positioned to benefit from the growth of e-commerce and the growth in DCs. Whilst the share price has had a notable move up, the multiple does not look overly extended at current levels. GMG is only trading slightly ahead of its long-term average PER of ~20x despite the expanded growth prospects from data centre operations.
We see upside earnings risks to FY25/26, driven by the performance fee backlog and further development of the DC business. This could see a continuation of the elevated development earnings for longer than what the market is currently forecasting.
Figure 3: PER trading slightly above the 10-year average and 1SD below the 6-year average (time since Amazon/e-commerce ramp-up)
Figure 4: Goodman Groups P/FFO remains below global peers.
Figure 5: GMG's ROE is significantly above its long-term average.
Figure 6: Dividend yield remains largely flat on 2022 levels.
