We lift our fair value estimate for Goodman GMG to $27 per security from $24, on transfer of coverage to a new analyst. The increase is primarily driven by a lower weighted average cost of capital assumption and our updated outlook for Goodman’s development pipeline.

Our current weighted average cost of capital (‘WACC’) of 7.0%, compared with 7.3% previously, is in line with similar Australian REITs under our coverage. We forecast Goodman’s development pipeline to reach $20 billion in the medium term, significantly higher than our previous assumption of $11 billion-$12 billion. This is due to Goodman’s pivot toward larger-scale, higher-value data center projects, which typically have higher margins than logistics developments.

At current prices, Goodman’s securities screen as materially overvalued. The market is bullish on the future growth of data centers amid the boom of artificial intelligence, the Internet of Things, and cloud computing. However, we are more cautious about assuming maintainable excess returns from data center investment in the longer term.

There are significant risks to Goodman earning above its cost of capital over the long term. First, data centers are a capital-intensive business. In some cases, Goodman not only develops, but also manages and operates fully fitted turnkey data centers. The group is responsible for power supply and fit-out. With the rapid development of technology, there could be risks of data center obsolescence, which may require intense capital spending on asset upgrades. Second, competition in the data center space is intensifying, as many rival REITs and data center operators are rapidly adding new supply, and suitable locations will be harder to obtain. This could introduce price competition and erode Goodman’s returns over time.

We maintain Goodman’s narrow moat, Exemplary Capital Allocation, and Medium Morningstar Uncertainty ratings. Despite the increase in our fair value the shares remain materially overvalued and trade at a 38% premium.

Business strategy and outlook

Goodman operates an own-develop-manage business model. A typical cycle starts from acquiring a site and developing it. Completed projects are either sold or retained in one of Goodman’s funds or partnerships. Goodman typically retains minority stakes in the investment vehicles and continues to manage the sites after completion.

The group’s development-led strategy fuels growth of its asset base. As of June 2024, Goodman’s assets under management, or AUM, reached AUD 78 billion, nearly triple the asset base of 10 years ago. Its development pipeline has also experienced significant expansion, growing to AUD 13 billion in fiscal 2024, compared with fiscal 2014’s AUD 3 billion. With a large development pipeline and an active development strategy, we expect AUM to enjoy high-single-digit percentage growth over the medium term, and the management segment to contribute almost 40% of group’s midcycle operating earnings.

The pivot toward larger-scale, higher-value projects not only expands pipeline size, but also increases project lead time. Today, an average development project takes 25 months to complete, up from 17 months in 2020. This reflects a higher percentage of data center projects, an area of focus for Goodman in the short to medium term.

Despite larger developments, capital management has remained prudent. Most development projects have capital partners involved, with high tenancy precommitment and long leases secured. The company has been rotating properties into its funds or disposing of its assets to external third parties. By doing so, Goodman is redeploying capital to new opportunities, and maintaining low leverage on its own balance sheet.

Goodman prefers urban infill locations in core gateway cities, and this adds to the appeal of its portfolio. These locations—typically in established and densely populated neighborhoods and close to end-consumer markets—are supply-constrained. Good locations, combined with structural tailwinds like e-commerce and cloud technology booms, are likely to underpin solid rent growth in the medium term.

Goodman bulls say

  • Structural tailwinds, such as rising e-commerce, supply chain transformation, and cloud technology are likely to continue having a significant bearing on industrial property demand.
  • Goodman’s large development pipeline is supported by its balance sheet capacity and the capability to attract capital partners.
  • Goodman’s investment vehicles are gaining investor inflows given their scale, strong track records, management expertise, and the ability to secure leases prior to development completion.

Goodman bears say

  • Industrial property has benefited from several years of tight supply, and rents have increased dramatically. There is a limit to how much more rents can grow, as tenants may not be able to keep paying higher rents if productivity is not going up at the same pace.
  • Rival REITs are competing to acquire industrial property and establish funds management businesses.
  • Goodman’s data center developments hinge on its ability to secure infrastructure and power. Regulatory approvals and environmental policy are a wild card.

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Terms used in this article

Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.

Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company's future cash flows, resulting from our analysts' independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued.

Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn about finding different sources of moat, read this article by Mark LaMonica.

Uncertainty Rating: Morningstar’s Uncertainty Rating is designed to capture the range of potential outcomes for a company. An investor can think of this as the underlying risk of the business. For higher risk businesses with wider ranges of potential outcomes an investor should consider a larger margin of safety or difference between the estimate of what a share is worth and how much an investor pays. This rating is used to assign the margin of safety required before investing, which in turn explicitly drives our stock star rating system. The Uncertainty Rating is aimed at identifying the confidence we should have in assigning a fair value estimate for a stock. Read more about business risk and margin of safety here.