Goodman Group (GMG) Earnings Call Transcript & Summary

Thank you all for standing by, and welcome to the Goodman Group FY '22 Full Year Results. [Operator Instructions] Please be advised that todays conference is being recorded. And I'd now like to hand the conference over to your speaker, Mr. Greg Goodman, CEO. Thank you. Please go ahead.

Thank you. Good morning, and welcome, everybody. I have Nick Vrondas here this morning with me on the call. Firstly, I'd like to begin by acknowledging the traditional owners of the land on which I'm presenting from today, the Gadigal People of the Eora Nation, and pay my respects to elders past and present. Goodman has delivered a strong FY '22 result with operating profit of $1.5 billion, and operating earnings per security at $0.813, up 24% on the last financial year. Statutory profit was $3.4 billion, up 48%. This includes the group's share of $8.5 billion of valuation gains. We continue to be prudent and patient with our capital. Gearing remains low at 8.5%, while the group has over $2.8 billion of liquidity available. By focusing our portfolio and development workbook on key infill locations, we're seeing very high demand, little to no vacancy and accelerated market rental growth. This has contributed to the growth and outperformance of our partnerships, which delivered an impressive return of 21% on average. As a result, all areas have contributed to the group's solid performance with investment earnings up 20%, management earnings up 28%, and development earnings up 34%. Our customers are dealing with inflation and cost increases around the world. So we're helping them to be more productive and sustainable in their supply chains. We're working closely with our customers to optimize space, leverage technology, provide strategic locations that lower transport requirements, costs and delivery times. The volume, scale and value of our developments has increased. Work in progress is now $13.6 billion, which is up 28% on last year. We're seeing good opportunities in our development program around the world with 85 projects on the go. Developments were 99% leased on depletion with an average lease term of 12.2 years. Construction costs have continued to increase globally. However, margins remain strong as accelerating regional growth is outpacing impact of these increases. Consistent execution of our development workbook and value add across our sites is contributing to margins and offsetting cost pressures. Total assets under management have increased to $73 billion, supported by strong revaluation gains, development completions and acquisitions. We have $18 billion of undrawn capital, and average gearing in the partnerships of 17.5%. This provides plenty of support for growth as we continue to look for opportunities to provide deep long-term value for our partners and investors. Property fundamentals remain strong in our markets with very high occupancy of 99%. Customer demand and low levels of supply have seen market rental growth accelerating. And as a result, passing rent reversion to market across our portfolio continues to expand. North America is the largest at over 40%, Australia and New Zealand at around 20%, Continental Europe and U.K. at 18%, and Asia has been more subdued at 4%. Now turning to Slide 6. Goodman is proactively responding to and delivering on our ESG commitments. We're taking action by reducing carbon emissions, regenerating infill sites, using renewable energy, developing greener buildings, building more equitable supply chains and through the Goodman Foundation partnering with community groups where we distributed $11.6 million throughout the year. Working with our customers and reducing our carbon emissions remains a priority. We have emissions reduction targets validated by the science-based target initiative. We're also on track to maintain carbon neutrality for our operations. And importantly, we're addressing the embodied carbon in our developments and investigating low-carbon materials. Now I'll hand over to Nick, who will take us through the results overview.

Thank you, Greg. Let's turn directly to Slide 10, please, to look at the income statement. We'll first cover the items that relate to our cash-backed measure of earnings, which we call operating profit and then discuss the items at the bottom of the table. We've used the same cash-backed measure consistently for over 15 years, and we continue to believe that it's the best representation of performance on realized profits. It excludes fair market value gains on properties that are unrealized. It also excludes mark-to-market movements on our hedges and the accounting fair value estimate relating to our employee long-term incentive plan. Overall, FX movements have not had a material impact on the translation of our foreign income when compared to the prior year, so we can just focus on the key operational drivers of the results. Looking specifically now on the movement in investment earnings. We've seen an increase of $83 million or 20% on this segment over the year. Net rental income from the directly owned assets is $24 million higher. This was due mostly to the addition of $250 million of stabilized assets over the past 24 months through net acquisitions and development completions. We had nearly $570 million of property inventory completed, but at the same time, we sold investment properties and have taken some off-line to commence their redevelopment. It's been typical in the past few years that we accumulate inventory until we can optimize our exit. These completed assets generate rent whilst on the balance sheet. As previously indicated, the growth in the workbook in the past couple of years has resulted in a commensurate increase in the working capital allocated to development. The net cash investment that added to inventories is reflected in our operating cash flow in the statutory financial statements. This was by far and away the largest cause of the difference between operating profit and operating cash flow for the period. Given the nature of these assets, some of them will come out of the portfolio, and so too will the rent they generate. So we don't expect to see this part of the income statement growing over the next few years. The other part of our investment income comes through our cornerstone interest in the partnerships. Over time, we want to grow this part of the business as we continue to expand our portfolio of assets under management and our investment in it. We also expect growth in rental rates to add to our income. Compared to last year, cornerstone investment income increased by $59 million or 18%. Rental growth accounted for $17 million of the increase, which is the result of the like-for-like NPI comparative. The net impact of acquisitions, disposals and development completions contributed $42 million of the growth. Over the past 24 months, we have invested a net $1.7 billion into the partnerships globally, $1.2 billion of which occurred in the past 12 months. The majority of these investments have been for the purpose of acquiring development sites and funding development CapEx. The remainder is related to acquisition of income-producing assets that are either for future value-add or redevelopment or the acquisition of completed assets from the group. The average income return on our capital contributions to the partnerships has been relatively consistent at around 4%, with a low initial yield on their acquisitions being offset by development completions at a higher yield. The benefit of our strategy shows up in the long-term income growth and total returns of the partnerships. Management revenue was up 28% or $129 million over the year. The volume of stabilized third-party assets under management has grown by $17.4 billion over the past 2 years to now stand at $60.6 billion. This has been driven by strong revaluation gains of $8.2 billion in FY '22, on top of the $5.6 billion in FY '21. The remaining increase came from net acquisitions and the completion of developments. The weighted average increase in stabilized third-party AUM was over 20%. As a result, ongoing management fees have increased by $70 million. Our base fees represented around 0.75% of that AUM. Performance and transactional revenues contributed $208 million this year compared to $149 million last year. Total management fee revenue as a percentage of average stabilized third-party AUM was 1.1% this year, broadly in line with last year. The timing of performance fee recognition may vary in any given year, depending on calculation dates and the degree of certainty ascribed. Over the long term, we continue to believe that 0.9% of third-party stabilized AUM is a good estimate for our likely management fee revenues. With AUM likely to grow through development and there being a backlog of unrecognized performance fees, we continue to see scope for growth in the management services over time. Development remains an important part of our strategy. We create significant value throughout the development and asset management process. It comes from the identification of assets and the construction of the portfolio, achieving planning outcomes, project delivery and then affecting the leasing outcomes. We've continued to execute on these core functions very well despite the challenges the world is facing, so our margins have been sustained. Strong risk management, cost control and rent increases in the markets we have chosen to operate in have supported the outcomes achieved. Over the past few years, the increase in development volumes has been a significant driver of income growth. The estimated end value of work in progress has increased from $6.5 billion 2 years ago to $13.6 billion to date. The development period for the projects has also increased from 17 months to 23 months. So our average annualized production rate has increased from $5.7 billion in FY '21 to nearly $7 billion this year. So as you would expect, our income has grown strongly. Realized development income was $961 million compared to $718 million for FY '21, representing 34% growth. I also want to point out that in addition to the realized cash income, over $650 million of development income was recognized as our share of revaluation gains that sit outside of operating profit. Of this, $334 million has resulted from properties that are subject to conditional contracts for sale. With the $96 million we had as at June 2021, it brings the cumulative tally to $430 million, which we expect to close over the coming period. If and when those sales complete, we will reflect these gains in our measure of cash-backed operating profit at that time. Customer investor demand for development opportunities remains positive at this time. We intend to continue to pursue the development-led approach to investment, provided the opportunities remain appropriate. This will drive growth in AUM and investment income and sustained income from the development business. We are aware of the risks in the market today, and should the environment turn, we can temporarily alter our strategy accordingly. Over the long term, however, the development-led approach has served us well and will ultimately be a long-term driver of our business. Growth in our operating expenses was 19% or $55 million, which is in line with our previous guidance and still moderate in comparison to the nearly $0.5 billion increase in investment, development and management earnings. Our employee base has grown to facilitate the growth in the business, and we have recognized the recent performance of the team and current labor market conditions. We've had an increase in some of our compliance costs, some business travel has returned, IT expenses are up, and we have scaled up our charitable contributions, again, too. Our aim is to keep the fixed cost relatively steady and instead to use at-risk variable costs such as STI and LTI plans to incentivize and align our people. Our borrowing costs were higher due mainly to new debt rates. Our tax expense was up given the growth in profitability. So as the nonoperating items are concerned, we had over $2.3 billion of revaluation gains in the year, which represents the group's share of the $8.5 billion in gains across the entire portfolio of assets under management. Cap rates compressed over the first half but remained relatively stable in the second half. On the other hand, rental rates accelerated over the second half, which became a very significant driver of those valuation gains. Development and valuation gains also continued to contribute to the total valuation result with $1.7 billion of the $8.5 billion recorded over the year. Around $0.6 billion of this was the result of developments completed within the period and the remainder was from gains emerged on investment properties under development to reflect their significant progress. The outlook for cap rates is less certain now, but the rate of rental growth is accelerating. The interaction between the 2, rents and cap rates, will determine the outlook for valuations in the coming period. We believe that in the long run, the quality of our portfolio and its growth prospects will ultimately transcend any near-term volatility. Another customary area of difference between operating and statutory profit is the fair value movement in the hedges, which were down $191 million overall. Mark-to-market derivative gains or losses are reflected in the income statement because the group does not apply hedge accounting. These movements should be considered in the context of the $144 million gain reflected directly in equity through the foreign currency translation reserve. The FCTR gain represents the translation of the foreign-denominated net assets for which the group holds derivatives to hedge against exchange rate movements. The net result of these movements is reflected in the statement of comprehensive income but excluded from operating profit calculations. As usual, we also exclude the accounting cost of the employee LTIP, but we include the tested units in the denominator when calculating our operating EPS. This is when they actually have an impact on security holders. The accounting cost of the LTIP has declined this year, mainly due to the decrease in the security price. A few remarks now regarding the balance sheet on Slide 11. The FX impact on the balance sheet when compared to June -- comparing June '22 to June '21 was not material. Despite the sales over the year, the wholly owned stabilized asset portfolio has increased in size. This was mainly the result of nearly $0.5 billion of assets being transferred in from development, around $0.5 billion of acquisitions and $260 million of revaluation gains. Partially offsetting this was over $820 million of disposals. Our share of the stabilized assets within our cornerstone investments in partnerships were up by $3.2 billion over the year. Around $1.8 billion of this was the result of the valuation and the remainder was due to net new investments and the completion of developments. Compared to June 2021, our development holdings are up by $0.8 billion overall. We had a $0.8 billion increase in our share of the partnership's development capital allocation. The investments, expenditures and revaluation gains from projects still in process exceeded the volume of assets completed. Noting again that some $0.5 billion of inventory was classified as stabilized property post its completion. Our cash position increased by around $130 million over the year. The cash generated from our retained earnings and the proceeds from our U.S. dollar bond issue funded the investments we've made, which is consistent with the design of our long-term capital management plans and the distribution policy. That's a good point to turn to Slide 12. As we said before, we'll operate our gearing within a range of 0% to 25% with the level to be set with reference to the mix of earnings and activity levels. In light of the continued growth and development, we aim to maintain low financial leverage for the foreseeable future. In addition, we continue to invest in the business to generate strong returns and fund its growth sustainably. That's why our distribution per security is expected to remain at $0.30 for FY '23. We have a strong hedge profile. So exposure to FX and interest rate movements is limited. That's all for me. Thanks, Greg.

Thanks, Nick. And now let's turn to the outlook on Slide 20. Goodman's agility, locational strategy and strong balance sheet mean we're well positioned to continue to adapt to the ongoing market challenges. We remain focused on providing deep value and operational excellence for our customers and all our investors. We forecast to deliver a positive FY '23 off the back of a very strong year. We have a significant development workbook underway, continued underlying structural demand from our customers and a robust capital position across the group and the partnerships. And as a result, we expect FY '23 operating EPS growth to be 11%. Thank you, and now we'll take questions.

[Operator Instructions] Our first question comes from Grant McCasker at UBS.

Greg and Nick, thanks for the detailed remarks. Can we just touch on the development earnings for a second. If we look through -- first of all, would you consider this a normal year? And what I mean by that, it looks like throughout the year, you've probably completed nearly $1.5 billion of product on balance sheet, albeit you've sold it down, and you're highlighting sort of a large development profit coming through in FY '23. Is this what we should expect going forward that you do that level of development and completions on an annual run rate on the balance sheet?

Certainly, when you look at the demand around the world and the opportunity set, yes, I think that's right. And we're looking at a lot of, even currently, a lot of large sites around the world which are in the regeneration -- regeneration sites and regenerative nature. And some of those are actually taken, as you know, on balance sheet, we work through them. And then there -- once they're derisked or they're planned or there may be infrastructure outcomes, they can go through, there's also activities around data centers as well with the same scenarios, land, supply power, could be 2 or 3 years in the making. And that tends to be what comes across the balance sheet into partnerships once we've had a significant derisking event on the way through. Yes, so look, I think moving forward, development is going to be robust. There is going to be use of the balance sheet when appropriate. There is going to be derisking of certain sites that are more of a regenerative in nature. And effectively, that's something we've been embarking on over the last 4 or 5 years. I think over the next few years, that will accelerate. But Nick, would you like to make a couple of comments?

I think, Grant, look, I think that for the purpose of modeling and projections, I would say, yes, you can run with that. But if that changes, and it can change over time in terms of the mix, I think, is the nature of your question in terms of where it's originated and where it completes. And our proportionate share of the income that results from where we -- at what point in time do we sell it down as it changes and if it changes, we'll keep you notified. But I think for the purpose of financial projections. That's the best way to look at it.

Okay. So then are you able to then maybe just give a bit of a guidance at the $1 billion of development earnings, what comes from sort of balance sheet development profits versus the season promotes from the funds?

Yes. No, we don't really give specific breakdowns on how that comes about. But what I will say is -- and you'll sort of recall from previous calls and discussions that the fee component relate -- the way our fees generally work is that we earn base kind of project management, development management fees, which is typically around the sort of 5% mark and then we get a percentage of the return over the benchmark. That benchmark, in some cases, is 0%. In others, it's up to 10%. And we typically would get something like 20% of the overage as a result. You can determine from yields on costs and where you think cap rates are, what kind of margins we're generating and therefore, with the percentage mix of what's on balance sheet and what's in partnerships, I think you can derive some conclusions around that, but we don't give specific breakdowns.

Okay. And then just one further one. Are you willing to just put a sort of an end AUM or third-party AUM number out there for the end of FY '23?

Look, pretty to do the calculation, it will be through $80 billion, and that's just for the run rate on development. What we're doing though and look at the partnerships and where they're sitting, average gearing, 17.5%, $18 billion of liquidity or opportunity for our investors. And we've just taken a couple of those opportunities in the last actually 2 or 3 weeks on some bigger sites and into the partnership. So I think you'll find that primarily with the capital, with the demand and with the opportunity, we'll be growing the asset under management relatively strongly subject to where valuations finish up and things of that nature over the next 12 months and currencies as well.

Our next question comes from James Druce of CLSA.

Greg and Nick, just a question on the DPS. Are we getting close to a point where that is going to grow or you think the outlook for the next little while is going to continue to retain more and more capital?

Sorry, James, was that the DPS?

Yes, just looking at the $0.30 guidance. So you're retaining more and more capital each year to fund the development pipeline. Just wondering when you expect that to start to grow.

It's something that we constantly reviewing and the Board constantly reviews. And so looking at the opportunity set that's out there looking at where our cash needs are and wanting to sustainably fund the business into the future, we deem at this point in time, it's appropriate that we continue to pay out $0.30. So that's something that we'll keep you posted in the future. I think we'll get to a point where we are generating enough free cash flow out of the retained earnings that we feel comfortable to increase at some point. But right now, we're looking down the barrel of a lot of opportunity that's quite attractive. And so it's appropriate for us to maintain distribution where it is for the short term.

Okay. That's clear. And just with your conversations with tenants, can you talk about how their CapEx priorities have been changing over the last 12, 18 months, just in relation to how they see the importance of automation or otherwise?

Yes. Really good question. And that's part of the, I think, the situation where we're seeing the opportunity that there is a very, very big focus on productivity out of buildings. I'd talked about it. I've been talking about it for the last number of years, but it's come to a point now where it's not optional. You must have a building that is operationally very, very efficient. It might cost you more. It certainly is costing you more, but you need to get more out of it. So the conversations with our customers around the world, going to my earlier comments, all about productivity, all about location. Location is really important in regard to drayage and costs of getting goods to and from the warehouse and where they're going. So that is way more important than it was, say, 5 or 6 years ago. And fundamentally, those locational aspects are now starting to pay dividends for the customers, but also means there's a lot of demand in the locations Goodman is around the world. And when we look globally -- and this hasn't happened in my 30 years in this business, where I do not have a -- or we do not have a warehouse available anywhere in the world in our portfolios, they're practically all full 99%. And the only buildings that are available are the ones we're building. So we're building into, primarily in our locations around the world, into markets with no buildings available. So I think I've never seen it before. But that is, I think, going to the nub of your question, which is around what are they doing, what we're seeing is they are actually looking for new facilities in critical infrastructure style locations where productivity is the key, and yes, they'll pay an extra 10% or 15% rent to get that productivity. And that's certainly what we're seeing. And we don't see that slowing down in the current inflationary environment. And if anything, the conversations with the customers are more urgent now than they probably were even a year or 2 ago.

Okay. And one more, if I may. Just how rent growth has changed over the past 6 months around the world just by market, if you can give some color there, please?

Yes. Look, I mentioned in my opening remarks in regard to mark-to-market. So I think that's the way you want to look at the valuations and the cash flow going forward, and we sort of did a bit of a spread in the U.S. So that's about 40% under. And I think some of the comments from some of the other big U.S. operators probably attest to that. I think Europe about 18% under. Then you work through Asia, primarily more subdued around 4%. And bearing in mind, Hong Kong will be sitting at about 2% -- 2% to 3%, but you've got to take that into account that the Hong Kong, China has basically been shut for pretty much 3 years now. So we expect some more activity and growth in rents in those locations probably as we go through an opening up process, which may be in the early type of the next calendar year. Aussie about 20%. New Zealand, similar sort of numbers under market. So look, we are hopeful that over time, certainly over the next 4 or 5 years, those rents will come through in the cash flows, and that will support and grow valuations. And when we look around the world as well, we're looking at a lot of our real estate, even at the valuations they sit today, is sitting under replacement cost. So I think we're feeling really good about the cash flows and the growth in the cash flows and the rents, but it's all about delivering the service to the customer and making sure that if the rents are moving, we're offering something to our customers that allows them to be more productive so they can afford to pay more rent. So we can't forget about where the money actually comes from. And that's primarily the customer and then ultimately the consumer.

James, the only thing I would add, just that the rate of market rental growth in the last 6 months has been the highest on record. It's accelerated in the last 6 months. And the outlook in the next 6 months is equally strong.

Our next question comes from Stuart McLean at Macquarie.

First question is kind of relating to the divi being flat this year. I was wondering what are you expecting the production to be next year? And the reason I asked is it was $7 billion in 2022, you're retaining more capital, I'm assuming that the production number starts to move higher.

Not necessarily significantly. It could do, and that's a possibility. But it doesn't need to move significantly. I mean, the delta on the retained earnings, Stuart, isn't that great in the sense that if we grow the divi by 10%, for example, that's the amount of capital in any 1 year. And then if you break that back to what proportionate share of the development with or the production rate, that means from a funding point of view is it's not that material, where it becomes material is in the long term, the compounding effect of that over time, plus once you've raised the divi, you don't want to be going backwards either, right? So we want to do it at a time when the next level of distribution is going to be the sustainable level going forward. So I wouldn't read too much of a direct linkage in those numbers in the short term. I think, yes, the outlook for production rate, the average this year was just under $7 billion. Right now, as we sit here today, we're just over $7 billion in terms of the spot position. So you could infer that in the coming 12 months, the production rate will remain above $7 billion. So there will be some growth, and that's what we've allowed for. If it grows even a little bit more than that, it's not hugely sensitive, and it's not like we're going to go cut the divi anytime soon to do that -- to deal with that. But in the long run, it's really about sources and uses strategy that's sustainable and reliable that the market can be comfortable with.

Okay. And speaking on the outlook for development, commenced $7.9 billion of developments this year. Should we expect a similar type of number going into FY '23, given the demand that you just talked about before?

Yes. Look, that's a [indiscernible]. I think the production rate or the time in production months may come down a fraction. And so even if we're not starting as much or the WIP balance itself can be a little bit -- it can stay at these levels, but still have higher production rate as well. And so, look, I think it's not a bad guide, but we certainly think that the production rate is going to be sustainable at $7 billion plus for the coming period.

And one other, just on the guidance, I think, Nick, you provided in regards to investment earnings being about 90 basis points of generating AUM. Just looking back at prior calls, I think you're going to closer to 1%. Is that just a rounding thing? Has anything changed to bring it from 1% down to closer to 90 bps?

Well, I think the biggest difference has been that the -- because cap rates have come down lower and a chunk of our base management fees are rental based, and so that doesn't actually move with rising property values, it's just the rental rate. And so that needs to be adjusted. So if cap rates were 5%, then it's more likely it will be closer to 1% because the rental proportion is higher. Does that make sense?

Yes, yes. That's very clear.

Our next question comes from Sholto Maconochie at Jefferies.

Just a few follow-ups. The performance fees were $208 million this year. What's the level left going over the next 5 years? I think it's around $1 billion on the last call. What's your assumption on performance fees going forward in the next sort of 5 years, retained?

Yes. The estimate at the moment of backlog is $1.2 billion.

Okay, $1.2 billion. And then just on the WIP, it looks like from the third quarter, if you look at the margin, I'm just trying to set guidance [indiscernible] conservative. If you look at the yield on cost went up 10 bps, cap rates stable. So margin at the gross level, 65%, which is still quite elevated. So I just want to work out the guidance, did you assume in the guidance any of that $430 million in the guidance? Or is that on top of the 11% you've guided to?

No, no, that's part of it. That's part of it.