Sandstone Analysis: Goodman Group's growth driven by rising Data Centre investment

ASX code: GMG

Suggestion: Buy

Need to know

• Data centre (DC) spending intentions across the 2025 to 2027 estimated period from global hyperscalers have increased by 6% during the third quarter (Q3) of 2024, reaching $925 billion. In parallel, Nvidia (NVDA) earnings have been upgraded by 11% over the same period
• Goodman Group (GMG) currently holds a DC development opportunity with a capacity of 5 gigawatts, which we estimate could have a total development value of $40-50 billion
• The price-earnings ratio (PER) multiple for GMG has risen by 30% to 30 times over the last 12 months. With spending intentions across the DC ecosystem continuing to be upgraded, we retain our Buy recommendation for GMG.

Investment overview

Industrial assets continue to be some of the strongest-performing in the real estate investment trust (REIT) sector. Rental growth is robust, supply is constrained, and demand is expanding. Goodman Group is well-positioned to benefit from these industry trends over the coming years.

GMG’s development pipeline remains strong, with DCs providing multi-year growth opportunities. DCs are becoming a larger part of the business, with over 5 gigawatts of potential power identified in the portfolio. Hyperscalers' capital expenditure (CapEx) indicates that the increased investment cycle into DCs is ongoing. GMG’s ability to secure prime locations with strong power allocation solidifies its position as a key player in DC development.

GMG remains conservatively geared at the lower end of the Australian Real Estate Investment Trust (AREIT) sector, significantly below global peers. We expect GMG to maintain a conservative leverage model, as it has since the global financial crisis (GFC).

GMG is well-positioned to benefit from the growth of e-commerce and DCs. During periods of over 15% earnings growth, the market tends to assign GMG a greater than 25 times enterprise value/earnings before interest, taxes, depreciation, and amortisation (EV/EBITDA) multiple. While the current multiple exceeds the long-term average, we believe the increase in long-term earnings due to DCs justifies the higher multiple.

We see upside earnings risks in medium-term estimates, driven by the performance fee backlog and further development of the DC business. This could result in elevated development earnings continuing longer than currently expected.

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Data centre spending cycle continues to be upgraded

We track global estimates of CapEx intentions from DC hyperscale cloud providers to assess the potential growth and size of the Goodman Group data centre opportunity.

Market consensus data from Visible Alpha shows CapEx spending estimates through Q3 of 2024 have been significantly revised upward for expected spending in the 2025 to 2027 period. The major hyperscalers all plan to increase their spending on DCs in 2025 compared to 2024.

Global data centre spending intentions

Previously, we were concerned that industry DC spending would rapidly slow from the more than 50% increase seen in 2024. However, it now appears spending in 2025 will be up by more than 20% compared to estimates from the second quarter (Q2) of 2024, outperforming the implied low-teen growth from June 2024. DC-related CapEx spending is expected to approach $70 billion per quarter in 2025.

Given industry constraints, this slower growth rate is justifiable but remains within expansionary bounds. In our view, this reduces GMG’s downside earnings risk over the coming years and will support GMG in maintaining a full development pipeline.

GMG expanded DC development opportunity

GMG’s prized 5-gigawatt DC pipeline could have a total development value of $40–50 billion. We believe the GMG DC opportunity can help fill the earnings gap in traditional industrial developments as demand for sites normalises post-Covid-19 demand shock.

Given GMG’s larger skew to second-half (2H) earnings in fiscal year (FY) 2025 versus prior years, we do not expect GMG to upgrade its earnings guidance at the annual general meeting (AGM). However, we do anticipate upgrades before the FY 2025 results.

Historically, the market has shown a willingness to pay a higher multiple during periods of new growth opportunities. Rapid earnings growth should bring the elevated multiple lower over time.

GMG PER multiple

Key comments from Hyperscalers Q2 2024 results

• Alphabet (GOOGL) 2Q24

"Our reported CapEx in Q2 was $13 billion. Once again, this was overwhelmingly driven by investment in our technical infrastructure, with the largest component for servers followed by data centres. Looking ahead, we continue to expect quarterly CapEx throughout the year to be roughly at or above the first quarter (Q1) CapEx of $12 billion, keeping in mind that the timing of cash payments can cause variability in quarterly reported CapEx.

The way I think about it is when you go through a curve like this, the risk of underinvesting is dramatically greater than the risk of overinvesting for us here, even in scenarios where it turns out that we are overinvesting, we clearly consider these infrastructures to be widely useful for us."

• Meta Platforms (META) Q2 2024

"We anticipate full-year 2024 CapEx will be between $37 billion and $40 billion, up from our previous range of $35 billion to $40 billion. We expect significant CapEx growth in 2025, driven by investments in artificial intelligence (AI) research and product development."

• Microsoft (MSFT) Q2 2024

"To meet the growing demand signal for our AI and cloud products, we will scale our infrastructure investments with FY 2025 capital expenditures expected to be higher than FY 2024.

We expect capital expenditures to increase on a sequential basis, given our cloud and AI demand as well as existing AI capacity constraints."

• Amazon (AMZN) Q2 2024

"Looking ahead to the rest of 2024, we expect capital investments to be higher in the second half of the year. The majority of the spend will be to support the growing need for Amazon Web Services (AWS) infrastructure as we continue to see strong demand in both generative AI and our non-generative AI workloads."

• Oracle (ORCL) Q2 2024

"We spent $3.5 billion on CapEx this quarter, with the $2.8 billion shown in the cash flow statement lowered simply as a result of timing of payments.

We are working as quickly as we can to get cloud capacity built out, given the enormity of our backlog and pipeline. CapEx in FY 2025 will probably be double what it was in FY 2024."

Global hyperscalers CapEx spending intentions

• Nvidia (NVDA) Q2 2024

"DC revenue of $26.3 billion was a record, up 16% sequentially and up 154% year-on-year (YoY), driven by strong demand for NVIDIA Hopper GPU computing and our networking platforms.

Demand for Blackwell platforms is well above supply, and we expect this to continue into next year."

GMG share price is has been strongly correlated with the NVDA share price over the last 12 months.

NVDA vs GMG share price

Risks to investment

Upside risks:

• Continued growth in industrial rents
• Resilient cap rate expansion and stronger transaction volumes, demonstrating no decline in asset values
• Growth in funds under management (FUM)
• Strength in e-commerce and consumer sentiment
• Falling bond yields
• Further growth in AI and DC demand

Downside risks:

• Cap rate expansions lowering property valuations
• Large outflows in FUM
• Economic downturn/recession
• Additional interest rate hikes
• Overstated AI demand or large declines in AI/DC-related spending intentions from hyperscalers

• _{The information provided by Sandstone Insights does not constitute investment advice and does not have regard to the specific needs of any person who may receive it. No warranty is given as to the accuracy or completeness of the information and any person acting on it does so entirely at their own risk.}