When Macro collides with Micro

“…look at the demand side … there's basically zero vacancy in our major markets we're operating in. Obviously, the risk on that side of the equation is lower than it's ever been in my career.”

Goodman Group CEO - Greg Goodman

Greg Goodman’s comment during the February 2023 reporting season was a bold statement given that his career spans over 30 years. Goodman Group was one of a few companies that provided a robust outlook despite the uncertain macro environment. However, positive stock specific fundamentals are sometimes ignored when the macro environment washes out a large number of companies.

In 2022, the macro theme of fast rising interest rates had several consequences for capital markets. The obvious one was the severe derating of many high-flying stocks. The ‘time arbitrage’ that many growth investors espouse on why growth stocks outperform over the long term disappears when the value of time decreases with increasing interest rates.

Unpredictable consequences of higher interest rates have also appeared. Firstly, the UK pension industry nearly collapsed in October 2022. The use of leverage to support UK defined benefit schemes meant that bonds were often used as collateral. The sudden rise in interest rates meant that the value of the collateral drops. This led to the doom loop of selling more bonds to provide more collateral, putting further pressure on bond prices. The Bank of England had to step in to provide emergency liquidity to help stabilise the market.

Secondly, the collapse of Silicon Valley Bank (SVB) in the United States led to a deposit run in other regional banks in March 2023. With rising interest rates, bank customers withdrew their deposits and put them in money market funds offering higher interest rates. SVB had a large exposure to technology start-ups that were also withdrawing deposits as funding was drying up. To help fund cash withdrawals, SVB had to sell their bond holdings at heavy losses because the bank failed to hedge their interest rate securities. The losses were so great that the bank was at risk of becoming insolvent. The fear of insolvency led to a faster run-on deposits and led to another doom loop of selling more bonds at a loss.

Regulators shut down SVB on 10 March 2023. Two days later, Signature Bank followed suit and failed after depositors withdrew large sums of money. The fickle nature of customer trust reverberated to the other side of the world and a week later Credit Suisse was on the brink of collapse. Regulators quickly forced the company to merge with UBS in an unprecedented move where the Swiss Government changed laws to bypass shareholder approval. In response to the banking crisis, US regulators promised to guarantee all deposits of SVB and Signature Bank. The Federal Reserve also provided emergency liquidity to help stabilise the market.

Central banks have done a credible job by providing a liquidity backstop to these crises. But so far they are not willing to stop economic gravity from the coming recession. While there is debate on the timing of a US recession, there is no doubt a recession in corporate profits has already begun. The million-dollar question is whether the 2023 fall in corporate profits will look similar to the 2001, 2008 and 2020 US recessions.

Source: FactSet

With such a bearish macro backdrop, it is easy to forget that there are some shining stars that have been sold off in the market correction. For example, Goodman Group (GMG) develops, owns and manages industrial property globally. Given that property valuations are linked to interest rates, GMG derated with the rest of the REIT sector when interest rates rose sharply in 2022. However, from an earnings perspective, GMG has not missed a beat and continues to demonstrate resilient growth.

Even during the February reporting season, consensus earnings was revised up as the company’s outlook proved stronger than expected. Goodman Group’s CEO commented about its strong outlook in several ways:

“Customers are driving structural demand, which combined with the lack of supply, is leading to strong rental growth in most regions.”

“We are seeing … unprecedented rental growth in some of our markets, and effectively zero vacancy.”

“The pipeline of demand is really, really, really strong … so, the renewal rates are really, really high.”

Despite the positive earnings revisions and commentary, GMG’s share price fell with other REITs during February due to lingering concerns about rising interest rates.

Shortly after reporting season, GMG announced the development of a 70-hectare site for air cargo logistics at Japan’s Narita International Airport. The project is estimated to be worth about US$4 billion (or A$6bn). This is a significant win for GMG as it increases their assets under management by 7.5% from A$79.5bn to A$85.5bn, as the property is developed over the next few years. Very few companies have continued to demonstrate robust growth in the current uncertain macro environment. However, on the day of the announcement, GMG’s share price fell as the market ignored positive news yet again. The stock’s valuation multiple is now trading at the bottom end of its five-year valuation range despite positive stock specific news that supports its robust earnings outlook.

GMG Share Price, EPS, and PE multiple

Source: FactSet

The uncertain macro environment is certainly holding back GMG’s share price. But there will come a time when its robust earnings profile in an uncertain macro environment catches a bid. Macro volatility always uncovers stock opportunities. At Vertium we are looking for them in plain sight and GMG is one such example.