Anything linked to property doesn’t sound appealing in this market with the negative publicity around falling home prices and the risk of loan defaults from overstretched households.
But while the outlook of stocks like apartment builder Mirvac Group (ASX: MGR) and residential and retail property developer Stockland Corporation Ltd (ASX: SGP) may be under a cloud, there is one property stock that stands out, according to Citigroup.
The broker believes that Goodman Group (ASX: GMG) is the top pick for the sector as the industrial property group is well placed to benefit from the burgeoning e-commerce tailwinds through its warehousing facilities.
The problem is that not many will see the stock as cheap, although Citi has a novel idea on how management can trigger another upswing in its share price, which has already surged close to 30% over the past year when the S&P/ASX 200 (Index:^AXJO) (ASX: XJO) is up a more modest 9%.
Goodman is trading on a FY19 consensus price-earnings of over 20 times. That’s not necessarily expensive but I think it’s starting to look fully valued given its expected annual earnings per share (EPS) growth of around 8% over the next three years and its dividend yield which is only keeping with inflation.
Citi thinks the way to appeal to investors and to get its share price higher is for management to cut dividends.
That sounds counterintuitive as our universe doesn’t work that way. In the natural order, companies who downgrade their dividends get punished while those who increase capital returns get rewarded.
But the broker believes the logic should be turned on its head for Goodman given the growth opportunities Goodman can pursue if it had extra capital to play with.
“Hypothetically, if GMG reduced its payout ratio from 60% to 40%, it would imply an additional [circa] A$180m – A$210m in retained earnings. Assuming a 6% incremental return on retained earnings, we calculate EPS [earnings per share] accretion of ~1.0% in year one, increasing to ~4.0% in year three, with the earnings growth increasing to 9-10% p.a.,” said Citi.
“Concurrently, DPS yield would only reduce ~90-100bps to ~2% implying a still strong total return of 11-12%. Importantly, this analysis does not assume increased gearing, and in our view could drive continued multiple expansion.”
I’m not sure if Goodman’s board will be bold enough to consider the move. It will come down to how confident management is in convincing shareholders that the upside is greater than the dividend pain.
At least it’s safe to say that most Goodman shareholders didn’t buy the stock for its yield, so the negative reaction from a dividend cut may not be as acute as say Telstra Corporation Ltd (ASX: TLS).
Citi has a “buy” recommendation on Goodman with a price target of $11.90 a share.
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Motley Fool contributor Brendon Lau owns shares of Telstra Limited. The Motley Fool Australia owns shares of and has recommended Telstra Limited. The Motley Fool Australia has recommended Scentre Group. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.