MoneyTalks is Stockhead\u2019s regular recap of the ASX stocks, sectors and trends that fund managers and analysts are looking at right now.<\/p>\n
Today we hear from\u00a0Morningstar<\/a>.\u00a0<\/strong><\/em><\/p>\n \u00a0<\/p>\n Investors have the tendency to chase performance. And we should stop.<\/p>\n This is one of the primary reasons why Morningstar\u2019s recent study (Mind the Gap) shows investors underperform the investments in their portfolio by 1.7% a year.<\/p>\n \u201cThe following 3 ASX shares have been on a strong run and while it can be tempting to assume those strong returns will continue into the future but our analysts believe all of them are significantly overvalued.\u201d \u201cTo say Goodman Group dominates the Australian real estate investment trust (\u2018REIT\u2019) is an understatement. Goodman currently makes up more than 36% of the S&P\/ASX 300 A-REIT Index.<\/p>\n In the past year the stock is up over 71%.<\/p>\n \u201cThis contrasts with global REITs which have been hammered as higher interest rates, shifts to online retail and vacant and underutilised office space worry investors. Goodman has avoided many of these fears with a portfolio of industrial properties and a push into data centres.<\/p>\n \u201cGoodman\u2019s rise in price has taken the shares from undervalued territory to trading at a 65% premium to our fair value of $20.75.\u201d<\/p>\n Business strategy and outlook<\/strong><\/p>\n Goodman Group is one of the world\u2019s premier developers and managers of industrial property projects and investments. The group was co-founded in Australia by Gregory Goodman who remains CEO, and according to Morningstar, now has projects and customers in Asia, Europe, and the Americas.<\/p>\n \u201cA typical project involves obtaining a development site, signing tenants onto leases, and attracting investors who pay for the development and buy the completed project. <\/p>\n \u201cGoodman typically retains a minority stake and continues to manage sites after completion, collecting development fees, leasing fees, management and performance fees, and a share of rent.<\/p>\n \u201cThe group\u2019s development pipeline has grown substantially, driven by the race to build e-commerce capability, modernise supply chains, and strong demand for data centres.<\/p>\n \u201cMost of the GMG\u2019s development projects end up in Goodman managed investments, boosting the group\u2019s assets under management enormously.<\/p>\n \u201cWe expect this to continue for the next few years as the race continues for the best logistics and data center sites, closest to transport links and the end consumer. Goodman should benefit from its expertise, and its legacy holdings of property, many of which are close to urban centers, and therefore more attractive than outlying greenfield industrial sites.<\/p>\n \u201cHowever, we expect the remarkable returns to eventually slowdown to a more modest level. First, there is only so much existing property that can be sold and developed, before new sites need to be acquired, likely at substantially higher prices. Second, we see much greater competition in future as many rivals are growing their presence in industrial property.\u201d<\/p>\n GPT sold its stake in iconic office building 1 Farrer Place, with its rationale in part to rotate more capital into industrial property.<\/p>\n \u201cLikewise Dexus (ASX:DXS)<\/strong><\/a>, Charter Hall (ASX:CHC)<\/strong><\/a>, Mirvac (ASX:MGR)<\/strong><\/a> and Stockland (ASX:SGP)<\/strong><\/a> are all eyeing opportunities on the sector, plus Goodman must contend with major overseas players such as Prologis and others.\u201d<\/p>\n Valuation<\/strong><\/p>\n Morningstar\u2019s fair value estimate for Goodman Group securities is $20.75 per security.<\/p>\n \u201cOur fair value is derived using a discounted cash flow valuation with a 7.3% weighted average cost of capital. Our fair value estimate implies a 2024 P\/E of 19.5 times, and 2024 enterprise value\/EBITDA of 17.6 times.<\/p>\n \u201cOur valuation for the group is over double its net tangible assets per security of $8.80, as of Dec. 31, 2023. The NTA incorporates the group\u2019s physical assets such as investments in its property funds, but does not capture the value of its intangible funds management and development operations. These are valuable business lines, particularly funds management, because it earns relatively stable management fees, plus the opportunity for performance and transaction fees.<\/p>\n \u201cWe expect investment management revenue around 1% of AUM in the near term, which is substantial considering the billions in assets that Goodman manages. We expect that ratio to compress as performance fees become harder to earn as asset price rises slow, and competition from rival REITs results in fee pressure.<\/p>\n \u201cEven so we still expect substantial revenue growth given we expect AUM to more than double over the next decade. Goodman should benefit from economies of scale, and we expect costs to rise at a slower pace than revenue as new dollars are added to its management platform.\u201d<\/p>\n Meanwhile the broker says withdrawals from Goodman investments are usually limited to predetermined windows that lock investors in for years.<\/p>\n \u201cThat makes rapid outflows unlikely, underpinning Goodman Group\u2019s base management fee income, margins, and our fair value estimate.\u201d<\/p>\n Fortescue shares have risen more than 32% in the past year, Morningstar notes.<\/p>\n \u201cUnlike some of the other large miners in Australia, Fortescue is a pure play iron ore play. However, there has been a good deal of investor attention on the firms attempt to transform into a clean energy company. While the company has ambitious plans the green energy initiatives are not currently contributing.<\/p>\n Fortescue is currently trading at a 65% premium to the firm\u2019s value estimate of $16.20.<\/p>\n Fortescue is the world\u2019s fourth-largest iron ore exporter.<\/p>\n Margins are well below industry leaders BHP and Rio Tinto, and some way behind Vale, meaning Fortescue sits in the highest half of the cost curve, says Morningstar.<\/p>\n \u201cThis is a primary driver of our no-moat rating. Lower margins primarily result from price discounts from selling a lower-grade (57% to 58% iron) product compared with the 62% iron ore benchmark. The lower grade is effectively a cost for customers through a greater proportion of waste to transport and process, additional energy\/coal per unit of steel and lower blast furnace productivity. This results in a lower realized price versus the benchmark. In the 10 years ended June 2023, the company realized an approximate 23% discount versus the 62% benchmark<\/p>\n \u201cFortescue increased rapidly thanks to favourable iron ore prices, aggressive expansion, and historically low interest rates. Expansion from 55 million metric tons of capacity in fiscal 2012 to around 190 million metric tons by 2023 was unprecedented. Fortescue built much of its capacity around the China boom peak and baked in a higher capital base than peers. This means returns are likely to lag the industry leaders who benefited from building significant capacity when the capital cost per unit of output was lower<\/p>\n Fortescue has done an \u201cadmirable\u201d job of reducing cash costs materially versus peers, Morningstar reckons.<\/p>\n \u201cHowever, product discounts remain a competitive disadvantage. The addition of about 22 million metric tons a year of iron ore production from the 69%-owned Iron Bridge joint venture allows Fortescue blending options. Iron Bridge grades are much higher, around 67%, meaning Fortescue could blend most of its iron ore to increase its average grade to between 58% and 59%.<\/p>\n \u201cFortescue is a China fixed-asset investment play, with practically all of the company\u2019s iron ore sold there. In the long term, we see demand for steel in China declining as the country\u2019s stock of infrastructure matures and with the rate of urbanization past its peak.<\/p>\n \u201cThe company\u2019s strategy is to transform into a diversified iron ore and clean energy company. Its green energy initiatives are at an early stage, but the company has big ambitions in the space.\u201d<\/p>\n In early April Morningstar reduced its fair value estimate for no-moat Fortescue to $16.20 per share, down from $17.30, driven by lower near-term iron ore prices.<\/p>\n \u201cWe now assume iron ore averages about USD 100 per metric ton from 2024 to 2026 based on the futures curve, down from roughly USD 120. However, we raise our assumed midcycle iron ore price to roughly USD 70 per metric ton from 2028, up from around USD 63 previously.<\/p>\n \u201cThis is based on our updated estimate of the marginal cost of production, driven by inflation pushing up and steepening the industry cost curve. Strong demand from China, which accounts for around 70% of the seaborne iron ore trade, is supportive of near-term prices.<\/p>\n \u201cHowever, longer term we expect demand from China to moderate as steel production peaks and starts to decline as its economy moves away from one reliant on fixed-asset investment to a more consumption-based economy. China\u2019s falling population along with rising scrap-based production also contribute to reduced demand for iron ore, in our view. We also think additional supply is likely, led by Simandou and Vale. Hence we expect a long-term price substantially below the current spot around USD 100 per metric ton.<\/p>\n \u201cCash flow is discounted at an 9.4% weighted average cost of capital, based on a long-term capital structure comprising 25% debt and 75% equity. The pretax cost of debt assumption is 8%. Our 11% cost of equity reflects very high systematic risk, specifically Fortescue\u2019s lower margins relative to industry leaders BHP, Rio Tinto, and Vale, and somewhat higher debt levels relative to peers. Our fair value estimate equates to an enterprise value\/EBITDA exit multiple of 6 in fiscal 2026.\u201d<\/p>\n \u00a0<\/p>\n Well. It\u2019s been a roller coaster ride for ZIP shareholders but the shares have rebounded over the last year and have risen 158%.<\/p>\n \u201cWe believe that the market is underestimating downside risks and the shares are currently trading at a 235% premium to our fair value of $0.40,\u201d Morningstar says.<\/p>\n Zip\u2019s business is more diversified than single-product buy now, pay later, or BNPL, players, with varieties in financing options, transaction limits, and repayment schedules.<\/p>\n Customers can crack on with simple sign-up and checkouts, high acceptance by retailers and flexible financing solutions to help better manage their cash flows. Merchant partners kinda benefit from increased conversion rates, basket sizes, and transaction frequencies.<\/p>\n Zip has a revolving credit business in Australia, the broker reckons.<\/p>\n \u201cCore products are Zip Pay, which finances up to $1,000; and Zip Money, which finances $1,000 and above. It also boasts a broader merchant base including retail, home, electronics, health, auto, and travel. Around 70% of revenue is derived from customers, mainly from account fees and interest.\u201d<\/p>\n Zip adopts an instalment financing model overseas, helping it scale up faster and keep up with competition in the under penetrated global BNPL landscape.<\/p>\n \u201cThe acquisition of USbased QuadPay materially boosts its growth prospects,\u201d Morningstar says.<\/p>\n The company enhances customer stickiness via ongoing product add-ons. It has a Pay Anywhere function that lets users transact at a wide variety of avenues without being confined to merchant partners. Users also benefit from promotional offers, cash-back deals, or free credits.<\/p>\n Other highlights for Morningstar include enhanced rewards programs, product protection insurance, or physical cards. For merchant partners, Zip invests in co-marketing to help them acquire new customers.<\/p>\n \u201cWe believe Zip can achieve profitability over the very long term, but we think its revenue margins will be increasingly under pressure and it will not achieve the same penetration and transaction frequency overseas as it had domestically.<\/p>\n \u201cWhile it benefits from the growth of e-commerce and increasing preference for more convenient\/cheaper forms of financing, we anticipate heightened competition to its products. The capital-intensive domestic business cannot scale up as quickly, its fee structure potentially creates friction for customers, and its product offering in the U.S lacks clear differentiation.\u201d<\/p>\n Valuation<\/strong><\/p>\n \u201cWe have materially lowered our transaction volume forecasts (implying share losses), lifted our funding cost assumptions, and increased our group expense projections\u2014which previously assumed faster cost-outs and fewer one-off expenses.<\/p>\n \u201cWe expect Zip to deliver positive cash earnings before interest, taxes, depreciation and amortisation (\u201cEBTDA\u201d) in fiscal 2024, but should only generate positive free cash flows in fiscal 2025. We expect cash transaction margins to average 3.1% of transaction volumes over our forecast period, at the bottom end of its desired range of 3.0%-4.0%.<\/p>\n Margin improvements are largely from keeping bad debts in line with its five-year average of 2.2%, processing cost-savings, higher product pricing over the near term, and gradual moderation in funding costs.<\/p>\n \u201cWe forecast funding costs to average 7.0% of receivables (or 1.8% of transaction volumes) over the three years to fiscal 2026, above fiscal 2023\u2019s rate of 6.0% and its three-year average of 4.5%.<\/p>\n But \u2013 and here\u2019s the kicker \u2013 Morningstar reckons Zip\u2019s strategy of cost-cutting and maximising revenue is likely to result in market share losses.<\/p>\n \u201cWe forecast transaction volumes in ANZ to grow to $5.1 billion by fiscal 2033 from $4.2 billion in fiscal 2023. This equates to a market share loss to less than 8% of the BNPL market from 20% over this period. Similarly, we see U.S. transaction volumes growing to $9.2 billion by fiscal 2033 from $4.6 billion in fiscal 2023. This amounts to a market share loss to less than 1.0% of the U.S. BNPL market from 2.3%.<\/p>\n \u201cCorrespondingly, slower-than-expected revenue growth is likely to result in operating margins of less than 5% by fiscal 2033, below our prior expectations of 9%.\u201d<\/p>\n \u00a0<\/p>\n The views, information, or opinions expressed in the interview in this article are solely those of the broker and do not represent the views of Stockhead.<\/strong><\/em><\/p>\n Stockhead has not provided, endorsed or otherwise assumed responsibility for any financial product advice contained in this article.<\/strong><\/em><\/p>\n <\/span><\/p>\n The post MoneyTalks: What \u2018overvalued\u2019 looks like on the ASX right now<\/a> appeared first on Stockhead<\/a>.<\/p>","protected":false},"excerpt":{"rendered":"
\n\u00a0<\/p>\nGoodman Group (ASX:GMG)<\/strong><\/a><\/h2>\n
Fortescue (ASX:FMG)<\/strong><\/a><\/h2>\n
Business strategy and outlook<\/h3>\n
Valuation<\/h3>\n
Zip Co (ASX:ZIP)<\/strong><\/a><\/h2>\n
Business strategy and outlook<\/h3>\n