Edcon: A catch-22 for mall owners

It seems highly likely that SA mall owners, including a number of JSE-listed heavyweights, will agree to Edcon’s rent-reduction request in a bid to prevent SA’s largest clothing retailer from going belly up.

But the big worry is that cutting Edcon’s rent will hit the dividend payouts to shareholders of at least a dozen JSE-listed stocks that hold multibillion-rand shopping centre portfolios.

These include Hyprop Investments, Liberty Two Degrees, Growthpoint Properties, Redefine Properties, Attacq, Resilient Reit and Fortress Reit. These companies own some of SA’s leading malls including Sandton City, Eastgate and Melrose Arch (Liberty Two Degrees); Rosebank Mall and Canal Walk (Hyprop); Victoria Wharf at the V&A Waterfront and Brooklyn Mall (Growthpoint); and Mall of Africa (Attacq).

In December, Edcon asked 31 of its SA landlords to reduce the rent for its 1,350 Edgars, Jet and CNA stores by 41% for two years in exchange for a 5% equity stake in its business.

The proposal to mall owners is part of a comprehensive recapitalisation plan to help the embattled retailer restructure its R9bn debt.

Though Edcon has declined to say what its annual rental costs are, the group’s rent bill is estimated to amount to more than R120m a month (based on a conservative monthly rental of R80 a square metre for 1.5-million square metres).

Edcon contributes about 2% of the listed property sector’s total rental income, but for some retail-focused property companies, the figure is close to 7%.

Keillen Ndlovu, head of listed property funds at Stanlib, estimates that Edcon’s proposed deal will result in an average drop of one percentage point in dividend growth for the listed property sector as a whole.

For retail-biased funds the impact will be more pronounced, especially for companies with high gearing or dual-class share structures.

Dividend growth among SA-focused property stocks is already under pressure due to stagnant demand for retail, office and industrial space in an economy that is barely growing. The listed property sector recorded an average 6% dividend growth in 2018 (10% in 2017). Ndlovu expects growth to slow further this year. "That will reduce to 3%-4% after factoring in Edcon’s proposed rent reduction," he says.

While the impact on dividends may not initially be significant, lower-than-expected growth could weigh on share prices and further dent fragile investor sentiment — last year the SA listed property index shed nearly 30%.

Landlords find themselves in a precarious position: accepting Edcon’s proposal will have a negative impact on rental earnings, but rejecting the bailout request could have more dire consequences.

"Reducing Edcon’s rent is not an ideal scenario. But landlords stand to lose much more if the group goes under. There will be a huge ripple effect on shopping centre vacancies and valuations if Edcon had to shut all its stores,"’ says Ndlovu.

Edcon currently occupies about 6%-7% of the total lettable space across SA’s 2,000-odd shopping centres. In large, regional and super regional malls, Edcon typically takes up 10% or more of the floor space. Ndlovu says if Edcon had to close its doors, the percentage of mall space standing empty across SA shopping centres could shoot up to more than 10% (given SA’s current 4.4% overall vacancy rate as recorded by MSCI Real Estate).

Vacancy rates have already increased markedly over the past three years as a glut of new retail space was added to a saturated market amid weaker consumer spending.

Vacancies in super regional malls (centres exceeding 100,000m²) surged to 6.3% in the third quarter of 2018, up from around 3% in early 2016 and more than triple the long-term average of 1.8%, according to the SA Property Owners Association’s latest "Retail Trends Report".

Edcon’s restructuring follows the failure of Stuttafords in 2017 as well as the closure of international fashion brands such as River Island, Mango and Topshop.

Naeem Tilly, head of research at Sesfikile Capital, agrees that the cost of Edcon’s demise would far outweigh a 41% rent reduction.

"Should Edcon fail, landlords face the prospect of a significant capital outlay to reconfigure the space. And they won’t be able to recover operating and municipal costs associated with the premises."

Tilly notes that the potential to re-let space previously occupied by Edgars is also limited in the short term given weak demand from both domestic and international retailers to expand their footprints.

"There will be major job losses, not just in the retail sector but in associated industries such as clothing manufacturing and logistics. This will have a severe impact on overall economic growth," he says.

Though "rent holidays" are unprecedented in SA — leases have traditionally included upwards-only rent escalations (around 7%-8% per year) — they are not uncommon elsewhere. In the UK, for instance, a number of struggling retailers have in recent years signed so-called company voluntary arrangements with landlords that provide tenants with breathing space during tough times.

However, analysts believe it won’t be in the best interest of all shareholders if SA mall owners adopt a blanket approach by agreeing to a 41% rent reduction across Edcon’s stores.

Catalyst Fund Managers investment analyst Mvula Seroto says it would be more prudent for landlords to negotiate varying rent reductions depending on the individual performance of stores in each centre.

He argues that owners of well-located, prime malls could even be better off by finding replacement tenants for space currently occupied by Edcon, given the uncertainty of whether Edcon’s business model is sustainable over the long term.

But he adds: "If the choice is between Edcon’s liquidation and a 41% rental haircut, preference would be for the latter."

Pranita Daya, real estate analyst at Anchor Stockbrokers, says proactive landlords have already been able to find new tenants for mall space where Edcon has closed underperforming outlets, some even at higher rentals.

Daya refers to Vukile Property Fund as an example.

"Of the 5,000m² vacated by Edcon in Vukile’s portfolio, management was able to re-let 65% of this space at a rate of R129 a square metre relative to the average R84 a square metre that Edcon was paying. This represents a significant uptick … which is clearly advantageous to landlords."

But Daya says the ability to find new tenants willing to pay higher rentals for space left empty by Edcon will vary from landlord to landlord and asset to asset.

"It will thus represent an opportunity for some but a risk for others. Overall, we believe a reduction in Edcon’s footpring will be negative for the sector as a whole in the short term."

Another potential pitfall that landlords face if they accede to Edcon’s rent reduction proposal is that other retailers will follow suit with similar requests.

"Other retailers may look at this as an opportunity to also reduce their rentals," says Tilly. "One really has to question if it is fair to favour one retailer over another."

He says other retailers are also likely to take issue with mall owners accepting an equity stake in Edcon in exchange for rent reductions. Though there is precedent for this in the US — for example, Vornado had a stake in Toys R Us and Kimco has an equity holding in Albertsons — Tilly says this has never happened in SA before. "The concern would be a potential conflict of interest."

Meanwhile, lease negotiations are apparently still under way.

Both Edcon and mall owners remain tight-lipped due to nondisclosure agreements. But the FM has been told that while some mall owners have put alternative cost-saving measures on the table, most are willing to go along with Edcon’s request in a bid to keep tills ringing.

"The situation is not pleasant. Everyone will take some pain, but we have to act responsibly and give Edcon a chance to succeed. If Edcon collapses we sit with a much bigger problem," says one mall owner who declined to be named.

He concedes that agreeing to Edcon’s request will undoubtedly prompt others to ask for rent concessions, but says there is no reason these should be granted.

"Edcon is a business on the brink of bankruptcy. We would assume that other retailers asking for rent cuts also face insolvency — would they want this message to be conveyed to the investment community if it’s not the case? I don’t think so."

The mall owner says conflict-of-interest concerns about the 5% equity stake proposal are "completely overstated" given that each landlord’s stake in the retailer would be minuscule. "It’s a goodwill gesture more than anything else."

The FM believes that Edcon expects to reach a settlement with most of its landlords by the end of January.