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Nepi Rockcastle shareholders hoping that the Eastern European property arm will pay a cash dividend for the June reporting period will no doubt be sorely disappointed.
Like most mall owners worldwide, the JSE’s largest real estate investment trust (Reit) hasn’t been able to dodge the Covid-19 bullet. The company, which owns more than 50 shopping centres across nine Central and Eastern European (CEE) countries, last week reported its first loss ever as two-month lockdown-related store closures and rental concessions ate into profits.
Nepi Rockcastle, which was founded as New Europe Property Investments (Nepi) in Romania in 2007 by former SA banker Martin Slabbert and Resilient Reit’s Des de Beer, has historically been one of the JSE’s most popular rand hedge stocks.
But for the six months to end-June, the company’s distributable earnings and net operating income plunged 31% and 20% respectively.
As a result, Nepi Rockcastle has followed the lead of most of its Reit peers — postponing interim dividends to shore up its balance sheet and improve liquidity.
But shareholders won’t be left empty-handed. Management is rewarding investors with a capitalisation issue of 4.2920 ordinary shares for every 100 held.
While Nepi Rockcastle’s interim results don’t look pretty, it’s not all bad news.
The general view is that retail spend and economic growth are likely to bounce back quicker in Central and Eastern Europe than in Western Europe and, perhaps more importantly, than in SA.
What’s more, the rental relief and deferrals that Nepi Rockcastle gave to tenants which couldn’t trade during the April and March lockdown aren’t expected to dent the company’s earnings beyond 2020.
Nepi Rockcastle remains one of Metope Investment Managers’ preferred sector picks. Metope investment analyst Kelly Ward says despite many of the CEE countries which Nepi Rockcastle is exposed to having downgraded their GDP growth forecasts for 2020, it seems the region as a whole is through the worst.
She adds: "These economies are unlikely to reach pre-Covid 19 levels until late 2021 or 2022, but we believe the economic prospects are far superior to what is on offer locally."
Ward cites the high quality and regional diversification of Nepi Rockcastle’s malls as well as its ability to generate strong cash flows as key positives.
"The portfolio has proved itself to be relatively defensive over this period," she says. "The balance sheet is well capitalised despite a small write-down in the property valuations of –3.4% and we don’t foresee any near-term liquidity issues."
Ridwaan Loonat, equity analyst at Nedbank CIB, agrees that the investment case for Nepi Rockcastle remains intact. He has a buy recommendation on the stock.
"In the current environment we prioritise balance sheet strength," he says. "That’s why we like Nepi Rockcastle. It has a strong balance sheet and a below-sector average loan-to-value of 36%." Loonat notes the loan-to-value ratio would fall further once Nepi Rockcastle completes the sale of its Romanian office portfolio, for €307m.
In other words, Nepi has some leeway if its assets are deemed to be worth less than their present values.
The company also has good access to liquidity to fund its development pipeline and meet any near-term credit repayment obligations.
He says: "There’s little to no refinancing risk in the short term when you look at the company’s debt maturity profile."
On whether Nepi Rockcastle offers value at current levels of around R85 and a dividend yield of 6% (in euro), Loonat says the counter looks cheap relative to its historical average. The share is trading at a 40% discount to NAV and well below its 2019 highs of R135.
But there is risk: Loonat singles out further asset devaluations and the ongoing adoption of e-commerce as key factors that could potentially affect Nepi Rockcastle’s earnings.
However, online shopping in Central and Eastern Europe is still in its infancy compared to Western Europe, the UK and the US. Speaking at Nepi Rockcastle’s results presentation, CEO Alex Morar said brick-and-mortar retail spend was likely to recover quicker in Central and Eastern Europe than in Western Europe.
E-commerce penetration is still at only 2% of total sales in Central and Eastern Europe, against 10% in Western Europe and 13% in the US.
One reason for the trend is that malls were introduced to most CEE countries only after the fall of communism in 1989. So the countries that Nepi Rockcastle invests in are still undersupplied in shopping centre space, with an average 107m² per 1,000 people versus 351m² per 1,000 people in Western Europe and 2,000m² per 1,000 in the US.
CEE malls are widely regarded as premier gathering spots for social interaction and leisure.
Morar said that by end-June, sales turnover at Nepi Rockcastle’s 54 malls was back to an average 88% of that achieved a year earlier. Foot count had recovered to about 80% of June 2019 levels. That’s despite restaurants, cinemas and other leisure tenants still not being allowed to operate fully in some CEE countries.
The strongest retail categories across Nepi Rockcastle’s malls in June were furnishing and DIY stores, sporting goods and pet shops.
Before Covid hit, Nepi sales turnover and foot count were up 8.5% and 4.3% respectively in the first two months of 2020 (year on year).
Morar argues that while the pandemic has curtailed retail activity, the dip will be relatively short-lived. For instance, Nepi Rockcastle’s latest addition to its €6.1bn portfolio, the 40,200m² Shopping City Târgu Mures in the north of Romania, opened in early July with a 95% occupancy. The mall, which has a sizable catchment of 517,000 people within a 45-minute drive, has since recorded better-than-expected sales and foot count.
Morar attributes Central and Eastern Europe’s retail recovery to a much lower Covid-19 infection and death rate than that of many Western European countries. He said the governments of most CEE countries imposed more drastic lockdown measures than their Western European counterparts, probably due to their weaker health-care systems.
And Poland, for instance, forced all retail landlords to suspend rentals during its 58-day lockdown. In exchange, tenants were obliged to extend leases for six months. Landlords were also given tax incentives.
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