Long-suffering B shareholders of Fortress Reit have been dealt a double whammy.
Not only have they lost nearly 80% of their capital in the year to date thanks to a plunging share price, they’re also gaining no income.
The company, which has a dual capital (A and B) structure, announced last week it won’t pay dividends to B shareholders for the six months to end-June as its entire distributable income will go to the A shareholders.
And even the A shareholders won’t get the full 76c a share to which they are entitled — dividends have been slashed to 23c. That translates into a payout ratio of 76% of distributable profits. This is still in line with the JSE’s requirement that Reits pay out at least 75% of distributable profit in the form of dividends to retain their Reit status.
Though not entirely unexpected (most Reits have cut or postponed dividends this year) the fact that B shareholders are getting zero dividends underscores how volatile the performance of this class of shares can be.
And it raises renewed questions about whether it’s time to do away with the split capital structure, which has become unpopular in recent years.
Fortress is one of less than a handful of Reits that still offer investors the choice of two share options. The practice, which is unique to the SA listed property sector, was introduced nearly 20 years ago to cater for investors with different risk profiles.
A shares are typically favoured by investors with a low appetite for risk as they have a preferential right to dividends, with growth typically capped at 5% a year (or CPI-linked).
So A shares are regarded as a good alternative to bonds and cash for pensioners or other income-dependent investors looking for predictable, annuity-type cash flow.
B shares are the higher-risk option, as they receive the balance of the distributable income only after A shareholders have been paid.
When a Reit and its underlying assets perform well the upside for B shareholders is amplified.
The flip side is that during tough times, the downside for B shareholders is equally pronounced. And this is now playing out.
As Keillen Ndlovu, head of listed property funds at Stanlib, puts it: "The A and B structure is doing what it was designed to do. The A shareholders get protected in tough times (like now) and B shareholders enjoy the good times (like before). Unfortunately, the outlook is bleak and it’s not good news for B shareholders."
Fortress CEO Steve Brown is in favour of collapsing the dual shares.
He tells the FM it’s not an optimal capital structure and creates a lot of complexities. "Investors these days prefer simple structures that are easy to understand."
Brown says management initiated talks with shareholders about doing away with the instrument earlier this year, as such a move requires shareholder approval.
But discussions had to be shelved when Covid-19 hit the world. "We had to deal with more pressing issues at the time," he says.
Asked if and when management would approach shareholders again, Brown said "only when the conditions are right". His focus remains on steering the company through the Covid crisis.
Fortress owns a R28.4bn directly held portfolio of shopping centres, logistics and industrial properties and offices. It also has a sizeable R12.4bn stake (30% of total assets) in Eastern European mall owner Nepi Rockcastle, its only offshore exposure.
Though dividends have been cut, mostly on the back of an 5.5% Covid-induced drop in income, a dividend halt from Nepi Rockcastle and the decision to keep back cash, Fortress has managed to deliver a decent operating performance for the year to the end of June.
Retail sales turnover across its 59 shopping centres — mostly commuter-related malls that cater to lower-income shoppers in rural areas and townships — are down only 2.5% for the year to the end of June despite lockdown-related trading restrictions.
Collection rates have also held up well, averaging 93% between April and August. By the end of August, collections billed were back at pre-Covid levels of 97%.
Vacancies across the SA portfolio have risen only marginally from 5.6% to 5.7% (by value) and from 8% to 8.9% (by gross lettable area).
The company’s performance has been supported by its large exposure to the logistics sector (modern warehousing, storing and distribution depots), which has become one of the hottest real estate sectors globally on the back of the rapid adoption of online shopping during lockdown.
Vacancies in its logistics portfolio continue to shrink: down from 5.5% in December 2018 to 3% in June. More critically, Fortress has enough cash on its balance sheet to continue growing its logistics footprint across SA and meet new demand.
Nedbank CIB equity analyst Ridwaan Loonat says unlike most of its peers, which have frozen spending on new developments, Fortress is pushing ahead and could add 172,000m² of logistics space to its portfolio over the next year.
"That will take its total logistics space to 1.3-million square metres, making it the largest SA logistics property owner on the JSE," he says.
Brown says that when all the vacant land Fortress owns across logistics parks in major transport nodes is fully developed — probably within the next three to five years — logistics will make up two-thirds of its SA portfolio.
While demand has been driven by retailers as well as courier and distribution companies gearing up to meet rising e-commerce volumes, Brown says demand for warehouses was boosted by many companies requiring overflow space to store goods they couldn’t sell due to trading restrictions during lockdown.
But he expects this trend to continue post-lockdown. "Retailers and wholesalers may well decide to store more stock, given how supply chains were disrupted."
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