Why Growthpoint has the blues

The grim set of results released by Growthpoint Properties last week is a stark reflection of the extent to which Covid, coupled with an economy that’s fallen off a cliff, has decimated profits in the commercial property sector.

As the JSE’s largest and most diversified SA-based real estate investment trust (Reit), Growthpoint is regarded as a reliable bellwether of the general state of SA’s retail, office and industrial property market.

The picture is not pretty — and it’s Growthpoint’s very diversification that has been its undoing.

As group CEO Norbert Sasse, known for calling it like it is, puts it: "The SA economy is in deep, deep, deep trouble. Income is under pressure on all fronts."

In light of the dire situation the SA economy finds itself in, Sasse says Growthpoint isn’t paying a dividend now. "And neither are we giving any guidance on what shareholders should expect next year."

However, Sasse remains committed to paying a dividend in some form or other by December, in line with JSE legislation which requires Reits to distribute at least 75% of profits to shareholders within six months of their year-end.

The company, which owns a sprawling R167bn real estate portfolio spanning SA, Australia, the UK and Eastern Europe, has taken a hefty knock on both the income and capital growth front for the 12 months to end-June.

Nearly R1bn was wiped off distributable income, while the SA property portfolio was devalued by more than R7bn. That’s pushed loan-to-value levels from 36.7% to 43.9%.

While Growthpoint’s dividend income from its offshore investments was cut, the bulk of its losses relates to rental discounts and deferrals given to SA tenants to help keep shops and other businesses afloat during the second-quarter lockdown.

A dramatic spike in arrears (up from R77.7m to R511m in the 12 months to end-June) further contributed to Growthpoint’s woes, and underscores how many distressed SA tenants are now struggling to pay their rent.

Vacancies in the SA portfolio jumped from 6.8% to 9.5%.

And more bad news is seemingly in the offing as Sasse expects rental arrears and vacancies to continue to rise over the coming months, with more companies likely to follow the Edcon group and others into business rescue. "The unfortunate reality is that some tenants won’t make it, despite rental deferments and discounts," he says.

It’s well reflected in Growthpoint’s share price — down 38% year to date, in line with the sector. Over three years, Growthpoint has given a return of –52%.

Not even Cape Town’s V&A Waterfront, the jewel in Growthpoint’s crown and traditionally its best-performing SA asset by a mile, could help lift earnings this time.

In fact, the R14.3bn mixed-use precinct, which Growthpoint co-owns with the Public Investment Corp, is bearing the brunt of Covid-related trading and travel restrictions.

Growthpoint SA CEO Estienne de Klerk says that until March the precinct was "really pumping". Annual retail sales and rental income growth were in excess of 5%.

Occupancies at the V&A’s 10 hotels as well as passenger numbers from cruise ships that docked at the V&A’s international cruise terminal had also been on a strong upward trajectory, which helped push annual visitor numbers to the precinct to a record 24-million.

Then Covid hit and foot count and retail sales dropped by more than 65% in the second quarter (year on year).

"The V&A’s earnings are heavily dependent on tourism," says De Klerk. "So it’s been a bit of a disaster."

Analysts appreciate the fact that Sasse and De Klerk haven’t tried to sugar-coat the numbers. Old Mutual portfolio manager Evan Robins says management has been forthright to the extent of talking down its own share. "We welcome that. There is no point pretending the market is anything but very tough and uncertain at the moment."

While most analysts are in favour of Growthpoint holding back dividends to help shore up cash reserves, there is a view that it’s time for management to also sell down some of its offshore positions.

Robins refers to Growthpoint’s "disappointing" foray into the UK, where it bought a 52% stake in mall owner Capital & Regional in December last year for R2.9bn. The value of that investment has since shrunk to R1.1bn. Robins says: "In this environment, with the core SA portfolio struggling, you can [hardly] afford poor results from peripheral holdings."

He reckons Capital & Regional was always going to be a risky investment, given the "terrible" state of the UK shopping centre sector. And it didn’t get in at a discount to market value, which Robins says would have given it a cushion.

"The risk is that Capital & Regional, in which Growthpoint now has a controlling interest, will soon need more cash."

Anas Madhi, director of Meago Asset Managers, shares this sentiment. He says given the tsunami of challenges faced by Growthpoint, the company, like some of its SA-based peers, should look at exiting "troublesome foreign ventures with their destructive cross-currency derivatives".

He adds: "Notwithstanding the economic impact of Covid-related lockdowns, misallocation of capital cannot only be resolved by forgoing dividends, but rather by acknowledging investment successes as well as shortcomings, and reprioritising capital accordingly."

To boost capital reserves, Madhi says Growthpoint could consider a partial divestment of its shareholding in Growthpoint Australia, with the possibility of dual-listing the Australian-listed company on the JSE.

It could also sell out of Eastern European-focused office property play Globalworth, in which it owns a 29.4% stake — or buy a controlling stake in the company, listed on the London Stock Exchange.

He believes Globalworth’s shareholder structure is likely to become problematic now that its former CEO has sold his stake in the company, leaving three strategic shareholders that need to agree on its future growth strategy.

Madhi also refers to the untimely entry into the UK retail sector via Capital & Regional, saying Growthpoint will hopefully not inject further capital into the company as and when a call for equity is made, which he anticipates will be within the next 12 months.

While the challenges faced by Growthpoint may well be amplified by the size and diversity of its portfolio, the company’s results are likely to prompt property investors to further lower their return expectations for the listed property sector as a whole.

Keillen Ndlovu, head of listed property funds at Stanlib, warns that it’s not only Growthpoint’s vacancies, arrears and bad debts that are likely to continue to increase — the same trend is expected for other SA-focused Reits.

As a result, Ndlovu expects distributable income for the sector as a whole to fall by double digits over the next one to two years.

In response, physical property values are also likely to drop by over 10% in the short to medium term, which he says will force more Reits to retain a portion of their profits to help strengthen balance sheets.

The upshot is that listed property investors should no longer focus only on dividends, but rather on total returns.

The one ray of hope for investors is that while share price volatility is likely to continue in the short term, Ndlovu believes most of the downside is already priced in, given that the sector trades at an all-time-high discount to NAV of an average 50%.

That suggests attractive buying opportunities for patient investors.