If you’re looking for a stock that can withstand the fallout from ongoing geopolitical conflict, German and UK-focused Sirius Real Estate should be on your radar.
The rand hedge stock, which was one of the JSE’s best-performing real estate counters until about 18 months ago when South Africa Inc stocks became the flavour of the month, owns a €3.6bn portfolio of factories, warehouses, and offices in Germany and the UK.
Over the past six months, Sirius has invested about €200m in industrial parks largely occupied by arms manufacturers and defence-related research & development companies. The military hardware typically made and tested at defence-related facilities ranges from submarines and drones to electrical components for fighter jets and armoured vehicles, as well as sophisticated laser-defence, optical sighting and robotics technology.
Sirius’s strategy to assemble a portfolio of these properties in Germany and the UK to complement its existing industrial assets was adopted about a year ago when both countries announced plans to ramp up defence spending on the back of the ongoing war in Ukraine and rising conflict in the Middle East.
At the time, Germany’s government committed to spending about €400bn on increasing its defence capabilities to 5% of its GDP by 2035.
Sirius CEO Andrew Coombs, a former enlisted soldier in the British Army, was quick to spot the opportunity. In a bid to gain first-mover advantage in a sector poised for what Coombs believes is explosive growth, retired Maj-Gen Angus Fay was appointed as a strategic adviser to guide Sirius’s pivot into properties that would meet the growing real estate needs of both Germany’s and the UK’s defence sectors.
Coombs tells the FM that Fay was the perfect fit for the job as he previously led the global logistics operations for the British defence ministry and represented the UK on the Nato logistics committee.
“Initially when Fay was appointed in June, we just wanted to gain an understanding of what was happening in terms of demand for defence properties and the impact it was having on the industrial real estate market. But things shifted quickly and three months later we had already bought two properties: one in Bedford in the UK and the other in Munich, Germany.”
Another two acquisitions have since followed, the largest being a 78,170m² business park in Kiel on Germany’s northern coast with direct access to the Baltic Sea. The area is a strategic logistics and manufacturing hub for the German navy, as well as the commercial maritime industry.
The property, which sits on a 226,600m² plot, was bought for €93.4m on an 8.2% initial yield and is anchored by Rheinmetall, Germany’s largest and oldest defence company. Coombs notes that the Kiel acquisition is a “big deal” for Sirius as it offers significant development and rental growth opportunities.
He’s looking at another €200m pipeline of potential defence-related deals. Coombs says that since the Iran war broke out in February, demand for industrial space suitable for military-related manufacturing has surged. He says production of undersea drones in particular is set to go “through the roof” in Germany in the next few months, as the closure of the Strait of Hormuz has heightened awareness of bulking up Nato’s naval defence capabilities.
In addition, Coombs notes that the UK, once revered for its warship and submarine building skills, has over the past 12 months been inundated with orders from other countries and is now running its capacity back up to levels last seen in the 1950s.
“Defence-anchored properties have become an extremely attractive sector for Sirius. And we want to own at least €1bn worth of it,” says Coombs. It’s a target he aims to reach within the next two years, which will take defence-anchored properties to about 20%-25% of Sirius’s overall portfolio.
Asked what makes this subsector a more lucrative investment bet than the standard industrial parks Sirius owns, Coombs says the military-anchored real estate sector is particularly attractive in Germany due to the government’s commitment to build its defence capabilities.
Defence-related tenants typically sign long leases … and are happy to pay annual rental increases instead of moving to new premises
— Andrew Coombs
In many cases, the government has already paid upfront for orders that can take 10 to 20 years to fulfil.
“Defence-related tenants typically sign long leases of 10 years-plus as they can’t afford to move machinery that can take weeks to recalibrate and risk production delays,” he says. “Once they sign up for a lease at premises that adhere to their specific requirements and is fitted with the right machinery and assembly lines, they are happy to pay annual rental increases instead of moving to new premises.”
Importantly, these properties can still be bought at yields of 8%-10%, which Coombs says is in line with what one will pay for industrial properties suitable for normal use. Yet standard industrial leases typically average just under three years.
“You’re getting secure, low-risk income streams that are virtually government-backed. We believe these properties should be trading closer to 4%-5% yields. So we’re effectively buying at a 50% discount.”
Coombs says defence manufacturers have very specific requirements in terms of size to accommodate large assembly lines, cranes and equipment. He adds that factories used for vehicle production are well suited, with several premises previously tenanted by automotive companies, including Volkswagen and Honda, now being adapted for defence-related tenants.
Military tenants typically also require a higher ratio of office to factory space, as most use the premises for extensive research and testing as well as manufacturing. The right climatic conditions for fibreoptic cables are equally important, as is a sufficient gas and energy supply for heavy metal works and smelting. Security also comes into play as some tenants want to operate discreetly.
Still, what will happen to tenant demand when the Middle East and Ukraine conflicts subside? Coombs says that won’t put an end to defence spending, as most countries now have a backlog of weaponry and military equipment which will take several years to restock. Besides, he notes that Nato members want to reduce their dependency on the US and will not want to risk being caught on the back foot again.
Analysts say Sirius’s newfound focus on lucrative defence-anchored assets is not the only reason it should be in South African investors’ portfolios. ClucasGray portfolio manager Brendon Hubbard says Sirius remains the boutique asset manager’s top property pick given its extensive track record of inflation-beating earnings and NAV growth, come rain or shine.
Sirius is set to deliver like-for-like rent roll growth of 6.4% for the year to March 31, marking the company’s 12th consecutive year of delivering income growth of more than 5%. “That’s a phenomenal return,” says Hubbard, “especially given that Germany and the UK have gone through tough economic times in recent years.”
He believes Sirius is better positioned than most other property stocks to withstand higher-for-longer oil prices, inflation spikes and potential interest rate increases if the war in Iran continues indefinitely, due to the company’s exposure to so-called flexi-leases.
Sirius’s portfolio of business parks includes a sizeable portion of SMEs and one-man bands that rent space via short-term flexible leases. That means Sirius can adjust its rentals upwards to compensate for higher inflation quickly, as opposed to other landlords that may be stuck in multiyear leases signed at fixed annual escalations.
Hubbard believes that despite Sirius’s 10% share price rally so far in April, it still offers plenty of upside, notwithstanding the stock now trading roughly in line with its NAV of about R23. He says given the high growth in the underlying business and track record of delivering inflation-beating dividend growth year after year, Sirius should in fact be trading at a sizeable premium to its NAV.
It’s a sentiment shared by UK-based brokerage Peel Hunt, which has placed a buy recommendation on Sirius with a 12-month share price target of 125p. That’s about 22% more than the 103p the stock was trading at on the London Stock Exchange last week.
