An investment in the South African Listed Property Index in 2002 would have seen total return growth of just over 22% per annum until the end of 2017. This dwarfed other asset class total returns – the All Bond Index (ALBI) returned 10% annually and the JSE All Share Index (ALSI) returned 14.5% annually over the same period. Since the start of the year, however, the ALBI (+8.7% year to date) has outperformed the ALSI (-5.3% year to date) and the laggard, listed property (-18.2% year to date).
What has caused such a swing of fortunes for listed property? As we mentioned in a previous article, the recent decline in the index is partly a function of its composition, the strengthening of the rand, rising global bond yields and recent developments in the Resilient group of companies.
Since the start of the year, the Resilient share price has plunged by around 65%. What sparked this massive sell-off? Towards the end of December 2017, rumours were rife that the Resilient stable would be the next target of Viceroy – the infamous money manager behind a damning report on Steinhoff released in early December. This spooked the market, which reacted negatively to Resilient.
HEDGE FUND ALLEGATIONS
Further rumours began to emerge that some local and offshore hedge funds would release reports detailing alleged wrongdoing, which further accelerated the sell-off. After the reports were released, the shares were sold off even further.
The primary allegations of the hedge funds centred on:
- The conflict of interest created by the existence of a cross-holding between Resilient and Fortress Real Estate Investment Trust (REIT)
- Arguments that the premium valuations were not deserved, but rather a function of related party transactions intentionally manipulating share prices
- Questions around the independence of the two groups’ broad-based educational empowerment initiative, the Siyakha Education Trust, and accounting irregularities.
Resilient management has communicated to the market via SENS announcements that the cross-holding of Resilient and Fortress REIT will be unwound, and that the group will restructure the relationship with the Siyakha Education Trust for Resilient and Fortress REIT. As a consequence, the two groups have announced that distributions will be lower than previously communicated and that gearing within the funds will increase.
INDEPENDENT REVIEW
Additionally, the Resilient board has commissioned an independent review, with the intention of making the outcome public. Shauket Fakie, an independent director at the Absa Group and a former South African Auditor General, will head up the review.
The JSE has said it’s currently reviewing the allegations – and will be investigating both sides. Essentially, the JSE is to look into any improper action by those who released the reports as well as by those against whom the allegations have been levelled. At the time of writing, the Financial Services Board (FSB) hadn’t yet announced any official investigation.
In the past our view has been that Resilient is just too expensive to take active positions in any of our portfolios. The recent share price decline, however, has merited further investigation. At the time of writing, the share price is trading at R54 – significantly lower than the high of R151 reached in December 2017. In line with our investment philosophy, we’re more interested in the share price relative to its perceived value than in past performance.
INVESTMENT CASE
Let’s look at the investment case. Resilient is a hybrid listed REIT, as it has both direct property exposure through physical assets in bricks and mortar, and indirect exposure through holdings in other listed entities. As at 31 December 2017, the direct portfolio focused on retail assets locally and, to a lesser degree, in Portugal and Nigeria. The listed components comprised Fortress (FFB), Nepi Rockcastle (NRP), Greenbay (GRP) and Hammerson (HMN). FFB, NRP and GRP are considered part of the Resilient stable.
Resilient’s net asset value per share (NAVPS), as reported on 31 December 2017, was R105.35. The direct portfolio, which makes up 44.5% of the investment portfolio, has performed well over the years and provides a solid underpin to the group’s valuation.
In the indirect portfolio, which makes up the remaining 55.5%, the cross-holding with Fortress and investments in the other counters have performed exceptionally well, and were recorded at high valuations on Resilient’s balance sheet, contributing to the latter’s NAVPS.
It’s important to note that all the shares in which Resilient invested traded at significant premiums to their own NAVPS (except for Hammerson, but this makes up a very small component). Resilient’s NAVPS of R105.35 relied on the premium ratings of the indirect investments. Why then would the Resilient share price also trade at a premium above the NAVPS when the premium of the underlying assets was already included in the NAVPS? For us, Resilient’s premium share rating looked expensive.
A number of arguments can be made to justify the premium rating of Resilient’s share price relative to the NAVPS:
- Resilient has a superior management team who have a reputation of being exceptional deal makers and efficient allocators of capital
- Resilient has high-quality dominant retail assets that trade exceptionally well
- The group has superior growth prospects.
Resilient’s growth prospects are a function of the capital cycle. The listed entities of Resilient, Fortress, Nepi Rockcastle and Greenbay have benefited greatly from raising substantial capital from the equity markets while trading at these premiums to the NAVPS.
This, in turn, is accretive to their bottom lines and allows the funds to raise capital cheaply and capture a positive spread on their investments while maintaining a low gearing. The premiums created in share price movement have reflected their ability to continue doing this. In our experience, expensive assets don’t have a sustainable margin of safety.
PRICED FOR PERFECTION
What are the implications of first, Resilient’s share price trading at a significant premium to its own NAVPS and second, its indirect portfolio share prices trading at significant premiums to their NAVPS?
First, and even taking into account the growth prospects that attracted investors, the Resilient share price was expensive – ultimately, in our view, priced for perfection. Second, if the underlying share prices of the indirect portfolio fall, the priced-for-perfection (read: expensive) Resilient quasi holding company will fall. Once the rumours sparked the sell-off in the underlying stocks, Resilient’s share price and NAVPS fell rapidly – the share price falling faster and by more than the NAVPS due to the premium rating.
NOT BUYERS – YET
We currently compute Resilient’s NAVPS to be around R68 per share. The share price is starting to offer value at these levels, as it’s currently trading at a discount to the NAVPS. However, we’re not buyers just yet, for the following reasons:
- We’re comfortable to sit on the sidelines while the investigations are under way or about to start. We don’t believe we have insight into the binary outcome and aren’t willing to invest for these types of outcomes. Significant volatility has been injected into the share price due to all the speculation and uncertainty.
- Globally, listed property counters seldom trade at premiums to NAVPS, with most markets trading at discounts. Our view is that it should be no different in South Africa. The arguments for Resilient trading at a premium aren’t compelling enough.
- We also think the capital cycle of raising capital at such premiums has come to an end and the market won’t pay up for this type of growth as it’s done in the past.
- We would require a greater margin of safety before making an investment when we have other opportunities on the radar offering better risk-adjusted returns.
