PICK OF THE MONTH

JSE investors who own shares in property stocks that are exposed to the UK must have had a few sleepless nights since Britain’s decision to exit the European Union on June 23.

Currently, no fewer than 16 of the JSE’s property counters own real estate in the UK, either directly or indirectly via other listed vehicles. Some are 100% invested in the UK while others only have partial exposure. Either way, most of these counters lost at least 10%-20% of their value on the day Brexit was announced.

London-focused Capital & Counties Properties (Capco) was punished more harshly than any other rand hedge counter on the JSE. The share price dived 33% in the first two weeks after Brexit, bringing the total drop to nearly 45% from its December record high of just more than R100. That translated into value destruction of some R48bn in terms of market cap wiped out in the year to date (to July 8).

What makes Capco’s extensive share price losses particularly hard for South African investors to swallow is that the counter has been one of the most popular rand hedges in recent years, delivering an impressive 50% capital return last year. That excluded dividends, albeit a small one, as Capco is primarily a capital growth play and trades at a dividend yield of less than 1%.

Analysts ascribe Capco’s bigger share price losses (relative to other UK-focused property stocks) to the fact that its entire portfolio is located in London. This being the UK’s financial capital, the general view is that London’s property market is likely to be hardest hit by corporates and retailers cutting back on expansion plans as well as waning investor appetite for residential property. Also, the weaker pound will put pressure on retailers’ margins and may affect their ability to pay rentals.

Capco owns Covent Garden (a trendy leisure and shopping precinct) and Earls Court, a large tract of undeveloped land which the company plans to turn into one of the largest new residential suburbs in London. The first phase of off-plan apartment sales kicked off last year.

The biggest worry is the impact that Brexit will have on London house prices and the knock-on effect on land and property values at Earls Court.

In recent weeks, a number of institutional open-ended property funds, including those of Standard Life, Aviva, Henderson and M&G, have suspended trading to stem potential losses from investors looking to cash out. “That’s an extremely worrying first sign that there is a lot of pain ahead for the UK property market,” says Avior Capital Markets investment analyst Adrian Jardine.

However, times of distress do offer buying opportunities for the brave. And it seems that UK property stocks such as Capco have been oversold in recent weeks, creating what could be a cheap entry point for South African investors looking to increase their offshore diversification. After all, London itself is likely to retain its status as a world-class tourism and financial hub in the long term despite current jitters. At the R53-R56 level at which Capco was trading earlier this month, the stock offered a discount to net asset value of about 26%.

Anas Madhi, director of Meago Asset Managers, says while Earls Court may face some adverse conditions, an investment case can be made for Capco based on the merits of Covent Garden alone.

The latter’s location, which exposes it to the dynamics of the prime central London retail market, means it should remain robust, even during what could be an extended period of uncertainty. In fact, Madhi says Covent Garden, being a tourist landmark, could even benefit from increased foreign tourism spending on the back of a weaker British pound.

In addition, sufficient asset management opportunities remain in the precinct to support medium-term rental growth. But Madhi cautions investors to be prepared to bear with volatility.

Stanlib’s head of listed property funds, Keillen Ndlovu, has a similar view. He believes most of the downside of a potential decline in rentals and property values is already priced in at current share price levels. But he says investors need to take at least a three-year view.

Avior Capital Markets’ Jardine is more bearish. “While it is tempting to have a stab at Capco at these levels, given the discount to net asset value, it’s anyone's guess how deep capital losses may go and how long the downturn in the cycle will last.”

Jardine says while Covent Garden and the development pipeline at Earls Court are truly prime, world-class real estate assets, the share prices of Capco and its peers should remain depressed and volatile until there is at least some sign that the market has bottomed. “Investors would be wise to avoid making hasty allocations until the outlook is clearer.”

It’s anyone’s guess how deep capital losses may go and how long the downturn in the cycle will last