SA sector can learn from Intu’s troubles

● With Intu Properties’ future hanging in the balance, the company, which was originally part of late billionaire Donald Gordon’s Liberty International empire, offers a cautionary tale to SA’s listed property sector on how the combination of high debt levels and low asset values can spell disaster.

Intu, which has been battling with a R100bn debt pile, asked the JSE to suspend its listing last Friday after it went into administration. KPMG has been appointed as administrator.

The UK-focused shopping centre owner’s troubles are a chill wind for SA, where the listed property sector, carrying large amounts of debt and experiencing weak market fundamentals even before the Covid19 pandemic, has been particularly hard hit by the lockdown.

SA has eased restrictions to lockdown level 3, but listed property stocks and the tenants they rely on have a long road to recovery ahead.

Paul Duncan, investment manager at Catalyst Fund Managers Alternative Investments, says although it’s “easy with hindsight” to tell companies to manage their debt, there is also a lot of “hubris”, with property stocks thinking they can simply ride out the tougher cycle.

“Maybe you will, but maybe you won’t. You always have to go into these cycles with a lot more headroom than you think.”

Duncan says a lot of fund managers advocate loan-to-value (LTV) ratios of 35%-45% for local listed property counters, but he prefers a more conservative 30%-35%, “so you are always on the front foot”. An LTV ratio measures the value of the loans a property portfolio has against its underlying value as a percentage.

With his ratio, “you have capacity to buy something without putting your balance sheet under pressure, but similarly if the market turns against you, you have a little bit of room to manoeuvre”.

Duncan says SA’s property companies are getting better at managing their balance sheets, but they must be more proactive in this regard because this is as important as the underlying assets.

Keillen Ndlovu, Stanlib’s head of listed property funds, says it is also important for property counters to have good relationships with their funders and “manage their debt expiry profile well, and renegotiate” debt long before it is up for renewal or expires.

He says property owners also have to “keep up with the times” and upgrade their centres, as well as understand their shoppers, tenants and competition, including online retail.

Duncan says problems began for Intu about three years ago when it entered a weakening retail property market while overgeared.

At that stage it had an LTV ratio of about 45%, which then gradually started increasing as asset values in the UK declined due to the physical retail property market coming under pressure from a surge in e-commerce, as well as fears about the country’s exit from the EU. It had exposure to the Spanish market, but had to sell two of its best properties there.

“As the assets got written down a bit every year, the LTV, which looked OK at 45% three years ago, was suddenly 65% or 70%,” says Duncan.

Laurence Rapp, CEO of JSE-listed Vukile Property Fund, which holds retail properties in Spain and SA, says “one big lesson” from Intu is that it’s not just about managing the LTV ratio. He says a company’s interest cover ratio — the ability to service interest with its banks — is of paramount importance.

He says LTVs “are a very subjective number in the valuation of assets. What’s not subjective is your cash flow.

“I think the cash cover at an Intu level was quite low, which meant that any sort of stutter in terms of ebitda [earnings before interest, tax, depreciation and amortisation] would put their ability to service their debt under pressure.”

Referring to Vukile’s 82.5%-held subsidiary Castellana, which owns the group’s properties in Spain, and the business as a whole, Rapp says it has an interest cover ratio of almost six times.

“Just to contextualise that, for us to have a problem with a covenant of funding, we would need a 66% drop in ebitda, which is about R1.4bn, which is equivalent to going eight months without rent.

“I’m not suggesting we’re going to go eight months without collecting rent, but it shows you the coverage and strength of our balance sheet.”

Intu directed queries to KPMG, which referred Business Times to a statement in which Jim Tucker, a KPMG partner and joint administrator, said Intu owns “many of the UK’s biggest and best-known shopping centres” and that market challenges were “exacerbated by the impact” of the pandemic.

‘Hubris’ as property stocks think they can just ride out tough cycle