Optimism rises in the east
Mall owners in Central Europe foresee earnings bouncing back quicker than those of their SA counterparts
Like the rest of the JSE’s retail-focused property stocks, sector heavyweight Nepi Rockcastle hasn’t entirely dodged the Covid bullet.
But the Eastern European mall owner is still paying dividends, and, more importantly, is the only real estate counter to date that has forecast earnings growth for 2021..
That will no doubt further support the investment case for Central and Eastern Europe as a region, and cement Nepi Rockcastle’s prime position on property fund managers’ stock pick lists.
The company is the largest retail property owner and developer in Central and Eastern Europe. It owns a €5.8bn portfolio of more than 50 shopping centres across nine countries, including Romania, Poland, Bulgaria, Hungary, Slovakia, Croatia and the Czech Republic.
Anchor Capital portfolio manager Glen Baker says: “The fact that management has given a
10% earnings growth outlook for this year suggests Nepi Rockcastle has come through the pandemic in better shape than its SA counterparts.”
Baker says that while most SA property stocks remain uncertain about their prospects, Nepi Rockcastle seems to have its ducks in a row and can grow earnings from here. “I don’t think many SA companies will be able to do that for at least one or two more reporting periods.”
Ridwaan Loonat, equity analyst at Nedbank CIB, who has an overweight recommendation on Nepi Rockcastle, shares this view. He says the property owner’s operational metrics remain sound, despite a 32% drop in distributable earnings for the 12 months to December on the back of rental concessions of €72m.
While only 85% of the company’s total gross lettable area is open for trade at present, the
rent collection rate had recovered to 97% by mid-February. Loonat also refers to the vacancy rate, which has remained fairly stable at 4.3%, with little risk of significant tenant failures or distress.
But the key attraction, Loonat believes, is Nepi Rockcastle’s healthy balance sheet.
In the six months to December, its loan-tovalue ratio has improved from 36% to a belowsector average of 31.5%, following the sale of its Romanian office portfolio for €307m.
The company now has €1.2bn liquidity on its balance sheet, which Loonat says places management in a position to take advantage of any acquisition opportunities that may come its way without raising too much concern of overleveraging and potentially breaching debt covenants.
Baker and Loonat believe Central and Eastern Europe continues to provide a compelling investment case for South Africans looking for geographical and currency diversification.
Over the past decade, the region has become one of the most popular offshore destinations for local property players looking to expand beyond SA.
Latest Stanlib figures show that the listed property sector has a 26.5% exposure to Central and Eastern Europe (in terms of weighted market cap).
Nepi Rockcastle, founded as New Europe
Property Investments
(Nepi) in Romania by former SA banker Martin
Slabbert and Resilient
Reit’s Des de Beer in
2007, was the first Central and Eastern Europe property company to list on the JSE. Others soon followed suit. JSE investors now have access to the region’s real estate markets through at least 10 counters, including MAS Real Estate, EPP, Redefine Properties, Growthpoint Properties and Hyprop Investments.
In last week’s fairly upbeat results presentation Alex Morar, Nepi Rockcastle’s Romania-based CEO, said Eastern Europe’s potential to outpace Western Europe in terms of wage, consumption and retail sales growth remains intact.
The region also has a lower unemployment rate — 4.2% versus 6.6%.
Morar says the general view is that economic activity — including sales turnover and foot count at malls — will bounce back quicker in Central and Eastern Europe than in Western Europe because the region’s vaccination programme is being rolled out at a faster pace.
In fact, 70% of the population in Central and Eastern Europe is expected to be inoculated against Covid-19 by mid2021.
In addition, Morar argues there’s continued demand among local and international retailers to open new stores and expand existing ones, in something of a reverse trend to the rush online that is prevalent elsewhere.
That’s because the concept of the modern, enclosed shopping centre was introduced to the region only after the fall of communism in 1989. Morar cites the latest shopping centre density figures, which show that the nine countries that Nepi Rockcastle is exposed to have only 178.23m² of retail space per 1,000 people on average, versus the whole of the EU zone’s 322m² per 1,000 people.
E-commerce also poses a lower threat to shopping in physical centres because of the prominent role malls play as popular gathering spots for family entertainment, says Morar.
For instance, the addition of a new 6,000m² leisure area at the Ozas Shopping and Entertainment Centre in Lithuania, which houses a large indoor swimming pool and a family entertainment park, lured 70,000 visitors in the first five months of its partial opening in June.
Morar says the 10% distributable earnings and dividend growth guidance given for 2021 is based on the assumption that Nepi Rockcastle’s malls won’t be hit by any further mass lockdowns this year.
It does, however, take into account expectations that lockdown-related trading restrictions will last for “several more weeks”, with restaurants and cinemas not yet allowed to operate fully in some countries in the region.
Nepi Rockcastle was trading at about R95 this week, up about 60% from its October lows. That’s below the stock’s 2017 highs of R200, and represents a discount to NAV of more than 10%.
The concept of the modern, enclosed shopping centre was introduced to the region only after the fall of communism
Initial public offerings (IPOs) of special purpose acquisition companies (SPACs) in the US have exploded over the past year. About half of all US IPOs in 2020 were SPACs, and 80% of all US IPOs so far this year have been SPACs, with more than $60bn raised.
These blank-cheque companies have been around for a long time, and have been perennial underperformers (on average) measured over longer periods. Could the latest crop of SPACs be any different? It’s worth looking at how they work.
A promoter of a SPAC raises cash from investors in an IPO, issuing shares plus free warrants to the SPAC’s shareholders. The promoter then has 24 months to use the cash in the publicly listed SPAC for a merger or acquisition. The deal must be approved by the SPAC’s shareholders, and a successful deal triggers the issuing of extra shares to the promoter. But if no deal is approved within the two-year window, the shares are redeemed and investors get their cash back (plus interest, minus costs).
The game-changer that has led to the recent surge in SPAC listings is a rulechange which allows for SPAC investors to vote in favour of a deal, but at the same time redeem their shares and get their cash back, holding on to their warrants only. This is an attractive investment proposition for hedge funds and other investors who participate in SPAC IPOs: it means they can always get their cash back, and the free warrants become valuable if the share price of the SPAC rises after a deal is consummated.
No wonder investors have been clamouring to invest in almost any SPAC that comes along — they have nothing to lose. To avoid all shareholders redeeming their shares and depleting the cash of the SPAC, promoters often clinch deals with “backup” shareholders, referred to as private investment in public equity deals. In some ways, a SPAC merger or acquisition is simply an alternative (or quicker) way for a company to list on a stock exchange. Companies that have listed in this way include:
DraftKings
In May 2018, the US supreme court declared a law that prohibited sports betting in most states as being unconstitutional. This sparked a boom in the business of online sports betting platforms such as FanDuel and DraftKings. In April 2020, DraftKings listed by merging with a SPAC, Diamond Eagle Acquisition Corp, valuing the business at $3.3bn. Today, less than a year later, DraftKings has a market capitalisation of almost $25bn. Revenue growth is impressive, almost doubling over the past year. The company is loss-making due to continued aggressive expansion, but given that it still only operates in a handful of US states, the long-term prospects are exciting.
Virgin Galactic
Founded in 2004 and beset by multiple delays since, Virgin Galactic aims to offer commercial suborbital spaceflights, giving anyone the opportunity to become an astronaut. It also aims to offer the research community a unique platform for space-based science. Chamath Palihapitiya, a prolific SPAC promoter, merged his Social Capital Hedosophia Holdings SPAC with Richard Branson’s Virgin Galactic in October 2019. Shares have risen sixfold since, reaching a market capitalisation of
$14bn, though they have fallen back sharply over the past month as further delays of test flights were announced. It now expects to launch its commercial service only in 2022.
Nikola Motor Company
Nikola plans to build trucks powered by 123RF/troyzen
battery electric and hydrogen fuel cell technology. Taking advantage of the halo effect triggered by Tesla’s meteoric rise, it became a publicly listed company in June 2020 when it merged with VectoIQ Acquisition Corp. Deals to manufacture zero-emission trucks were announced soon afterwards, and General Motors (GM) would also acquire an 11% equity stake in Nikola. Shares surged to reach almost $80, representing a market capitalisation of more than $30bn. Respected short-sellers Hindenburg Research then alleged that Nikola had misrepresented its technology, and the founder, Trevor Milton, stepped down. Nikola recently admitted to various “inaccuracies”, including that a moving Nikola truck in a promotional video was actually not drivable and had simply been rolled down a hill. The shares now trade at $18, and the GM deal has fallen through.
Pershing Square Tontine Holdings
Renowned investor Bill Ackman raised $4bn in September 2020 for his SPAC, which has various novel attributes more friendly towards investors than other SPACs. His ability to identify attractive investment opportunities will be put to the test, since more than 350 SPACs are hunting for deals at present. The competition is intense, and the clock is ticking.
If history is anything to go by, some good deals will be done, but most will leave investors disappointed down the line. The incentives at play suggest the outcome for long-term SPAC holders will be less than spectacular. x
No wonder investors have been clamouring to invest in almost any SPAC — they have nothing to lose
Following last week’s drama in global bond markets in which yields slid precipitously, then rallied again, Berkshire chair Warren Buffett had this to say in his annual shareholder letter: “Fixed-income investors worldwide — whether pension funds, insurance companies or retirees — face a bleak future.” Bond yields are now so low that investors have to look elsewhere to earn a return, which is partly why equity and commodity markets have enjoyed their incredible gains of the past few months. But, warned the Sage of Omaha, “some investors may try to juice the pathetic returns now available by shifting their purchases to obligations backed by shaky borrowers. Risky loans, however, are not the answer to inadequate interest rates.” Why are these formerly staid markets so wild? And what does this mean for the once typical investment portfolio of 60% in equities and 40% in bonds? The FM spoke to Futuregrowth chief investment officer Andrew Canter.
What is the import of the huge swings experienced by global bond markets last week?
AC: The thing about any investment, whether it’s property, a bond or an equity, is that the best indicator of your future return is your starting yield. So if a 10-year bond yield is at 1.5%, your best estimate for the coming years is a return of only 1.5%. The other reality is that the yields can’t really go much lower.
We see negative yields in some markets, but where do you go from there? It’s very hard to see a rally in bonds [yields going down and prices going up] in a global recovery. That’s what Buffett is saying — the outlook is skewed towards risk, not return.
Also, it’s pretty evident that the dramatic fall in cash and bond yields has also been the impetus to push up all other asset values. There is so much money floating around the global financial system, because people are stuck at home and they’ve had stimulus packages [in the US] that money is leaking out and showing up in places like bitcoin, online trading and some crazy stuff. It’s a form of inflation: too much money is chasing up the price of financial assets.
What has changed in the past six weeks is the realisation that mass vaccination is rolling out and economies are going to move back to normal. The enormous amounts of money that have been pumped into developed economies and the pent-up demand mean that economies are likely to reopen strongly. We’ve had an incredibly sharp recession that has shaken out weak competitors across industries. Less competition and rising demand is a recipe for inflation.
I’m confused, though: if there is inflation on the horizon, don’t central banks need to hike interest rates? So why are they doing their utmost to keep yields down?
AC: They want low rates to give economies a boost. They’ve pushed rates down by cutting short-term rates and buying long bonds. That lowers the cost of capital and supports the economy. But they only have that wiggle room to manipulate rates as long as there’s no actual inflation.
Once inflation starts picking up, if central banks want to maintain any sort of long-term credibility they will be forced to start pushing rates up. It takes away the fun. The first interest rate hikes we are going to see are “good-news rate hikes” — as economies recover, things look better, so bond yields rise. The badnews rate hike comes when there’s actual inflation; though I think it’s premature to panic about that. But these are the things to watch.
Going back to Buffett’s point — isn’t it a nightmare for pension funds? What do savers do?
AC: I think it oversimplifies how pension funds should be run — based on longterm assets which are held to make future pensioner payments. [But] if you were starting to save for your retirement now you’d have to save more, because you’re looking at low expected returns.
Are bonds still a safe bet, though? Are they still what MoneyWeek editor Merryn Somerset Webb calls “antifragile”?
AC: Last year, when the equity markets plummeted by 30%, bonds rallied as interest rates fell sharply. Equities got clobbered, but you made a lot of money in bonds.
Bonds, by and large, in times of economic crisis will act contrary to equities, so they are a risk stabiliser in a retirement fund. I don’t think anybody’s abandoning the idea of a balanced pension fund.
However, the definition of a “balanced fund” has evolved to include a wide mix of equities, bonds, credit, property, inflation-linked assets, and alternative assets like venture capital, private equity, infrastructure and absolute return funds. x
Bonds, in times of economic crisis, will act contrary to equities, so they are a risk stabiliser