Bateleur Capital, is a boutique investment house that was founded in 2004, and started out as a manager of two successful hedge fund strategies. In 2010, following the success of their hedge fund strategies, the firm launched a long only flexible fund, followed by the launch of an equity fund in 2012. Bateleur is a shining example of a boutique investment house. The team have solid track records, they guard their independence fiercely and are acutely focussed on the investment management aspect of their business.
The Bateleur Flexible Prescient Fund, managed by founder and portfolio manager Kevin Williams holds a material exposure to JSE listed companies with offshore property portfolios that have a predominant exposure to Europe. The following extract from their 2015 Q3 report provides a fascinating insight into their views on this investment theme.
An investment theme that has served the fund well in 2015 has been offshore listed property with exposure to Europe. Collectively these property holdings total 12.3% of the fund’s net asset value and include positions in Stenprop, Sirius Real Estate, Capital & Regional, Capital & Counties and MAS Real Estate (“European property cluster”). All of these companies have a secondary listing on the JSE, thereby not detracting from the fund’s capacity to invest directly offshore.
The European property cluster has contributed a combined 2.5% to the fund’s 13.4% YTD return. Individual share price returns and impact on fund performance are shown below.
The investment into the European property cluster was premised on both top down macro considerations and company specific reasons. From a top down perspective, there is a wide spread between the rental yields on European property companies and the corresponding yields on 10 year government bonds.
For example, in Germany, yields on the residential property market currently approach 6.5% compared to 10 year government bond yields of 0.6%. This is a spread of 5.9%, high in both absolute terms and relative to history (charts 1 and 2). With economic growth rates slowly improving in Germany and inflation remaining subdued, there is an argument for further yield compression in the listed property market.
Nevertheless, even a relatively small property company such as Sirius Real Estate (operating in Germany) has been able to secure five year fixed funding on recent property transactions at an interest rate of less than 2%.
This represents a healthy spread between rental yields and borrowing costs, and provides a favourable backdrop to operate in. In SA the situation is somewhat different.
Distribution yields on domestic focused listed property currently average 5.4% against 10 year government bond yields of 8.4% (charts 3 and 4). This is a negative yield spread of 3% and would tend to indicate, that unless annual rental and distribution growth forecasts are material, or there is a structural shortage of quality commercial and retail properties (neither of which is apparent), that listed SA property is an unattractive investment proposition at present.
European property analysts argue that the reason behind the high rental yields in Europe is due to low inflation rates, and the resultant difficulty that property companies encounter in securing above inflation rental increases.
Fundamental research is therefore necessary to identify those companies that can successfully operate and grow in a low inflation environment. The European property companies that the fund has invested in have specific asset management strategies in place to grow the NAV per share over time and to generate annual distribution growth in excess of inflation. Considerable time has been spent with the management teams of the invested companies to obtain an appropriate level of comfort with their often differing strategies for extrapolating value. Personal site visits to the estates of three of the selected companies – Sirius Real Estate (in Germany), Capital & Counties (in London) and MAS Real Estate (in Edinburgh and Glasgow) have also taken place. A brief summary of each of the holdings is discussed below.
STENPROP
Market cap R6.6bn; Primary listing Bermuda; Secondary listing JSE main board
Stenprop owns a portfolio of office and retail properties located in major cities in the UK (42% of the portfolio by value), Germany (38%) and Switzerland (20%), collectively valued at €807m. The company’s investment objective is to generate consistent growth in distributions per share and long term capital appreciation, although it is not actively involved in development activity.
Stenprop’s office portfolio in central London has performed especially well, with rental increases (upwards of 30% on renewal in some instances) driven by buoyant tenant demand and a structural shortage of available office space. This in turn has assisted overall group NAV growth.
The property portfolios in both Germany and Switzerland (both low inflation environments) have not seen material rental increases, and hence NAV growth in these areas has been more subdued. Nevertheless, these properties offer high and secure rental yields with low vacancy levels. Group loan to value (LTV) currently sits at 54% (bank debt expressed as a percentage of group property value) while group wide vacancies are a negligible 2%.
Stenprop trades at a 4% discount to disclosed NAV per share, a forward income yield of 6.2% and a forward distribution yield of 5.5% in Euros (i.e. not all income earned is distributed). Despite a solid re-rating having already taken place over the past year, the valuation remains attractive.
SIRIUS REAL ESTATE:
Market cap R5.8bn; Primary listing UK (AIM); Secondary listing JSE main board
The fund has been invested in German based property company Sirius Real Estate (“Sirius”) since June 2013 – the longest holding period of the fund’s offshore listed property investments. Management, led by Andrew Coombs, have done an excellent job in transitioning the company from an overleveraged business with a bloated cost base and properties of questionable quality; into an efficient owner and operator of specialist business parks with over one million square metres of lettable space (currently valued at €515m). Sirius operates at the unglamorous end of the German property market. Most of its office parks are located in the suburbs outside of city centres.
The company’s business model is to acquire underutilised mixed use properties with high vacancy levels and convert or reconfigure these into flexible workspaces that can be let out at higher yields. The company further attempts to maximise the value of the overall portfolio through active purchases and sales of buildings. Over the past eighteen months, the share price of Sirius has increased from 23 Euro cents to current levels of 52 Euro cents.
From trading at a discount of 54% to NAV, the share now trades at premium of around 10%. Over the same period the LTV has reduced from 65% to 47% while the average funding rates on secured bank debt have steadily reduced as the risk profile of the company has improved.
The company currently distributes 65% of net income as dividends each year. Based on projections to March 2016, Sirius trades on a core income yield of 6.6% in Euros, and a distribution yield (based on a 65% pay-out ratio) of 4.3%. Sirius has come through a challenging period and is now seeing the benefits of recent management actions. These include enhanced scale, improved funding rates, increasing rentals, lower vacancy levels and improved efficiencies. There is a likelihood of further yield compression (and hence NAV uplift) in the Sirius portfolio over the next twelve months.
CAPITAL AND REGIONAL:
Market cap R9.8bn; Primary listing UK; Secondary listing JSE main board
Capital & Regional’s property portfolio includes six dominant regional shopping centres (“the Mall portfolio”) located mainly in the South East of England, with a combined value of £791m as at 30 June 2015.
The company has recently navigated through a period of transformation, the most important of which was the acquisition of 100% of the Mall portfolio in 2014. Prior to this, it held a 37.5% minority interest in these six shopping centres.
With complete ownership and full control of the cash flows, Capital & Regional has initiated various capital expenditure and asset enhancement programs on the Mall portfolio (budgeted at £65m). If executed correctly, this should drive increased footfall and lead to further rental increases.
The company’s investment objective is to generate both income and NAV growth through the aforementioned asset management initiatives, as well as undertaking consolidation opportunities in the regional shopping centre space in the UK.
The company distributes 90% of the annual Mall operating profit, with a forecast 4.5% distribution yield in Pound sterling to December 2015. Capital & Regional trades in line with its latest published NAV per share and at a discount to the expected forward NAV per share. Further yield compression in the portfolio is expected over the next twelve months.
CAPITAL & COUNTIES:
Market cap R74.4bn; Primary listing UK; Secondary listing JSE main board
Capital and Counties (“Capco”) is the largest of the fund’s offshore property holdings by market capitalisation, and the one that SA investors will be most familiar with.Capco’s properties are centred on two distinct areas in London, the Covent Garden estate (currently valued at £1.8bn), and the Earls Court development project (valued at £1.3bn).
The company’s investment objective is consistent NAV growth, something it has comfortably achieved since unbundling out of Liberty International in 2010. Over the five year period to June 2015, Capco’s NAV per share has grown at a compound annual rate of 20% in Pound sterling.
The Covent Garden Estate consists of 70 buildings with 420 rental units focussed on retail and dining. Through selective acquisitions and astute asset management, Capco has transformed Covent Garden into a prime retail destination that has 42 million customer visits a year, and successfully competes with the high streets of Regent, New Bond and Oxford.
The Earls Court project is an ambitious multi-year mixed use development where Capco is the majority shareholder and project driver. Under the masterplan, approximately 7,000 new homes are planned for Earls Court in what is a lengthy, costly and highly complex project. There is a strong probability that as the project evolves and more execution certainty emerges, that Capco will de-risk its exposure to Earls Court through the introduction of new development partners or a partial sale of its stake.
Capco currently trades at a premium of 25% to the latest disclosed NAV per share. Our assessment is that the NAV of Covent Gardens is conservatively stated while material upside exists in the Earls Court valuation should the project proceed as envisaged.
MAS Real Estate:
Market cap R5.7bn; Primary listing Luxembourg; Secondary listing JSE main board.
MAS Real Estate is a hybrid property company with a focus on both income generating properties and development properties (combined value of €376m including investments and treasury).
The income generating properties are mostly located in Germany and the UK with an emphasis on retail and mixed use tenants. The annualised rental yield on the income producing properties exceeds 7.5% in Euros. As the company acquires additional income generating properties and introduces further bank funding into the portfolio, the LTV is expected to increase above 40%.
Development properties include a substantial mixed use development in Edinburgh, Scotland (hotels, retail, and office) and two further mixed use developments in England. The development portfolio is currently ungeared.
Developing usually allows for a higher income yield and superior capital growth compared to a straight acquisition, but there is a lengthy time lag between costs incurred in developing the property and the initial receipt of rental income. There is also an inherent execution risk in delivery. MAS attempts to reduce these risks through pre-letting the properties upfront, and limiting the overall portfolio allocation to developments (currently 22% of group NAV).
MAS trades at a modest 11% premium to underlying disclosed NAV, although the NAV is conservatively stated with negligible uplift currently attributed to the development properties. Strong NAV growth is anticipated as the Edinburgh development approaches completion in the next two years. MAS trades on a forecast dividend yield to June 2016 of 4.5% in Euros. The fund has been invested in MAS since March 2014.
