These are tough times in South Africa, and consumers are pinching every penny. The Rainbow Nation’s economy shrank 0.7% in the first quarter of 2017. Unemployment is up – rising from a rate of 24.5% at the start of 2016 to 27.7% today. And wage increases are failing to keep pace with inflation – declining 2.5% in real terms.
Thus, it’s not surprising that some of the Johannesburg Stock Exchange’s most prominent retail stocks have taken a beating. The JSE’s General Retailers Index has dropped 17.9% over the past twelve months.
But some retail-oriented stocks are better insulated against the sector’s chill than others, giving long-term investors an attractive entry point to potentially benefit from an eventual recovery. And one of them is a real estate investment trust (REIT) with one of the largest portfolios of South African retail property. Vukile Property Fund, which trades on the JSE under the symbol VKE, is a significant holding in our Africa strategy.
Founded in 2002, Vukile (www.vukile.co.za) owns 67 properties across South Africa and Namibia. Retail properties account for 91% of the portfolio’s total market value. A 50% ownership stake in Boksburg’s East Rand Mall is its flagship asset, but the sprawling facility just three miles from South Africa’s busiest airport (OR Tambo International) isn’t typical of the portfolio. Most of Vukile’s properties are small regional shopping centers and strip malls located in low to middle-income areas and leased to retailers that sell the necessities of life: food, clothing, and household goods.
It wasn’t always this way. Four years ago, Vukile’s collection of real estate assets looked quite different. At that time, only half of the company’s portfolio was allocated to the retail sector. The remainder was comprised of office space and industrial facilities. But CEO Laurence Rapp believed there was a glut of office buildings in the local market and soon began to jettison them from Vukile’s portfolio. He and his team have now replaced most of these properties with high-traffic malls full of deep-pocketed tenants like Steinhoff, Shoprite, and Spar. Such properties have proven to be highly resilient to the country’s slack growth due to low tenant turnover and long-term leases with annual rent escalations. Vukile’s net property income (excluding acquisitions) climbed 9.9% over the past 12 months. And the improved profitability resulting from the new portfolio mix has fueled NAV/share growth at an annualized rate of 29.8% over the past five years.
Now, due to the dwindling supply of local properties that meet its desired profile, Rapp and his team are looking further afield for high-yield real estate. Vukile has accumulated a 29.6% stake in the UK-focused REIT, Atlantic Leaf and in recent months purchased two commercial properties in Spain.
And, thanks to a concerted effort to reduce the company’s debt level, Vukile now has plenty of resources freed up to upgrade existing properties and pursue its expansion plans in the UK and Spain. The REIT’s gearing ratio is at a comfy 23%, and it has R1.5 billion (approximately $116 million) sitting on hand to invest. Nine major renovation projects have been approved or are in the works and another Spanish acquisition is under evaluation.
Vukile management believes the company will deliver distribution growth of 7-8% in the coming year, a fine result considering South Africa’s economic doldrums. We believe this growth, plus a distribution yield of more than 8.0% make the REIT a particularly compelling opportunity for patient investors.
Africa Capital Group LLC
1330 Orange Avenue, Suite 302
Coronado, CA 92118