Group CEO’S review
For now, we remain alert to opportunities but averse to risk. In the short to medium term, our priorities will be defined by the actions necessary to protect our balance sheet.
As we moved into the financial year, we were concerned about the low economic growth which, over the previous five years had averaged only 0.6% and led to negative property fundamentals. We were expecting a tough year and anticipated performing in line with FY19, with nominal growth overall.
While we were recording negative growth in the South African environment, the gains we were set to make from the V&A and our offshore investments, together with the benefit from currency gains, meant that we were substantially on track to achieve our guided performance, as was evident from our results for the first six months of the financial year. We remained on track until mid-March, near the end of the third quarter of FY20.
Just days after we announced our half-year performance, the government announced a state of disaster in response to the Covid-19 pandemic. A week later, the initial 21-day lockdown was announced. At that stage, it could not be foreseen that it would result in such harsh, restrictive and protective measures. No one could have anticipated how difficult it would be. Since then, the world has been turned upside down.
Events in the final quarter of our financial year have had a material impact on our South African business, as described in the relevant section of this report.
The V&A has been a standout performer for Growthpoint for the past five years and a key contributor to its growth. This investment has long been a defensive buffer against the weak South African economy because of its exposure to international tourism, but this strength quickly became a weakness when the lockdown caused it to lose its biggest market completely, and we expect it to suffer disproportionately to the rest of the South African portfolio until international tourists feel safe to return to Cape Town.
The impact of loss of tourism on the V&A would have been even worse if not for its diversification of uses, including offices, industrial, marine and residential properties, all of which have been much more resilient.
However, the socialising for which the V&A is designed, from its restaurants and entertainment venues to its events, was severely curtailed during the first three stages of the lockdown. In addition, the high proportion of fashion and jewellery in its retail mix is largely reliant on discretionary spending which also decreased, notably due to the absence of international visitors as well as the economic fallout of Covid-19 locally.
We thus expect a slow recovery at the V&A to start gaining traction only towards the end of 2020 and to begin approaching pre-Covid-19 levels only in the latter half of 2021.
Our international investments in GOZ and GWI were also affected by Covid-19, but to a much lesser extent, mainly because of their focus on the office and industrial property markets, not retail. GOZ’s customer base is weighted towards large, listed corporates and government, making it defensive. Likewise, GWI is mainly tenanted by large multinational and national businesses, which has protected it. Of its two portfolios, Romania outperformed due to the Polish portfolio’s greater but still low exposure to retail and small businesses in multi-tenant buildings.
Operationally, our investments in Australia and CEE are doing well. They are liquid and sustainable and have enviable access to new liquidity as well as unutilised debt facilities. Even so, as has become common in this environment, both have taken a conservative approach to reduce dividend pay-out and payment ratios to conserve their strong liquidity and balance sheets. As a result, Growthpoint received less dividend income from these entities in FY20 than initially expected.
Our new international investment, UK shopping centre owner C&R, has faced much greater challenges than GOZ and GWI. While Brexit and the accelerating shift to online retail have significantly changed the UK retail scenario in recent years, there were still some exciting opportunities for us when we made our investment in December 2019. Since then, the impact of Covid-19, coming on top of the already weak economy, has been severe on the UK property market. Valuations have plummeted further and faster than we expected when making this investment and the retail environment has deteriorated with the UK’s lockdown. This has had a negative effect on C&R’s operations and placed limits on its performance.
On 9 July, Growthpoint advised the market that its distributable income per share for FY20 would be more than 15% lower than for FY19, with the final number being 16% lower.
In the last three months of the financial year and right up to the date of this report, we placed much emphasis on managing liquidity within the Group after paying our half-year dividend of R3.3bn in March.
Growthpoint enjoyed a strong liquidity position at the onset of the Covid-19 pandemic in South Africa, and defending and increasing this became an immediate priority. Our focus turned to capital management, securing additional facilities from domestic and international banks, refinancing bonds and managing expiries in the bond market.
Growthpoint became one of only a few companies that successfully refinanced a bond in the midst of the Covid-19 crisis, and we were able to increase the size of the refinance significantly. This is a remarkable achievement.
Focusing on containing expenses, we scaled back on capital and development commitments, except for those projects that had already started and were advanced or nearing completion. New investment and development activity will remain suspended for the immediate future.
When entering the final quarter of FY20, we were still confident of achieving results in line with our guidance. At that stage, there was already a trend among SA REITs of considering lower dividend pay-out ratios to strengthen balance sheets and manage liquidity, with 75% being the lowest level permitted for a SA REIT, but Growthpoint was not actively reconsidering our historic policy of paying 100% of distributable earnings. However, with the dramatic change in our operating environment, it became necessary to review our policy in this regard. While we were cognisant of the call from a number of our investors for Growthpoint to withhold the payment of our dividends in totality, we felt that a balanced approach which took into account the needs and requirements of all our shareholders, from the biggest to the smallest investor, as well as our funders and many other stakeholders, would be more appropriate. We also needed to ensure our continued REIT status, and as a result it was decided to reduce the dividend payment ratio to not less than 75%.
We are also adopting a more conservative approach to the manner in which we determine distribution per share, to ensure that our dividends are sustainable. This approach is likely to result in a reduction in the traditional 100% distribution ratio.
Notwithstanding the industry-wide discussions with the JSE and the National Treasury for temporary concessions for REITs with regard to dividend payment ratios, Growthpoint’s FY20 dividend payments will be sufficient to comply with the requirements necessary to maintain REIT status. While there is likely to be a tax liability on any retained earnings, we aim to ensure that this is managed in a way that is both tax efficient and compliant.
At the same time as South Africa locked down to flatten the curve of Covid-19 infections and the economy shut down, Moody’s downgraded the country’s credit rating to sub-investment grade and our own international and national ratings were adjusted in step with this, which is not a factor within our control. We premise our LTV and debt covenants on Moody’s measures. This is not an immediate concern, but we remain mindful that our debt covenant and solvency ratios as well as our ICR’s are likely to decrease as property values come under pressure globally and in South Africa in particular. They will need to be managed in the medium term to ensure we have sufficient headroom on the measures that Moody’s focuses on. We will do this to maintain Growthpoint’s optimal credit rating in an environment where asset values are expected to decrease.
We believe property values could decline by a further 10% in the next 12 to 24 months. Growthpoint adjusted its property values down nominally at the half-year as a result of the depressed economy and a further 8.8% at the end of FY20 due to the broader economic impact of Covid-19. At this stage, the market consensus is that it will take at least four to five years to return to pre-Covid-19 levels. In a slow and gradual recovery, it is inevitable that our asset values and income will come under further pressure. The vast majority of downward valuations will be linked to lower income assumptions, stemming from lower rental income growth, higher vacancies and costs, while around 20% can be attributed to discount rates moving higher.
The consolidated Group loan-to-value ratio (SA REIT LTV) was 43.9% for FY20 (FY19: 36.7%) and includes the increase in net derivative liabilities from R116m in FY19 to R3 155m. The LTV would have been 2% lower if derivative liabilities were not included.
To minimise the risk of spreading the Covid-19 virus within Growthpoint’s operations, we imposed strict measures to protect our employees and all who use our buildings. We invested extensively in safety and sanitation at our many properties, including shopping centres across the country that were supporting essential retail, to safeguard the wellbeing of millions of South Africans.
We also prioritised the financial security of our people, and protected livelihoods by retaining all our employees and maintaining salary levels.
Throughout this worrying and challenging time in South Africa, the most significant impact of the Covid-19 lockdown measures has been financial. Our clients’ inability to access or use their premises as a consequence of the lockdown set the stage for the non-payment of rent, leading to a sudden, dramatic and unpredictable change in our business. We were collecting 98% of contractual income one month and struggling to reach 70% of collections the next. While not immediately measurable, the financial effects of the lockdown were felt by our staff, client base, business and supply-chain partners, all their communities and beyond.
All our teams faced extreme operational difficulties. Our retail team tackled the enormous task of managing shopping centres during lockdown. Vague and confusing regulations from the government resulted in clients, shoppers and regulators all interpreting them differently. The situation changed monthly from April to June, each time with substantial deviations and ambiguous orders. The challenge of managing operations in choppy waters awash with ambiguity, was profound. It soon became equally difficult for our office team and, to a slightly lesser extent, our industrial team. The on-site management of our properties intensified, with the need to vacate and deep clean them regularly. The pressure of dealing with all these issues has been profound for everyone, including our HR team and our management teams, and I offer my thanks to each one of you.
Growthpoint was also a major contributor to the property industry’s response and relief efforts, with our SA CEO leading the initiative and Group FD and others making significant contributions. The details of the Property Industry Group’s initiatives, and the positive impact they have had on the sector and our business, are mentioned throughout this report, specifically in the SA CEO’s review.
Growthpoint was proactive in managing the evolving lockdown situation by being in constant communication with all our tenants and adopting an open and collaborative approach. We provided material financial stimulus to our customer base. We moved quickly to offer support, mostly in the form of R436.3m worth of rent reductions and deferments early in the process, to try to ensure the sustainability of our clients through and beyond the pandemic. Sustainability was at the heart of our actions and decisions. Our goal was to help our clients to weather the storm and so also to protect the sustainability and security of our income.
Our ability to respond to this crisis with the necessary agility and composure was enabled, in part, by the excellent Board support that our management enjoyed. The significant knowledge of and insight into Growthpoint, of our longer-serving Board members, together with the wealth of experience and fresh approach of new members, has served the business well during this most trying of times. I extend my appreciation to all our Board members, and to our chairman Francois Marais in particular, for the availability, guidance and conduct that was a tremendous support to our entire executive team during a difficult time indeed.
The crisis has highlighted the plight of the unemployed, uneducated and other vulnerable members of South Africa’s population. There is no doubt it will also redefine acceptable corporate conduct. Profiting at all cost has become unpalatable and business is going to have to take into account key issues such as environmental sustainability and poverty alleviation to a much greater degree than previously. We are entering an era where business will be more socially responsible, starting with the direct connection to employees and their families and extending to communities and the country as a whole. The Covid-19 pandemic also resulted in business in general, and Growthpoint specifically, viewing sustainability in a new light.
In FY20 we persevered in our corporate social responsibility, which is focused on sustainable entrepreneurship and creating bright futures through education. Various projects are described throughout this report and more detail can be found in the CSR and HR sections. During the Covid-19 lockdown, we stepped up our support of these initiatives and helped them adapt. We also redirected some of our CSR spend towards greater hunger relief and access to technology and connectivity. In addition, many of our business leaders supported the national response to the pandemic by contributing to the Solidarity Fund, furthering the country’s consolidated effort to detect and prevent the spread of the Covid-19, care for those in hospital, ensure a supply of personal protective equipment and feed and shelter people left vulnerable by the pandemic.
Even in the uncharted waters of the Covid-19 pandemic, our commitment to the environment is steadfast. In fact, we believe healthy and sustainable environments have taken on new relevance and will gain even more in the wake of the pandemic. You can read more about our environmental sustainability highlights in the Operations section.
The short-term impact of the pandemic for us was felt in the tsunami of rental relief requests received and the sudden difficulty of recovering rent as a result of the lockdown, as detailed above.
The medium-term impact is being felt in the devastating effect the pandemic has had on the global macro-economy and the decimation of our local economy. It has hurt our business and our customer base and we all face a long, slow and difficult road to recovery of at least four years.
Beyond this, in the medium and long term we expect to see trends that were already evident pre-Covid-19 gaining greater traction, from online retail in some segments of the market to a more dynamic mix of working options in some business sectors. These will not immediately have dramatic impacts but will drive longer-term structural changes in the property market. Fortunately, Growthpoint had previously identified many of these shifts and already started developing and testing strategies to respond to them.
For now, we remain alert to opportunities but averse to risk. In the short to medium term, our priorities will be defined by the actions necessary to protect our balance sheet. Once our balance sheet position allows more agility, we will continue driving forward the three pillars of our long-term strategy.
Having assessed our strategic pillars – internationalisation, introducing new income streams and optimising and streamlining our South African portfolio – in the light of the expected future operating environment, to the extent that this can be known, they all remain relevant.
We will have to wait for liquidity to return to the market before we can further our desire to expand offshore and progress on our internationalisation strategy. In the meanwhile, we will sharpen our focus on and refine our approach to international investment.
Building on the good momentum gained in introducing new income streams with our Funds Management strategy, we will continue to pursue and possibly accelerate our efforts in this area, where opportunities are more likely to arise, given the challenges in the current market and this platform’s efficient use of capital.
In this environment, it is reasonable to expect that the scale of our trading and development activity and their income streams will decrease, with development opportunities being scarce and generally less feasible and trickier to fund. We will rigorously assess all development and investment risk. We have suspended all speculative development. New development projects, if any, will be restricted to opportunities that are necessary to create immediate guaranteed additional value, which are likely to be small, tenant-driven reconfigurations of existing assets.
Portfolio streamlining and optimisation will continue to underpin our South African strategy. This was already challenging pre-Covid-19 and will be even more so in the future. There are few buyers in the market and little capital.
In determining our prospects, the macro-environment is deeply concerning. The South African economy is expected to shrink by 7% to 10% this year, the deepest contraction in nearly a century. The stringent Covid-19 containment measures severely disrupted economic activity in an already stuttering economy.
Even before the restrictions were imposed, South Africa was in recession and unemployment at 30% was at a 17-year high. One of the world’s strictest lockdowns has left millions more jobless and slashed economic output. Investment outflows in the first half of 2020 were at the highest levels on record, while consumer confidence was at the lowest since 1985, when the country was the target of global economic sanctions due to its apartheid policies. The government intends to cut spending by R230bn over the next two years and national debt, which was a record high 62.2% in 2019, had reached 80% at the time of writing and is set to surpass GDP soon if not kept in check.
Our prospects are inextricably linked to our operating environment. As the world and the South African economy recover gradually, we have a tough couple of years ahead of us. But we are a strong and diversified business, and this is precisely the time when our conservative approach to management is designed to support outperformance.
Growthpoint has the advantages of a strong balance sheet and good credit standing, diversification across geographies and sectors and best-practice corporate governance. We will place even greater emphasis on proactive and prudent balance sheet and liquidity management going forward and ensure that we are effective and efficient in the management of our operations to enable us to pursue suitable opportunities to further our stated strategies.
Our performance in the year ahead will be defined by optimal and efficient use of capital to achieve our clearly stated strategies and drive higher returns, by protecting the strength of our balance sheet with conservative financial management and by fully utilising the abilities of our people, who are our greatest strength. Growthpoint’s robust business platform is built on our core skillsets of funds management, financial, asset, development, property management, leasing and facilities management and we will continue to leverage our multi-skilled platform to ultimately grow our business and deliver superior returns.