/CHAIRMAN'S STATEMENT
JSE PROPERTY AND ACUCAP RIDE OUT THE STORM WITH APLOMB
The past twelve months have proved very trying for investors in most asset classes everywhere. The exceptions to this unhappy state of affairs however included, surely surprisingly to many, property companies listed on the JSE, including acucap. While listed property in the US and UK have been among the worst affected by the global credit and liquidity crisis, SA property has ridden out the global financial storm in excellent shape. The JSE property Loan Stock Index (PLS), measured in USD or rands, has gained significant value since June 2008. By contrast the average US and UK Real estate Investment Trusts (Reits) are, on average, worth but half their year ago USD values, even after recovering from their deeper lows of early March 2009 (see below).
GOOD PROPERTY RETURNS WERE EARNED WITH LOW RISK
Not only did SA property listed on the JSE perform absolutely well, it did so subject to much less volatility than was the case with the market values of most other asset classes. It is also striking that the volatility of the JSE listed PLS Index has been much lower than that of the JSE All Share Index, but also of the JSE Financial Index. Volatility is measured here as the 30-day moving average of the Standard Deviation of daily percentage movements in the respective Indices. The defensive qualities of listed SA property have never been better demonstrated.
EXRAORDINARY RESULTS DEMAND A FULL EXPLANATION
This extraordinary divergence of the performance of listed property in SA and abroad, given the intergrated global capital market that had a highly negative influence on JSE listed equities in general, demands explanation. That foreign investors are not yet well represented among the holders of PLS units, as they are well represented on the share registers of the larger SA listed companies, helped the sector escape the direct assault on values caused by the credit and banking crisis. Thus the sector was not exposed to the forced sales, that is the deleveraging process, forced on borrowers exposed to the savage price declines in equity and corporate bond prices that followed the Lehman bankruptcy of September 2008. It was also important for SA property investors that SA banks and credit markets were not directly exposed to the credit crisis in a damaging way.Though as important for the listed property sector in SA, is that it had contained its appetite for debt in the years leading up to the crisis. Low levels of debt relative to rising asset values were encouraged by the traditional focus of investors in the sector on high first year yields and the apparent dangers of yield dilution. The essential conservatism of property investors, reluctant to pay up for growth in distributions and asset values in the form of lower initial yields, despite a long period of outstanding good performance in both, served property investors very well when the credit world fell about.
PROPERTY FUNDAMENTALS HAVE DRIVEN PERFORMANCE
The protection offered by consistently good performance delivered by the listed SA property loan stocks and trusts was surely the most important force sustaining property market valuations in SA. The sector has continued to deliver strong growth in cash distributed to investors and this growth was well sustained over the past twelve months. The sector, unlike its offshore peers, continued to perform very well in 2008-2009 as we show below. Pleasingly Acucap has more than kept up in this regard. Between May 2005 and May 2009 the PLS distributed cash to unit holders at a compound average rate of nearly 14% pa. In the twelve months to May 2009 cash distributed by the PLS Index grew by 11.27% while the cash distributed by Acucap was up by 12.3%. This growth has helped to sustain the initial distribution at attractive levels relative to long term bond yields and declining money market yields.
PAST AND FUTURE PERFORMANCE - THE STATE OF THE ECONOMY WILL BE CRUCIAL TO THE OUTCOMES.
An explanation of past performance will not necessarily explain future performance. The future performance of the JSE PLS sector will continue to depend as much as it has in the past on the after-cost rental income of their portfolios of commercial property. The key driver of net rental income will remain the real state of the SA economy and so the ability of tenants to meet their contractual commitments to property owners, as well as to take up available space in established buildings, and the limited supply of additional space coming on to the market will continue to benefit owners of established real estate.
There is little room for complacency about the outlook for the SA economy over the next twelve months. Household spending growth has slowed to a complete halt and the growth in fixed capital formation by the private sector has fallen away in sympathy with much weaker household spending.
The support for the economy is coming from public sector spending that is maintaining a very rapid rate of growth, and especially on much needed additional capital formation. Fortunately years of great plenty in government revenues, linked to the previously buoyant economy, have been used not only to fund increased government spending but also to reduce government debt to GDP ratios. Accordingly the interest charge to the budget of the central government has declined to very manageable levels, and there remains much scope for the SA government to maintain its planned spending even as tax revenues fall away. The contrast with the state of public finances in Europe and the US could not be more favourable to the SA economy. The public sector can continue to act as a very necessary stimulus to total spending in SA without fear of prejudicing its credit rating.
HOUSEHOLD SPENDING IN SOUTH AFRICA NOW NEEDS ENCOURAGEMENT
The weakness of household spending in our judgment has had very little to do with the global credit crisis. It is the unfortunate result of overly severe interest rate settings. Short term interest rates in SA were raised and were sustained at high levels long after it was apparent that they had slowed down interest sensitive spending.
It is instructive that vehicle sales in SA were already in decline by May 2007 after which interest rates continued to rise further and were only to level off in August 2008 and to be reduced in December 2008, well after the global credit crisis had erupted (see right). It seems very clear to me that injudicious monetary policy caused the SA recession. The credit crisis and its impacton global economies and their willingness to import goods and services has made it that much harder for SA to escape recession.
IT WILL TAKE MORE THAN LOWER INTEREST RATES TO REVIVE THE ECONOMY
It seems also clear to me that monetary policy should be doing all it can to revitalise household spending in SA. A recovery in household spending that directly accounts for over 60% of GDP is essential if the economy is to advance at anything like its potential. Lower interest rates are helpful to the purpose but alone will not be sufficient given the reluctance of the banks to provide credit on normal terms to the household borrower.
SA banks, to their credit, escaped the credit crisis with their capital, strengthened by years of rapid growth in retained earnings, largely intact. But the SA banks, like many of their peers offshore with capital exhausted by injudicious lending, have also become highly fearful of bad debts to come. Their general reluctance to lend represents a threat to the economy and as such makes bad debts ever more likely.
THE CASE FOR QUANTITATIVE EASING IN SA
Quantitative easing to encourage SA banks to lend more so that the economy can recover its growth momentum is as essential here as it is abroad. It makes even more sense because the supply of central bank cash in South Africa is growing very slowly. In the US the supply of cash has grown very rapidly but much of the extra cash is being held idle at the Federal Reserve Bank in the form of very substantial excess reserves. SA banks are not holding excess reserves and supplying more cash to them on favourable terms will encourage them to lend more.
I have recommended two forms of quantitative easing. Firstly, when unwanted rand strength is countered by purchases of dollars in the currency market, the Treasury should no longer neutralise such purchases of dollars on the cash supply by selling government debt. Secondly, that repurchase operations by the Reserve Bank should be undertaken on a more extended basis. The banks are paying up for twelve month money given their anxieties about longer term funding. The Reserve Bank could ease such anxieties with twelve month and more money on attractive terms. This easier access to funding will surely encourage the banks to increase the supply of bank credit to the household sector that is currently in retreat.
LIGHT TO BE SEEN AT THE END OF THE GLOBAL ECONOMIC TUNNEL
The global credit markets have benefited from a very welcome decline in risk aversion. The recovery of global equity markets from their lows of early March 2009 is testimony to this as is the much improved volume of issuance by corporate borrowers and lower risk spreads attached to their costs of borrowing. The outlook for the US and global economies have become less fraught with uncertainty and the prospects of a return to still subdued, but positive real growth, is in sight.
These trends will be helpful to the SA economy via improved levels of exports and higher commodity prices. However, any strong early rebound in the SA economy is very unlikely, though there is every reason to believe that the inherent strengths of our economy and the participants in it will see the economy pick up momentum again in 2010 and that the economy will be restored to full health within three years. Thus a degree of caution by SA property owners and investors is entirely appropriate to these times, while the long term promise of the economy and its listed property sector remains undiminished, and will perhaps even be enhanced by a further display of its defensive qualities.
ACUCAP IS WELL PLACED TO REVEAL ITS DEFENSIVE QUALITIES
Acucap is very well placed to navigate more difficult conditions in the property market as has been fully reported in our commentary on our financial statements. More recent trading trends do not give cause for any additional concerns about the outlook for rental income. We are comforted that our strategy will prove helpfully defensive against more difficult economic times. Our retail offering upon which we rely for much of our income is occupied mostly by the major listed retailers who remain in robust economic health despite a more difficult retail environment. They seem very willing and able to take a long term view of their requirement for well located trading space of the kind we supply. Such space will prove particularly valuable and in short supply when the economy revives, and our major tenants seem very well aware of this.
With our focus on managing a relatively small number of key properties, our management is able to closely examine our tenants for early signs of distress so that appropriate remedial action can be taken. As indicated in our reports on trading densities, we have noticed few signs of serious stress to date and remain confident that vacant space will not threaten our performance materially, and that contractual commitments to pay rent will be well honoured.
A TRIBUTE TO MANAGEMENT AND THE BOARD
Acucap is a very well-managed company as our comprehensive reports and financial results hopefully make very clear. I am able again to pay unreserved tribute to the revealed competence and commitment of our senior management and the able team they have built to support them and their efforts. My thanks are also due to our highly experienced and capable board of directors. My belief is that we exercise our corporate governance responsibilities with a thorough process and independent and yet sensitive judgement. I look forward to the next year with great confidence that the merits of our company will be well demonstrated in more challenging economic circumstances.
