Chairman's Statement

Brian Kantor Chairman

ANOTHER GOOD YEAR
Acucap has had another very good year as our operating and financial results make very clear. The 6.3% growth in cash distributed to our unitholders has continued to exceed the inflation rate, one of our primary objectives, while the independent valuations have resulted in a very pleasing R507m fair value adjustment upwards this financial year to the value of our investment properties. This represents an increase in the value of our investment property of approximately 8.52% and adds proportionately to our balance sheet strength and the ability to raise debt to fund additional profitable investments.

COMPLIMENTS TO THE MANAGEMENT TEAM
The reported financial results and the property owning fundamentals that back them up are a tribute to the soundness of our strategy and the ability of our management team to execute the strategy successfully. The essence of the strategy has been to realise the available economies of scale, with relatively few individual property assets of high quality that would benefit from the close detailed attention of talented and experienced property managers who are appropriately incentivised.

REALISING THE ECONOMIES OF SCALE
The purchase of Sycom Property Fund Managers and the intergration of the management of the Acucap and Sycom portfolios have been most effective to this end. The success of this integration can be measured in the highly satisfactory 11.6% net cost to income ratio as well as in the quality of our in house property administration. The company pays very close attention to both the costs and the benefits of our administration regarding both as critical to our long term success.

The process of integrating Acucap and Sycom will be completed when as intended the two companies can be fully merged to the advantage of all unitholders. There is considerable overlap directly and indirectly (via other listed property Loan Stock Companies with stakes in Sycom and Acucap through the same institutional shareholders). Acucap’s  20% direct shareholding in Sycom represents part of the overlap in ownership, while it also ensures the alignment of the interest of our own unitholders with those of Sycom unitholders. These common cross holding should encourage a formal more rational, still more cost effective, merger of the two entities.

THE SUCCESSFUL FOCUS ON SHOPPING CENTRES
The focus of Acucap on owning large regional shopping centres has proved particularly well judged. The sustained strength in the demand by national retailers for well located retail space, with strong balance sheets and excellent returns on the capital they invest, has been the foundation of Acucap’s success in keeping vacancy rates to a minimum and growing its rental revenues. Our retail assets are being continuously upgraded and improved and extended imaginatively, in the attempt to meet to our profit, the demands of retailers for additional space to trade in. A core competence of our management team has been to identify and realise the opportunity to improve and extend our offering to retail tenants.

THE ESSENTIAL PARTNERSHIP WITH SERVICE PROVIDERS
It is widely recognised that our tenants are responsible for more than the rental agreements they have with their landlords. They may be responsible for their share of real estate taxes and charges levied by the municipal service providers for water and electricity. However these charges are contracted for, they represent a threat to the rentals property owning companies are able to charge. What the rental market will bear must depend upon the total costs met by the tenant independently of how the charges are segmented.

These service charges and property taxes have been rising over recent years at rates well above inflation generally and the growth in rents collected by landlords. We have shown however that almost all our retail tenants, judged by the ratio of their full costs of occupancy to turnovers, after allowing for differences in operating profit margins, are not at all distressed, despite these increased cost pressures. Hence the very low vacancy rates recorded in our rental centres and the unsatisfied demands for additional space.

The threat of rising service charges and higher property taxes to the ability of landlords to raise rentals in line with and in excess of the increase in the costs under their direct control has been contained, as our rental reviews and new rental agreements indicate. We appreciate that the local authorities and service providers are key and indispensable partners in the assets we own. Without good access to our centres and without adequate reticulation of electricity and water and the removal of waste the shopping and work experience could be highly unsatisfactory and destructive of property values. It is also well understood that overcoming historic backlogs in the essential infrastructure needed to deliver the essential services can mean sharp temporary increases in the tariffs required to recover costs, including the costs of funding additional essential plant and equipment and the costs of maintaining and improving the road system.

As landlords, we are very willing to be charged directly and indirectly through our tenants, to recover the full costs, properly measured and managed, of supplying essential services. We will make every effort through our Property Owning Organisations and Rate Payer Associations to ensure that we are not over charged for the services provided or unfairly taxed relative to other property owners. Unfairly high charges can result from excessive reliance on current tariffs to recover capital expenditure that is properly amortised over the full, often very long economic life of the assets, or can be the result of inefficient management by the service providers.

We are confident that the providers of these essential services to property owners and their tenants will appreciate that they share fully in our efforts to improve property valuations. The more valuable the property the greater the tax base and so the more tax that can be collected without stress to the advantage of all those with a stake in the rental income collected, including the local authority. Good services provided by the municipal authorities provided at reasonable tariffs will add to commercial and residential property values. Higher valuations mean that increased tax revenues can be fairly extracted to the advantage of all, including the disadvantaged suburbs, so lacking in essential services.

THE ECONOMY AND THE PROPERY MARKET
The SA economy is in the second year of a recovery from the severe recession of 2009. The pace of recovery has been maintained, however there is little sign of any recent acceleration in the underlying growth rates. That the economy continues to operate at less than its growth potential is revealed by tepid growth in money supply and bank credit growth, in house prices that are on average unchanged from a year ago and building and construction activity that remains depressed. Employment in the formal sector is not growing anything like rapidly enough to absorb a growing labour force even while employment benefits, including wages, for those in jobs, continue to outpace inflation. While economic conditions have improved in SA these are anything but boom times for the SA economy or property owners. The recent economic achievements of Acucap and the other successful Property Loan Stock (PLS) Companies listed on the JSE through and after the recession owe significantly more to good management than good luck.

THE MARKET HAS BEEN SLOW TO RECOGNISE IMPROVED QUALITY IN PROPERTY ASSETS AND THEIR MANAGAMENT
I have argued before that the quality of Acucap and the PLS Sector generally, especially its ability to deliver consistent and predictable growth in cash distributed was but reluctantly recognised by portfolio investors. Hence the exceptional returns provided year after year by the property Loan Stocks as valuations played catch up with much improved economic realities. Over the period March 2003 - June 2011 Acucap (first listed in early 2002 and paid its first dividend in 2003)  it has provided a average compound total rate of return (capital gains plus dividends) of close to 24% pa calculated monthly compared to the All Share Index with average return of 16.6% over the same period. The PLS Index returned 24.4% while the All Bond Index (ALBI) returned an average 10.2%. Inflation has averaged about 5.4% over the period indicating that all asset classes provided good real returns while commercial property owners enjoyed quite exceptional, well above required risk adjusted returns.

The market returns realised by Acucap and the PLS Index over the past twelve months June 2010 - May 2011 have been below this average, lower than all equity returns, but still very satisfactory, as we show top right of the order of 16%.



DEFENSIVE QUALITIES REVEALED
The year 2011 has proved to be a very difficult one for equity investors. The second quarter of 2011 has seen negative returns for the JSE. Acucap unitholders, Investors in the PLS Index and in the All Bond Index, in that order have been much better served as we show below. The listed property sector has proved especially defensive recently during a period of marked market turbulence. That bond yields have fallen as investors sought safety in fixed interest clearly helped the Property Sector. But excellent property fundamentals in the form of continued growth in distributions paid, as in the case of Acucap, must have helped to maintain the market value of listed SA property.



In the figure below we compare dividends per share distributed pre and post the Global Financial Crisis to JSE shareholders, and to unitholders in the PLS Index and Acucap. As may be seen the comparison is extraordinarily favourable to property owners. While ordinary JSE dividends per share collapsed by 54% from their peak in  March 2009 to the trough a year later under the pressure of the global recession, over the same period PLS distributions were unchanged while cash distributed by Acucap was up by nearly nine per cent. While JSE dividends have since recovered strongly, they are still below their pre-crisis peak, distributions per linked unit paid by Acucap and the PLS  Index have continued to advance at well above the pace of inflation and are now approximately 20% above their January 2008 levels.



A RERATING OF THE PROPERTY SECTOR APPEARS OVERDUE
The recent defensive qualities of the PLS sector of the JSE are surely well explained by these highly favourable comparisons. It may be thought that such qualities would have resulted in something of a rerating of the property sector relative to the bond market. That is investors might have been prepared to bid up the PLS Index and reduced the initial yield on offer below that of the yield offered by long term RSA bonds. As we show below this has not happened. The trailing dividend yield on the PLS Index has closely tracked that of the long bond yields. Or in other words no re-rerating has taken place.



My own view is that inflation linked or beating growth in cash distributed should be worth more than an initial 8%. I am of the view that, were the Property Companies confidently to be expected to consistently deliver inflation equalling distributions, an initial yield of 5% would be justifiable.

THE TASK AHEAD
The task for the management of Acucap set by its board is to continue to realise inflation equaling growth in distributions over the long run. I would like to record my appreciation of the excellent results achieved by our team in 2010-2011, and have every confidence in their ability to continue to realise very good outcomes for unitholders. I have great appreciation also for the key roles played by my fellow board members, who have played a material role in setting the appropriate strategy for Acucap. They bring years of property and business experience to the governance of Acucap, and set very high standards for Acucap management. The respect of the board for the managers and of the managers for the board is deservedly mutual and highly constructive.