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While the direct consequences for businesses operating in the UK or Europe are very difficult to predict, it is clear that a disorderly resolution of the terms of Brexit could have a very negative effect on a number of companies and sectors globally.
“Fear and uncertainty typically create an opportunity to buy at distressed prices and we have been actively screening for opportunities to buy quality UK or European assets, including looking in to the UK property market,” says Shaun le Roux, fund manager at PSG Asset Management.
“The sharp decline in listed UK property has caught the eye, with the likes of JSE-listed Capital and Counties trading 50% lower than where it was in December. The plunging stock prices reflect the change in sentiment that accompanies the uncertain outlook for the UK economy, and London property, in particular.”
Though the major listed UK property groups are now trading at discounts to their published net asset values (NAVs), Le Roux says PSG has yet to find attractive opportunities within the UK property sector. “While currently prices might seem optimally cheap, we believe that these published asset values are rather stretched.”
The assumptions baked into the valuations extrapolate the recent lucrative environment for UK landlords many years into the future. “Over and above very rosy rent assumptions, the rates at which the properties are capitalised are, in our view, a function of artificially low interest rates and result in unrealistic values,” he adds.
As an example, consider Capital and Counties, which has dropped from a premium of 22% to a discount of 18% relative to its published NAV over the last six months.
“Our estimate of fair value, however, comes in below the current share price. More generally, we will be interested when these property companies are trading at discounts to net asset values, which have been marked down to more reasonable levels,” Le Roux says.
Where is PSG finding value locally?
Le Roux would argue that the poor shape of the South African economy and the fear around potential debt downgrades demonstrates similar characteristics to the Brexit fears. The difference is that a dire outcome is priced into many of the financial and industrial shares on the JSE and as a result PSG has been an active buyer of good businesses at very good prices.
Since the political events of December last year, a specific opportunity has arisen to buy well-managed and highly-capitalised banks in SA. For example, FirstRand offered a dividend yield comfortably in excess of 5% for the first time since the financial crisis. “By contrast, many of the UK and European banks remain under-capitalised and run by management teams with questionable capital allocation track records,” he says.
PSG sees risk in expensive stocks including SA listed property
As far as the JSE is concerned, we feel there is currently less risk in owning good businesses that are economically-cyclical, but very cheap and much more risk in owning expensive stocks that are pricing in very high expectations.
“We think the sell-off in listed UK property should serve as a warning to investors in expensive stocks in SA. Similarly, we would be very cautious of the local listed property sector. The yields offered by SA REITs continue to come down as investors continue to pay up for predictable distributions.”
The dividend yield on the JSE Property Index has reduced by 280 basis points over the past three years despite the supply/demand fundamentals for the sector deteriorating. Low borrowing rates and booming property prices have resulted in a continuous addition to office and retail space, which will result in increased vacancies and lower rent increases.
Many of the SA property companies have also rushed into foreign markets, especially in Central and Eastern Europe, where in some cases, we see even more risk than in the SA market. “We believe that the price and economic fundamentals of JSE listed property are out of kilter and this raises the risk of poor future returns and the loss of capital,” Le Roux concludes.
