Liberty Two Degrees: new look, fresh potential
A restructured L2D could deliver an improved dividend and share price, but some still need to be convinced of this
Despite co-owning what is widely regarded as two of Gauteng’s most prized retail assets — Sandton City and Eastgate Shopping Centre — Liberty Two Degrees (L2D) has had a disappointing run since listing nearly two years ago. The share price has been on a steady decline since the Liberty Group brought a portion of its property assets to the JSE via L2D in early December 2016, with the stock shedding around 30% of its value — from R10.50 at listing to R7.14 this week.
L2D has also not lived up to dividend growth expectations. Distributions were down around 1% for the latest reporting period (six months ended June).
However, loyal investors are likely to be rewarded for their patience over the next few years following the successful completion of a major restructuring exercise, through which the company began trading in its new guise as a corporate real estate investment trust (Reit) last week.
L2D’s restructuring was prompted by what many believed was an ill-advised and complicated ownership structure. It provided Liberty with a put option to sell its assets to L2D at preferential prices that could be dilutive to L2D shareholders given the company’s cost of equity. The market was also highly critical of L2D’s external management company, which is an unpopular structure because of the fees it incurs.
The restructuring, which was announced in May, is now complete. It entailed three key aspects: the cancellation of the Liberty put option; the conversion of L2D from a collective investment scheme in property to a corporate Reit; and the internalisation of the management company.
L2D simultaneously bulked up its portfolio by acquiring properties from Liberty worth an additional R1.2bn. These include stakes in the Sandton Convention Centre and two neighbouring hotels, InterContinental Sandton Towers and Garden Court Sandton.
That takes the total value of L2D’s portfolio to R10.8bn. Besides Sandton City and Eastgate, L2D also co-owns Melrose Arch in Johannesburg, Sandton’s Nelson Mandela Square, Liberty Midlands Mall in Pietermaritzburg, Liberty Promenade in Mitchells Plain in Cape Town, Botshabelo Mall in the Free State and several Sandton office blocks.
The biggest upshot for L2D shareholders is that the company is now in a position to deliver dividend growth that is more closely aligned with income growth in the underlying property portfolio.
For the year ending December 2019, management expects to achieve a 5% dividend growth — a substantially improved performance from the zero growth shareholders will still have to be satisfied with this year.
L2D CEO Amelia Beattie says there is no doubt that the new structure will position the company to achieve long-term, sustainable growth and unlock more value for shareholders. "We have never had the opportunity to show investors what the portfolio can do. Now that there is no longer any impediments from the put option, the quality of our portfolio will become evident."
Beattie believes investors who shied away from L2D simply because of its external management company are also likely to take a fresh look at the restructured company. She says that L2D’s portfolio is in good shape despite tough retail trading conditions.
In fact, some of the key performance metrics in L2D’s shopping centre portfolio have had a strong rebound this year, she says. She refers to trading densities (turnover per square metre) recovering from an overall decline of 6% in June 2017 to positive growth of 2.1% in June this year.
"That’s a significant improvement, which speaks to the success of our asset management initiatives," she says.
Overall vacancies have declined from 6.4% in December to less than 4% now, following the reletting of all the space left empty in Sandton City and Eastgate after the demise of Stuttafords in 2017.
Sandton City and Eastgate recorded decent trading density growth of 5.4% and 3.1% respectively for the June reporting period, and Beattie expects further trading upside to filter through over the coming months as new tenants at both malls become fully operational.
The space previously occupied by Stuttafords at Sandton City has been taken up by pharmacy group Dis-Chem, Turkish fashion brand LC Waikiki and a Pick n Pay clothing store, among others, while a Sportsmans Warehouse has replaced Topshop. At Eastgate, H&M and Mr Price have recently opened new-generation flagship stores.
Fund mangers and analysts have welcomed L2D’s efforts to address investor concerns. However, there are mixed views about whether the stock now offers a good buying opportunity. Anchor Stockbrokers real estate analyst Pranita Daya says: "It is certainly a step in the right direction, as it simplifies the structure and eliminates the potential of perceived conflict between the owner of the manager and the shareholders of L2D. However, Liberty Group remains the controlling co-owner in terms of assets owned jointly with L2D, and therefore there may still be a perception that the strategy is driven by Liberty Group as opposed to L2D."
Anas Madhi, director of Meago Asset Managers, voices a similar sentiment. He says the restructuring is a start towards L2D removing legacy issues linked to its origins in Liberty Holdings, but that it will take time for L2D to convince the market that it is able to acquire, develop and operate a portfolio independently of Liberty.
Madhi also refers to L2D’s "strategic drift" from premier retail assets to the less popular office and hospitality sectors.
The latter now consist of a sizeable 49% of total gross lettable area, which Madhi says is the result of L2D’s current portfolio being predominantly derived through an exchange agreement with Liberty.
"Unfortunately this strategic drift takes away from improvements being seen in trading densities in several of L2D’s retail assets. Instead, the drift is likely to continue to hinder growth in distributions, increase the risk of lease expiries via its office exposure and hamper its ability to acquire significant retail assets through a higher cost of capital," says Madhi.
Kelly Ward, investment analyst at Metope Investment Managers, says that though the restructuring should lure more investor interest because of the high quality of L2D’s portfolio, she doesn’t foresee any significant rerating of the share price, as Metope believes L2D to be "fairly valued" at present.
L2D was trading at a dividend yield of around 8% last week, below the 9%-9.6% on offer from other blue-chip retail-focused property stocks such as Hyprop Investments, Growthpoint Properties and Resilient Reit.
Peter Clark, portfolio manager at Investec Asset Management, has more of a contrarian view. He believes that L2D offers good value, based on its discount to NAV of almost 25%. "That compares with the rest of the market, which is trading at an average 10% discount to NAV. Considering the resolution of the governance-related issues, the high quality of the portfolio and the strong balance sheet, this could be a catalyst for a rerating over the medium term. In addition, recent operating metrics appear to be improving," he says.
But Clark nevertheless warns that there are still some near-term headwinds, such as more potential store closures by Edcon and the overhang of the Liberty shareholding, which he says are likely to temper L2D’s share price performance.