MTI benefits from strong growth dynamics across its business segments. We are...
Grit Real Estate Income Group (LON:GR1T) is a multi-listed (LSE, JSE, SEM) property company with a focus on selected African countries with a combination of economic growth, investment friendly policies and political stability. Rental income is underpinned by a blue-chip multinational tenant base, hard currency leases, and high occupancy rates.
Grit has a strong management team, with more than 59 years’ African experience cumulatively. The portfolio has grown to US$642mln from US$210ln in 2015, and the company achieved its LSE main board listing in July 2018.
Grit offers a dividend yield of 8.7%, which is among the very best in class compared with LSE-listed property stocks or with the global peer group. In this report we examine the financial dynamics behind this strong dividend yield.
The Grit property portfolio produces a Weighted Average Capitalisation rate of 8.3% compared with typical figures 3-6% for the London listed peer group. Grit operates a lean administrative cost base and maintains a high pay-out ratio of rental income into dividends.
Stocks delivering an 8.7% dividend yield in the London market would typically be companies perceived as facing financial distress and a dividend at risk. Grit, by contrast, has delivered nine consecutive income distributions in line with guidance, and has just achieved an LSE main board listing and a well-supported capital raise.
In terms of managing risks and therefore sustaining the dividend, Grit has a multi-tiered strategy. The company maintains a diverse portfolio in terms of geography and property sector, as well as a strong and diverse tenant base, and tightly manages currency risk and capital repatriation risk – some 93% of rental income is in hard currency or pegged currency. In this report we examine the risk management strategy in some detail. We conclude that Grit offers a compelling risk/reward profile.
Grit Real Estate Income Group is a property company investing in African properties across diversified non-residential sectors including retail, office, hospitality and others.
Background and capital raising
The company was founded in 2014 and listed on the Johannesburg Stock Exchange (JSE) ALT-X board. In 2015 the company made an additional listing on the Stock Exchange of Mauritius (SEM) and moved from the ALT-X to the Johannesburg main board. The company raised additional capital in 2017 and grew the property portfolio to US$588mln by January 2018, from US$210mln at year-end June 2015.
In July 2018, the company listed on the LSE main board, in addition to the JSE and SEM listings, raising US$132mln in additional capital. The following schematic illustrates the use of the new funds.
The US$132mln equity raising gave rise to net proceeds of US$121mln, of which US$73mln was earmarked for acquisition of new properties already close to deal completion, with the remainder used to pay down group-level debt.
The following charts show the expanded property portfolio by value, in terms of the sectoral and geographic split.
Grit generates exceptionally high rental returns on its property portfolio and delivers commensurately high-income returns to its shareholders.
The company essentially operates as a REIT (real estate investment trust), although the REIT legal/tax structure is currently not applicable in some of the jurisdictions where Grit operates, and therefore the company is not incorporated as a REIT. Nonetheless, we find it instructive to compare Grit’s dividend yield with a REIT peer group.
The following chart shows Grit’s dividend yield compared with a selection of LSE-listed REITs (identified by their ticker symbols).
The dividend yield also compares strongly against a global peer group. The following chart shows the Grit dividend yield compared with global peers, as measured by the FTSE EPRA/Nareit indices.
The strong dividend yield has a simple explanation:
The following chart shows the rental income yield on Grit's portfolio compared with some of the UK-listed peers, in terms of net initial yield (see the glossary).
We believe that Grit’s rental yield is more accurately reflected in the weighted average capitalisation rate (see the glossary), which currently stands at 8.3%, but the net initial yield gives us comparability with the peer group.
Clearly, as an income investment Grit offers returns that are among the best in class; we believe there are two main questions that investors then need to ask:
• Does the African real estate risk demand a dividend yield as high as 8.7%? We argue that in fact, the yield is generous relative to the level of risk
• Does Grit have the right portfolio and the right structure operationally and financially?
We examine these issues in the remainder of this report. We conclude that Grit screens favourably on a risk/reward basis.
A key pillar of Grit’s strategy is sector diversification. The property portfolio comprises five main verticals (see chart p2). We consider the three biggest segments in more detail.
In the office sector, Grit owns office buildings in Mozambique, Ghana, and Mauritius. The focus is purely on the blue-chip or multinational tenants, and rental payments are in $US (for Ghana and Mozambique) or Euros (for Mauritius).
The following image shows a typical representative of the office portfolio.
The following charts outline the main characteristics of the portfolio in the office sector, based on the expanded portfolio as per p2.
The office sector has a number of attractive characteristics in terms of risk mitigation. In addition to the blue-chip tenant base, the segment also benefits from the use of offshore guarantees on some rental agreements, meaning a global corporate tenant guarantees the lease contract at the corporate level rather than at the local subsidiary level. Despite the attractive risk profile, the office segment actually generates a rental yield slightly higher than the group average.
In terms of cost of debt, we believe that the higher cost for the commercial sector, versus group average, reflects the geographic base of the office segment.
Going forward, Grit has negotiations underway to acquire further commercial property in Ghana and could consider additional geographies in the future.
In the retail space, Grit owns shopping malls in Morocco, Zambia, Mozambique, and Kenya. The focus is on convenience retail, as opposed to luxury malls which can be more cyclical in an emerging market environment. The following image shows a typical example of the retail portfolio.
The following charts outline the main characteristics of the portfolio in the retail sector, based on the expanded portfolio as per p2.
The rental yield on the retail portfolio is slightly lower than the group average; however, there is a favourable tax regime in Zambia for income repatriation, which means that in net terms the retail segment matches the group average. In terms of rent escalations and cost of debt, the retail segment is similar to the group average.
Looking forward, the company has received an offer for the Buffalo Mall in Kenya and is considering this disposal. There are no other acquisitions or disposals in the retail segment within Grit's publicly disclosed pipeline.
In the hospitality segment, Grit has property ownership (no operational management responsibility) of four resorts in Mauritius, operated by Beachcomber (3 resorts) and Lux Island Resorts (1 resort). The following image shows a typical example of the hospitality portfolio.
The following charts outline the main characteristics of the portfolio in the hospitality sector, based on the expanded portfolio.
The hospitality portfolio attracts a lower cost of debt financing than the group average due to the investment grade status of Mauritius and the euro-denominated funding. Rent escalations have been lower than the group average due to the long lease durations (weighted average lease expiry 12.6 years).
Going forward in the hospitality sector, Grit has negotiations ongoing to acquire further properties in Mauritius and also in the Seychelles and in Senegal.
The other property sectors for Grit are light industrial (3.3% of group portfolio) and corporate accommodation (11.0% of portfolio). The assets comprise industrial warehouses in Kenya and Mozambique and a corporate housing estate in Mozambique.
The company is in negotiations for further light industrial properties in Kenya and Ghana.
In addition to diversification by property sector, Grit also seeks to maintain diverse portfolio exposure in terms of underlying economic drivers. The strategic aim of maintaining balanced economic exposure follows several key parameters:
The following table summarises the general economic characteristics of the countries in Grit’s portfolio.
The following chart shows GDP breakdown for the main countries in Grit’s portfolio. For these purposes we have excluded the government and transport & general services sectors, which make up about 50% of each country’s GDP by do not reveal much about what differentiates the countries. We have focussed instead on the sectors which really drive GDP.
We believe that the chart and table together demonstrate that Grit is well aligned with its target of balanced investment grade against emerging economies and balancing sectoral drivers.
We have demonstrated that Grit generates strong returns on its portfolio. The next natural question is to examine how the attendant risks are managed.
The company mitigates risks in its business model by maintaining a set of standards called its “margins of safety”. These can be summarised as follows:
We consider the underpinnings of some of the risk mitigation measures.
Currency risk management
The following charts show Grit’s currency exposure in terms of income and in terms of debts owed.
The main US dollar (USD)-pegged currency is the Moroccan Dirham. Revenues from Ghana, Mozambique and Zambia are primarily in $US, while Mauritian revenues are in euros.
Debt financing is broadly matched against revenues.
We argue that overall Grit has a well-balanced FX exposure.
Financing risk management
The following chart shows Grit’s borrowings by institutional lender.
The debt finance base is balanced between African and global lenders, with the global lenders being from Asia and Europe. The company avoids over-exposure to any one lender or jurisdiction.
The next chart shows the debt maturity profile.
Debt maturity is weighted towards the outer years, which minimises liquidity risk. Furthermore, via the July 2018 capital raise, the company has reduced its loan-to-value ratio to 43% from 51.4% at June 30, 2018 and has managed down its weighted average cost of debt from 5.78% at June 30, 2017 to 5.75% at present. Going forward the company is exploring entering the debt market with a note programme, which would further diversify the debt financing base.
The final risk parameter that we consider is tenant grading. Grit targets global corporate clients, with 67% of the tenant base consisting of Forbes 2000 companies or other global players, weighted by rental income.. The following chart shows the composition of the tenant base, weighted by rental income, based on the expanded portfolio.
Tenant concentration is another important measure of risk. Grit has no individual tenant exceeding 10% of group property income. The following table summarises the top 10 tenants.
We argue that Grit has a well-diversified and high quality tenant base, which serves as another risk limiting factor for the group.
Grit targets a return on net asset value (NAV) of 12%, based on 8.2% rental income return on properties, plus gearing effect, plus capital gains, minus costs and taxes. The following chart illustrates how the returns model works.
The company has already achieved rental income returns in line with the business model. In terms of NAV returns, we believe that results for FY June 2018 demonstrate that returns are converging on target, and we expect this to continue in 2019e and 2020e. The following chart shows gross rental yield compared with return on equity (return on NAV).
For this purpose, we have defined gross rental yield as:
We define Return on Equity as:
The adjusted EPRA net income is an important measure of profitability in our view, as it offers the best measure of cash net rental income available for distribution to shareholders, i.e. it is the adjusted EPRA net income which underpins dividend payments. The profit measure can be described as follows:
Adjusted EPRA net income
EPRA is the European Public Real-Estate Association. This trade body has defined a set of standardised accounting metrics applicable to property companies, and these are the industry standard for LSE-listed property companies.
EPRA net income differs from IAS net income in that it strips out certain non-cash items, notably fair value adjustments on property values. In this sense EPRA net income attempts to capture the true level of cash income from rent.
Grit’s adjusted EPRA income strips out some further non-cash items such as accounting tax accruals.
Based on adjusted EPRA net income, we are forecasting RoE of 9% in 2020e. This is after admin costs and taxes, but before NAV capital gains. Once capital gains are included, we believe the company meets it target returns model.
The next chart provides some more detail on the convergence of NAV returns towards the target. The chart shows adjusted EPRA net profit compared with net property income (rent for wholly owned and joint venture properties, net of property operating costs).
In our forecasts, the net property income is driven by the rental yield of 8.2%, in line with history and targets. The increases in absolute net property income come about from full-year inclusion of the expanded portfolio.
The chart shows the gap between net property income and EPRA operating profit remaining broadly constant, as administration cost remains broadly constant over the forecast period (details p14). This means that the incremental property income is delivering a strong drop-through to net profit, and this is the main driver of the increases in RoE in our forecast.
Given that dividend yield is one of the main elements of the Grit investment proposition, we are interested in measuring how well the dividend is covered by cash earnings. For this purpose, we focus on adjusted EPRA earnings per share, as this is the best proxy for distributable cash. There are some other elements to consider, the largest being cash benefits from value added tax (VAT) and tax credit arrangements. These are detailed in Note 15 of Grit’s June 2018 earnings release. The following chart shows dividend cover by adjusted EPRA earnings per share (EPS), plus the VAT/tax benefit.
We believe that the 2019e and 2020e projections therefore fully realise the shareholder return model, with NAV returns of around 8% property income and 3-5% capital gains, and with fully covered dividends.
We conclude that Grit presents a compelling offering to shareholders:
Superior dividend income relative to LSE-listed and global comparable companies
Driven by a high quality and diverse property portfolio with high rental yields
Robust risk mitigation
The shares have only been listed in London since July 2018. We believe that as the market becomes more familiar with the Grit investment proposition, the shares could re-rate from the current valuation of 1.04x price/NAV.
EPRA – European Public Real-Estate Association
EPRA EPS – A definition of earnings per share determined by EPRA, which excludes property revaluations and other non-operating items
Net initial yield – annualised rental income divided by gross market property value
Weighted Average Capitalisation Rate – Ratio of Net Operating Income to Property Asset Value
P & L
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