The Finance Ghost: REIT debate rages and Grindrod’s ship comes in

22 Aug 2022

Fortress REIT’s dual-share structure seemed like a good idea when it was put in place years ago, offering one class of shares for income-focused investors and another class for those willing to take more risk of variable returns. Unfortunately, it didn’t contemplate small inconveniences like a pandemic.

The REIT (real estate investment trust) rules on the JSE are strict on matters such as distribution of income as REIT status is a special tax dispensation designed to make property funds appealing to investors.

Based on the intricacies of its dual-share structure and recent economic pressures, Fortress REIT, a commercial property group, is unable to meet these requirements.

The plan to collapse the structure into a single share class was intended to address this issue. The problem was getting the shareholders to agree on a suitable exchange ratio.

The A shareholders and B shareholders had diametrically opposed interests. Fortress managed to get about 60% of each shareholder group to vote in favour of the scheme. Sadly, 75% approval was required.

We are now in unfamiliar territory, as Fortress will be the first REIT to lose that status because of falling foul of the rules. As many institutional investors in the sector only have a mandate to hold REITs, funds will be heading for the exit.

Grindrod’s ship has come in

Both Grindrod businesses on the JSE are flying. Grindrod Shipping has doubled in the past year and Grindrod Limited is up more than 130%.

For Grindrod Shipping, being at the right point in the cycle has been incredibly lucrative. The latest quarterly result is the company’s highest-ever quarterly dividend, as ongoing supply constraints in the industry allow the group to achieve excellent shipping rates.

It also helps greatly that the dry bulk market has been largely unaffected by inflation and higher interest rates.

For Grindrod Limited, this has been a story of unlocking value in a diversified group with some excellent assets and a few noncore investments that have been letting the team down.

Such is the level of focus that even Grindrod Bank is being sold to African Bank for R1.5-billion. Banking just isn’t as exciting as the story playing out in the port and terminals business. This segment has more than doubled its earnings year on year, something that banks simply cannot do.

Lesson in operating leverage

A scan through Curro’s results for the six months to June 2022 reveals the magic of operating leverage.

Average learner numbers increased by 7% year on year. When combined with inflationary increases in fees, revenue growth came in at 15%.

Operating leverage refers to the level of fixed costs in a business model. Whether there are 20 kids in a class or 25, there is still the cost of a classroom, a teacher and all the supporting materials. The last few kids have a big impact on profitability.

With revenue growth of 15%, I fully expected to see margin expansion. Earnings before interest, taxes, depreciation and amortisation grew by 20%. The leverage continues further down the income statement, so headline earnings per share increased by 31%.

Although this sounds like an A+ performance, there is a worry about the recoverability of debtors. Curro is owed R74-million from parents of learners who have left the school.

There’s no interim dividend from Curro, and the management team has chosen to wait for clarity of full-year earnings before paying out a dividend. Is that just a convenient way of saying that they are also worried about the debtors? As a Curro shareholder, I know that I certainly am. The profit growth story is shaping up nicely, but the balance sheet needs to follow suit. BM/DM

After years in investment banking by The Finance Ghost, his mother’s dire predictions came true: he became a ghost.

This story first appeared in our weekly DM168 newspaper, which is available countrywide for R25.

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Business Maverick

Grindrod’s ship has come in

Lesson in operating leverage