2019 Integrated annual report

Chairman's report

Overview

The year under review was difficult for South African property companies with an extended period of mediocre economic growth impacting on tenants' ability to afford rentals and administered cost increases. Reversions for many sectors were negative with financially stressed consumers contributing to muted retail sales growth.

The strong outperformance of the South African property sector over recent years ended with initial market doubts as to certain companies in the sector followed by a recognition that the ability of property companies to outperform a number of the fundamental challenges they face is limited.

The property index declined by 5,9% from July 2018 to June 2019 in the context of South African GDP growth of 0,5% over the same period. The trade war between the United States and China reduced growth internationally, and having started the financial year with expectations of interest rate increases, we now see some of the major international economies cutting rates to provide further stimulus to slowing growth.

Financial performance

Hyprop declared a dividend of 359,3 cents per share for the six months ended 30 June 2019, a decrease of 5,5% on the corresponding period in 2018. The total dividend for the year of 744,9 cents per share is a decrease of 1,5% on the prior year.

The decrease in the dividend was a function of a solid performance by the South African portfolio, a strong performance from the centres in Eastern Europe and a disappointing return from the sub-Saharan African portfolio.

South Africa

The South African portfolio is the backbone of the company and produced a resilient performance in a difficult market. The Glen and Woodlands benefited from investment in their food offerings and a number of the other malls produced pleasing growth in trading densities in the latter part of the year.

Concerningly, property expenses increased by 14%, largely due to a 16% increase in non-controllable expenses that include rates, taxes and energy costs. While we accept that business has a responsibility to contribute to the environment in which it operates, a tendency by government, whether local or national, to allow administered inflation at levels well above those at which business can recover the costs will ultimately lead to less investment and fewer jobs.

It is common cause that South Africa has an oversupply of retail space and while Hyprop's malls remain destinations of choice, we are conscious of the need to invest in our properties to maintain their appeal, and of the need to understand the changing nature of retail and the evolving demands of our shoppers, and to position our properties accordingly. During the year the company adopted a revised strategy that focuses heavily on what will be required to position our malls for success in the likely South African economic environment over the medium term.

While vacancy levels across the retail portfolio decreased to 0,8% at 30 June 2019, this should be read in the context of rent reversions at negative 9%, offset to an extent by a weighted average escalation rate of 7,1%. As with many other businesses, retailers are under significant pressure and in the absence of revenue growth, will increasingly be forced to reduce costs to survive.

Edcon received much publicity during the year under review. As a result of the support provided by landlords, and an injection of investor funds, it has continued to trade. The rent reduction granted by Hyprop resulted in a marginal reduction in distributable earnings in the current year (which will increase in the next financial year), but provided flexibility to reduce the group's exposure to Edcon.

Unfortunately, high crime levels continue to be a significant problem for the economy. We endeavour to provide a safe shopping environment and carefully monitor trends in the broader market with the objective of taking whatever measures we can to insulate our shoppers.

Eastern Europe

The Eastern European portfolio produced a strong performance with distributable income from Hystead, through which the group holds its interests in the underlying properties, increasing by 13% over the previous year. All of the centres grew their trading densities and/or their net operating income.

The portfolio is financed through a combination of in-country asset-backed finance and loan funds, guaranteed primarily by Hyprop. As both the funding and the assets are Euro denominated, there is a risk that if asset values decline, the Euro funding may place pressure on Hyprop's balance sheet. This risk is carefully monitored by management and regularly assessed by the board. Should the properties begin to underperform or should Eastern European asset values enter a period of decline, Hyprop has the capacity to refinance an appropriate portion of the debt in Rand.

We are pleased to report that the Mall of Sofia successfully completed a 12 000m² extension during the year with very positive feedback after opening. A number of projects are planned for some of the other properties which should further entrench their dominance and provide growth in earnings.

We have a strong management team in this portfolio with executives capable of the active asset management needed to grow returns.

Sub-Saharan Africa (excluding South Africa)

This portfolio produced a poor return.

Vacancies in the portfolio increased with a number of South African retailers electing not to renew leases. Replacement tenants were obtained at lower rentals, and certain of the economies in which our properties are located had a very difficult year.

The group will exit sub-Saharan Africa, other than South Africa, and in line with this disposed of its interest in Achimota Retail Centre in Ghana during the period, and its interest in Manda Hill shopping centre subsequent to the year-end.

The carrying amounts of the remaining properties were impaired to align with their anticipated sales values, resulting in an overall impairment of R1,46 billion for the year. Our venture into Africa produced reasonable returns where we acquired existing centres, however, where we were involved in developing new properties, we grossly underestimated how long it would take to convert an informal shopping culture to mall-based shopping. In addition, the currency volatility to which we were exposed due to sovereign factors meant that the hedges that existed in Dollar-based rentals were ineffective in many cases.

We are implementing a number of changes to the manner in which the portfolio is managed that should improve returns but do not expect the portfolio to yield any material distributions in the period to its disposal.

Sustainability

We recognise the importance of a sustainable business and of integrating sustainability into the different facets of our operations. Our commitment to being a good corporate citizen pervades our approach to business and we endeavour to act in a responsible, balanced and commercially sensible manner.

Our regular evaluation of the longevity of our business model and its relevance to the economies in which we operate resulted in the adoption of a revised strategy that will position the group to succeed in a changing economy and retail environment.

We are conscious of our impact on the environment and have been measuring and mitigating this for several years. We have made meaningful progress and our process has become increasingly sophisticated, with demanding goals and accountability for outcomes.

Transformation is a priority for sustainable South African businesses. Hyprop has made substantial progress in this area by implementing initiatives that benefit our people, our business and the environments in which we operate.

Corporate governance

Hyprop is committed to the highest standards of corporate governance. Details of our governance structures and the extent to which we apply relevant principles of corporate governance, including King IV, and regulatory requirements, are set out elsewhere in this report.

Board changes

Brett Till joined Hyprop as the CFO in October 2018 and Morné Wilken as CEO with effect from 27 December 2018. Both have made a significant contribution.

Pieter Prinsloo resigned with effect from 31 January 2019. The board thanks him for the considerable contribution he made and wishes him well in his future endeavours.

Subsequent to year-end Annabel Dallamore joined the board to add a strong technology perspective to deliberations. Annabel will also join the audit and risk and the investment committees. We welcome Annabel and look forward to a productive relationship with her.

Mike Lewin retires by rotation at the annual general meeting on 2 December 2019 and has not made himself available for re-election. We thank Mike for his considerable contribution to the group over nine years and wish him well in his retirement.

Shareholding

Hyprop, based on JSE criteria for public shareholders, has a 100% free float. Foreign shareholders owned 18% of the company at 30 June 2019, a decrease from 23% at 30 June 2018.

Outlook

The company appointed a new executive team during the year under review and this, together with the global changes in retail markets and the material changes taking place in the South African economy, prompted the development of a revised strategy.

The implementation of this strategy will result in lower short-term earnings but should provide the foundation for solid earnings growth in future years.

The South African economy is a concern. Some form of stimulus is necessary for the economy to escape the multi-year low growth trap it is in, however, government has to date squandered its traditional ability to provide that stimulus. Business requires some level of predictability regarding the future environment to justify investment, and the world economy is not growing sufficiently to provide the required stimulus. Until government takes steps to catalyse the confidence that business requires to accelerate investment and job creation, the country will continue getting poorer and the current levels of civil unrest will grow. Given the high levels of poverty in South Africa, this may unfortunately result in further shifts within the political spectrum, less investor friendly policies and further reductions in growth levels.

Hyprop's South African shopping centres are outstanding properties and there is ongoing investment to maintain their appeal. The retail environment in a number of developed economies has changed substantially with a reduction in the appeal of traditional shopping malls. Although this trend is apparent in South Africa its impact has been far less than internationally; however, we have a number of idiosyncratic factors that necessitate careful work to ensure that our properties remain relevant and desirable. In this regard we are considering the appropriateness and commerciality of investing in and/or creating mixed-use precincts around certain of our centres. While this would mean that Hyprop would no longer be a pure shopping centre fund, there are attractive returns available on the related properties, and those assets should support and enhance the value of the malls.

Further stimulus to the European economy has recently been announced. The Eastern European economies in which we are invested have continued to produce pleasing levels of growth that have been echoed by the results produced by our shopping centres. We have a number of earnings accretive projects planned for the next year which, together with strong asset management, should result in pleasing earnings growth.

Our decision to exit our sub-Saharan African portfolio resulted in a significant level of impairments and we are unlikely to distribute any income from the portfolio in the period to its disposal. After considerable analysis we believe that the resources currently devoted to the sub-Saharan African portfolio would be more effectively applied to the South African and Eastern European exposures.

Technology is playing an ever increasing role in most aspects of our lives and there are opportunities for enhancing the use of technology throughout our business. To date online shopping has gained less traction in South Africa than it has in more developed countries and while there are clear reasons for that, our shoppers' use of technology is nonetheless increasing and the manner in which they shop is changing. Pursuant to the revision of the group's strategy, going forward there will be considerable emphasis on the use of technology in the retail, property and infrastructure spaces, and on related opportunities from a defensive and a growth perspective. Resources will be devoted to this with the dual objectives of improving business efficiency and creating further income, where possible.

Hyprop will consider property acquisitions, domestically and internationally, where the risk adjusted returns justify the cost. We will also continue to look at corporate activity where appropriate opportunities exist. Conversely, we regularly evaluate the properties in our South African and Eastern European portfolios and will sell assets should we believe that they are no longer relevant to the portfolio.

Prospects

We expect a reduction of 10% to 13% in distributable income per share in the 2020 financial year, followed by positive growth in distributable income for the 2021 financial year, and beyond.

This guidance is based on a number of key assumptions set out elsewhere in this report.

Appreciation

On behalf of the board we thank our executives, management and staff for their considerable efforts during the year. We also thank our stakeholders for their support and our fellow board members for their guidance and support.

Gavin Tipper

Chairman