Stari Most, stone bridge

Why Invest in Terra Capital

We think it would be helpful to shareholders to review the company's investment objectives as set out in the tender offer circular.

  • Corporate activism.
    The concept is to invest in funds or companies with potential to turnaround or otherwise achieve recovery as a result of input from, or actions taken by, shareholders. Since the Investment Manager's standards for activist investments are rather strict, there may be few, if any, activist opportunities available.
  • Diversified portfolio of value stocks.
    Alongside and whilst waiting for activist opportunities the Company will invest in a portfolio of value stocks diversified by sector and country, concentrating on small and mid-cap companies with strong cash flows and positive dividends. Close attention will be paid to long term cash flow trends. We favour companies with reasonable returns on equity, strong, sustainable current dividend yields and a lack of excessive leverage.
  • Investing in emerging and frontier markets.
    A variety of emerging and frontier markets suffer from a lack of sufficient capital to properly value securities efficiently, causing natural inefficiencies that reward stock-picking efforts and thorough fundamental analysis. Examples include sectors which are currently out of favour or markets in which opening accounts and clearing and settling trades is procedurally more difficult. Such markets often present unusual opportunities due to various barriers to entry.
  • Provide cash flow to investors.
    A consistent dividend stream is an important indication of a company's strength and the company will attempt to invest in companies exhibiting high levels of corporate governance with regular dividend streams so that the Company can declare dividends to its Shareholders.

With the above objectives in mind, a sampling of what we have been investing in and our logic behind these purchases can be found in the area titled regulatory news.

Please review our continuous RNS announcements for a more complete understanding of the entire portfolio since we provide reasons for each of our purchases as they become a significant part of the portfolio i.e. over 1.5% usually. Please be aware that the information in the brief summary does not constitute the entire report on which the Investment Manager made its decision to purchase a position and it is presented for illustrative and informational purposes, as are the reports to the market.

Société de la Tour Eiffel (indicated gross dividend yield of 9.6%)

What is it?: This is a SIIC, a French version of a REIT that owns mainly office parks and commercial properties on the periphery of Paris and trades on Euronext.

Why did we buy this?: It sells at a 38% discount to its NAV so we are paying roughly 1,400 Euros m2 for office space and 450 Euros m2 for warehouses and other types of properties. The stock yielded slightly over 10% p.a. when we started to purchase it at a price to earnings ratio (P/E) of 9.9. We bought into this position at an average price of 41.79 Euros and subsequently received a semi-annual dividend of 2.10 Euros (equal to more than 10% p.a. gross). The dividend terms allowed us to receive shares at a discounted price of 37.04 Euros while the stock was selling at 41.25 Euros. Taking into account the dividend, we bought in at about 40.22 Euros average price.

The portfolio is 85% (in value) in office space with about 15% in warehouses and some other small investments. The company concentrates on office parks in the outskirts of Paris and regional business hubs such as Lyon and Strasbourg which are easier to rent with a much lower land cost, leading to lower valuations for office space per square meter than La Defense or other important office centers in Paris. Its main tenants are multinationals seeking to avoid the high costs of downtown Paris for their large office staff. Much of this property is leased to large corporates (Alstom, C&S, etc.) and the state (through the Post office and Ministry of the Interior) until 2016, and these tenants represent a steady income stream. 62% of its rental income is from the top 15 tenants, and the list of tenants consists mainly of solid multinational companies.

Tour Eiffel's debt cost is relatively low at a blended rate of 3.5% p.a. and this is 93% hedged with a combination of CAPs and Swaps. Interest coverage, after all corporate expenses, is roughly 2-1 and the company is well within range of all its debt covenants and should be able to sustain a high dividend. Should pessimism on European property generally leave the market, we hope the company would re-rate to reflect this high yield, even without a significant increase in NAV, so in addition to harvesting a nice dividend it provides the potential of attractive capital gains.

What could go wrong?: The greatest risk is a significant drop in prices for suburban Paris office properties; however, in the period since the crises, these have shown decent resilience. The large discount, however, should provide a buffer between our investment and potential real capital losses. On the other hand, continued negative sentiment on Europe could increase the discount to NAV, thereby lowering its price. In summary, we think Tour Eiffel will continue to provide value for the fund.

Portucel Soporcel(indicated gross dividend yield of 10.5%)

What is it?: Portucel Empresa Produtora de Pasta e Papel SA (PTI) produces and sells writing and printing paper and related products and it is present in all of the value added chain from research and development of forestry and agricultural production, the purchase of wood and the production and sale of bleached eucalyptus kraft pulp (BEKP) and electric and thermal energy. PTI is a vertically integrated forestry group that exports its products to 119 countries over five continents.

Why we bought it?: In line with our policy to find great companies in troubled markets, PTI'S valuation, based on P/E, EV/Sales and EV/EBITDA stands close to the lowest levels over last 10 years. We attribute this to its listing in Portugal rather than to any issues with the company itself. Although we are well aware of the situation in paper industry, the Group has been able to overcome even worse times (three or four years ago) without posting a loss. Furthermore, based on new production facilities during the last few years, Portucel has been able to increase its output (as well as sales) in the paper market despite a shrinking market, continuously increasing its market share. The Company invested about €1 billion over the last few years into new manufacturing facilities equipped with the state-of-the-art technology that produces with high efficiency, creating a positive impact on its margins. The Group has proven its ability to wisely use external financing (all covenants related to borrowings have been comfortably met); this, in conjunction with strongly cash-generating operations, shows the strong position of the Group and we have high confidence about its financial situation and its ability to adequately cover all of its debt amortization. Although Portucel recorded a slight decline in revenue from European markets in 2011, it offset this drop by doubling revenue from other markets; obviously, the Group has been able to find new markets for its production. Further, the Group pays solid dividends; its current dividend yield exceeds 10%.

Current Developments: Despite the harsh business environment, especially for the paper business, a significant increase in the cost of electricity and natural gas which caused the Group to record an overall increase in total production costs and industrial disputes in September in port operations negatively impacting the Group's logistical costs, Portucel group's consolidated turnover grew by 1.2% over the first nine months of 2012.  Other key figures were an increase in operating profit of 12% despite a decline in EBITDA of 1.8%.  Net earnings increased 11.2% and ROS increased almost 10% from 13.1% to 14.4%.  The group was also able to continue to de-lever, decreasing net debt by 20% from 488.4 to 390.9 million.  It continued to increase its share of European paper market while improving its Net Debt / EBITDA ratio to 1.0. The Group owns the largest nurseries for “certified forest” plants in Europe.

What can go wrong?: A reduction in the Portuguese tariffs for electricity produced in co-generation facilities, from renewable and non-renewable sources (the effect is not possible to reliably estimate, at the moment); the enlargement of production capacities in Brazil and Uruguay (from 2013 onward) could disrupt the balance between the paper supply and demand in subsequent years..

Oman Cement(indicated gross dividend yield of 4.6%)

What is it? Oman Cement is a high growth company, dominating cement manufacturing in Oman, a company in the midst of a long term infrastructure expansion program led and managed by a centralized government agency. As opposed to other Gulf countries, urbanization of Oman has started in the relatively recent past, with roughly only 40% of the population currently urbanized with significant future urban expansion planned.

Why did we buy it?: The company has negligible leverage, is conservatively run, and we were impressed with the abilities and management's conservative outlook when we met the CEO personally during our site visit. Oman Cement, as opposed to its GCC competitors, is connected to its own gas line making it the low cost manufacturer in the region. This was one of the factors that allowed it to maintain its market share, although at the cost of slashing margins, during the Dubai crises. Oman Cement has suffered in recent years due to the boom-bust cycle in the UAE. As part of the GCC, Oman had to deal with dumping prices from Dubai cement manufacturers, who were not able to sell in their local markets. The fact that the company was able to survive, and even profit, during those recent difficult years gives confidence that it will be able to prosper during less challenging times. Now that some smaller Dubai cement companies have gone under, the situation has turned around with Oman cement not only done fending off imports, but exporting some of its production to Dubai. As we went to print, the company released its unaudited interim financial statements for the nine month period ending September 30, 2012. The Company recorded total sales of 41,761,564 Omani Rials for the nine months ended 30th September 2012 as compared to 36,265,393 Omani Rials in the corresponding period of the prior year; this lead to a pre-tax profit increase for the period to 14,463,929 Omani Rials as compared to 11,035,537 Omani Rials for the corresponding period of the prior year.

What can go wrong?: The Omani government could be forced to cut back on its ambitious building program. The Omani Government budget was set on assumed prices of USD $75 per barrel oil. While oil is still well above this price, if it should drop substantially this could adversely affect the government's budget and building plans.

The stock seems to be relatively closely correlated to the movements of the Omani stock market, and even world indices, since cement prices are a commodity product so a global drop would not insulate this position.

Equity Bank (indicated gross dividend yield of 4.3%)

What is it?: Equity Bank is the largest bank in Kenya (by most metrics) and has a significantly different approach to third world banking -- providing services to the significant “unbanked” market throughout Kenya. It also has operations in Southern Sudan, Uganda, and lately Tanzania and Rwanda and holds a 24.9% stake in Housing Finance, a leading mortgage provider in Kenya. The bank's loan book is divided into two main segments, with roughly half of all loans made to SME clients and the other half consumer spending loans, with a very small corporate book. As common in microcredit companies, NPLs are low: under 3%. Because of the spike in interest rates in Kenya, caused by the Central Bank's attempt to keep inflation low, it would be reasonable to see a spike in NPLs, but this has not happened -- most likely because of the resilience of SME and Microcredit loans to any but the worst macroeconomic shocks.

Equity Bank differs from most microcredit banks due to its reliance on a domestic, unbanked deposit base. It provides rural area residents the chance to have a bank account and receive interest, and does not merely take deposits from wealthy urban centers (or IFIs) and loan them at a punitive interest rate. The difference shows in the spread: whereas a typical Microcredit in Bangladesh pays depositors 7-8% and charges 35-40%, Equity Bank pays depositors about 11-12% and charges only 24%. Although the spread is high by conventional banking standards, it's the best deal in the microcredit world. Not surprisingly, Equity Bank now has half of all open Kenyan bank accounts.

Why did we buy this?: Kenya is the biggest economy and the hub of the East African Region (Horn of Africa) with a nominal GDP of $30 billion. The Kenyan economy has been growing consistently since political and economic problems in 2007/8. In 2008, real GDP growth was 1.5%, which accelerated to 2.6% in 2009. The growth rate doubled in 2010 to 5.6%. Initial estimates for 2011 had placed the country's GDP growth at 5.0%, but the actual growth was 4.5%. Equity Bank currently trades on an annualized forward P/E of 7.1x, making the bank cheap on an earnings basis. Both the present and the prognosis for the macro situation in 2012, and our conclusion is supportive of an improved performance from Equity Bank.

Current Developments: On November 6, 2012, Equity Bank Group announced a 30% growth in pre-tax profit for the period ended 30th September 2012. The group posted a profit of Kshs.11.8 billion up from Kshs.9 billion realized in the third quarter of 2011. Profit after tax increased from Kshs.7.29 billion to Kshs. 8.3 billion in a similar period last year. The Group also improved its asset quality to 3% from 3.1% for the period and Global Credit Rating gave the bank a long term AA-interpreted as “… very high credit quality…” and short-term AI+, meaning “... highest certainty of timely payment…” in line with the reported asset quality. Total assets posted a 19% growth during the period to close at Kshs.232 billion up from Kshs.195 billion with the most significant growth being achieved in loans to customers and cash and cash equivalents. The Bank maintained a strong capital position which grew by 24% to reach Kshs.39.2 billion up from Kshs.31.76 billion. The bank's liquidity ratio stood at a strong 42%.

What could go wrong?: The Kenyan macroeconomic environment is notoriously volatile. The Kenyan government was recently forced to significantly raise deposit rates - to almost 18% - to defend the shilling from collapse after a drought increased food imports. A significant devaluation of the shilling would negatively impact this position, (even if the company continued to perform well in shilling) and interest rate volatility could hurt the company's results. Until now Equity bank has been very good at navigating the Kenyan environment but it could stumble.

Eurobank Properties (indicated gross dividend yield of 8.2%)

What is it?: This is a Greek REIT managed by EFG Eurobank that trades on the Athens stock exchange. We began to buy it around 4 Euros a share when it was trading at about a 60% discount to its stated NAV of 10.32 Euro. Our average unit cost of 4.26 Euro produces a discount of 59%, whilst the current price (4.73 Euro) represents a healthy 54% discount to a very conservative NAV.

Why did we buy this?: Eurobank was beaten down due to the Greek crisis but it seems to be a case of throwing out the baby with the bathwater. It holds Net Cash of 53 million Euros ("Net" means we calculated this number after taking into account repayment of all its liabilities, including working capital liabilities, and all outstanding mortgage debt using its cash on the balance sheet). About 14-16% of its property is in Romania and Serbia with the remainder of its assets in mainly "A" class retail and office properties in Athens with occupancy ratios around 90%. The properties generate approximately 41 Million Euros annually and have no net debt. The average price per square meter is 1,648 Euro, valuing its current properties at a cap rate of about 7%, which is in line with estimates we have received on other Greek properties, although there have obviously been few comparable transactions lately.

Nevertheless, if we analyse the portfolio by disregarding its large cash position, we are effectively buying property with a 28% cap rate. At the current discount this means that we are purchasing some of the most prestigious office space in the capital of a European country at approximately 675 Euros a square meter. To put this price in perspective, it is cheaper than Moldova, Macedonia, Bulgaria, Zimbabwe or even the cheapest property we are aware of, downtown Detroit, Michigan. Despite the property being in the world's least favourite investment destination right now - or perhaps because of it - we feel the shares are a good investment. The shares sell at a P/E of 9.8x (no revaluation differences considered) with a dividend yield of 9% in Euro (10% at our purchase price). We believe that it can continue to collect the rent and payout a significant dividend. While its NAV at June 30, 2012 decreased to €628m or €10.32 per share compared to €11.24 as at June 30, 2011, the decline was mainly due to the decrease in the fair value of investment property. Based on its current share price of €4.6 +/- the company currently trades at approximately a 54% discount to its NAV.

Current Developments: In its August 3, 2012 press release, the company announced the following basic ratios:

  • Current ratio: 7.5x vs. 11.8x (Dec-11);
  • Debt to total Assets: stable at 13%;
  • Loans to Value (LTV): 15% vs. 14% (Dec-12);
  • Funds from Operations (FFOs): €19m. vs. €20.1m.

As of June 30, 2012 its cash and short term deposits were €146m (vs. €144m a year earlier) while outstanding loans decreased to €85.6m vs. €87.9m for the same periods. Interest income increased by 19% (from €3.7million to €4.4million) as a result of higher interest rates and successful cash management and operating expenses decreased, for the fourth consecutive year, by 11% (from €1.8million to €1.6m) due to management's successful efforts to reduce costs. Its interest expense decreased by 14% from €2.1million to €1.8m as a result of lower outstanding loans and the decrease in Euribor rates, while taxes increased by 13% from €1.5m to €1.7m mainly due to the recognition of extraordinary tax on property. Excluding fair value losses, net profit after tax amounted to €19m compared to €20m in the previous period.

On August 23rd Prem Watsa, a Canadian value investor and chairman of Fairfax Financial Holdings, purchased 19.12% of this fund for 4.75 euro, which was a premium to the then market price of 7%.

What could go wrong?: In the short term, the company could suffer if Greece were ejected from the Euro (or benefit if the Euro crisis is somehow solved). Although the long term value of central business district property usually remains high, even if hyperinflation would occur due to Greece's expulsion from the Euro, until the Drachma stopped devaluing some, or all, of the rent could come in the form of less valuable Drachma. This may cause the stock price to lag the property's true valuation until some time following such devaluation. However, we believe these risks are mitigated by the low valuation in general.


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