In its residential business and its commercial property development and investment business, both of which are vulnerable to deterioration in market conditions, Mitsubishi Estate continues to clean up its balance sheet by applying more stringent standards to its acquisition of properties and by collecting on its investments. It has reduced inventory in its residential business unit, and sales are relatively strong, but profitability remains low. We expect the company to sell fewer condominiums in fiscal 2012 (ending March 31, 2013) than in fiscal 2011 because of the delivery schedule for some condominiums. However, the company's profitability is likely to gradually improve because it has reduced the proportion of properties it acquired at higher prices. In our opinion, the delay in a recovery of the real estate investment market makes it likely that the company will take time to post stable earnings on property sales in its commercial property development business.
Mitsubishi Estate continues to be more highly dependent on debt than other industrial corporations, reflecting the financial characteristics of the real estate industry. The company's debt increased slightly in fiscal 2011. Standard & Poor's expects the company to actively invest in redevelopment in its building business, commercial property development business, and overseas business over the next two to three years, which in turn is likely to keep the company's debt at high levels. In addition, the fall in unit sales in its residential business is likely to reduce funds from operations (FFO). Combined, these factors are likely to cause debt to rise year on year by approximately JPY350 billion in fiscal 2012 (this includes the impact of consolidating special purpose entities in fiscal 2012). The company's ratio of debt to capital, which was 57.7% on March 31, 2012, may worsen year on year but is likely to gradually improve in the medium term thanks to accumulated earnings and investment collections. In addition, we expect Mitsubishi Estate's financial profile to remain sound for the following reasons:
-- Real estate leasing, a highly predictable and stable source of income, accounts for a high percentage of the company's overall cash flow;
-- A comparatively conservative financial policy; and
-- Large unrealized profits, mostly from lease properties in the Marunouchi area.
Mitsubishi Estate's liquidity is "adequate" in our view. As of March 31, 2012, the company had JPY216.6 billion in cash and marketable securities on a consolidated basis and JPY20 billion and $250 million in unused committed credit facilities, covering JPY224.4 billion in long-term debt due to mature by the end of fiscal 2012. The company's funding needs largely depend on the status of acquisitions and sales of properties. In light of its endeavors to collect on invested funds and its relatively solid property sales, we expect the company's debt repayments and refinancing to proceed smoothly. Stable cash flow from rent revenues nearly matches its capital investment needs. Moreover, interest-bearing debt for long-term lease properties (fixed assets) has long maturities, and payment schedules are diversified.
The stable outlook reflects our view that steady rent revenues from its leasing business will underpin Mitsubishi Estate's overall earnings despite deterioration in the office leasing market and a delay in the recovery of earnings from the residential and commercial property development businesses. Taking into account its latent profits and various off-balance-sheet debts, we believe the company's capital structure and debt profile should remain sound despite its high dependence on debt.
We expect the ratio of FFO to total debt for Mitsubishi Estate to fall to about 5% in fiscal 2012, compared with over 10% in the past two fiscal years, owing to the fall in unit sales in the residential business. We may consider lowering the ratings if the company's profitability declines beyond fiscal 2012 owing to stagnation in residential property sales, a delay in the collection of returns on its investments amid a protracted slump in the real estate investment market, or a material deterioration in leasing market conditions, leading us to conclude that the possibility of erosion in its debt-to-capital structure would increase over the medium to long term. Specifically, we may consider a downgrade if it becomes more likely that FFO to total debt will remain below 8% in the long term and the debt to capital ratio will remain above 60% in the long term. Conversely, we may consider raising the ratings if the company continues to enhance its real estate portfolio and starts to generate stable cash flow in its operations other than its building business at higher levels than at the present, thereby reinforcing the company's financial profile through debt reduction. However, upward pressure on the ratings is limited because we expect the company's investments to remain high for the foreseeable future.
Related Criteria And Research
Key Credit Factors: Global Criteria For Rating Real Estate Companies, June 21, 2011
2008 Corporate Criteria: Analytical Methodology, April 15, 2008
2008 Corporate Criteria: Commercial Paper, April 15, 2008
Corporate Criteria--Parent/Subsidiary Links; General Principles;
Subsidiaries/Joint Ventures/Nonrecourse Projects/Finance Subsidiaries; Rating Link to Parent, Oct. 28, 2004
Mitsubishi Estate Co. Ltd.
MEC Finance USA Inc.
Corporate Credit Rating A+/Stable/A-1
Senior Unsecured A+
Mitsubishi Estate Co. Ltd.
Commercial Paper A-1