RPT-Fitch Rates Prologis, L.P.'s EUR700MM 3% Notes Due 2022 'BBB'; Outlook Stable
Nov 27 (Reuters) - (The following statement was released by the rating agency)
Fitch Ratings assigns a credit rating of 'BBB' to the EUR700 million aggregate principal amount of guaranteed notes issued by Prologis, L.P., the operating partnership of Prologis, Inc. (NYSE: PLD; collectively including rated subsidiaries; Prologis or the company). The 2022 notes have an annual coupon rate of 3% and were priced at 99.483% of the principal amount to yield 3.072% to maturity or 167.4 basis points (bps) over the benchmark rate.
The notes are senior unsecured obligations of Prologis, L.P. that are fully and unconditionally guaranteed by Prologis, Inc. The company intends to use a portion of the net proceeds of approximately EUR693.6 million to repurchase all of the outstanding principal amount of its 5.875% notes due Oct. 23, 2014. The total principal amount of the 5.875% notes of Prologis International Funding S.A., a majority-owned subsidiary of Prologis, is approximately EUR494 million.
An indirect subsidiary of Prologis holds approximately EUR86 million of these notes, and approximately EUR407 million is being reduced with net proceeds of the 2022 notes offering. The company will use the remaining net proceeds for general corporate purposes, including to repay or repurchase other indebtedness.
In the short term, the company intends to use the net proceeds to repay borrowings under its multi-currency senior term loan and/or its global line of credit.
In addition to the 2022 notes, Fitch currently rates Prologis as follows:
--Issuer Default Rating (IDR) 'BBB';
--$100 million preferred stock 'BB+'.
--$2 billion global senior credit facility 'BBB';
--$659 million multi-currency senior unsecured term loan 'BBB';
--$5 billion senior unsecured notes 'BBB';
--$460 million senior unsecured exchangeable notes 'BBB'.
Prologis Tokyo Finance Investment Limited Partnership
--JPY45 billion senior unsecured revolving credit facility 'BBB';
--JPY10 billion senior unsecured term loan 'BBB'.
The Rating Outlook is Stable.
KEY RATING DRIVERS
Prologis, Inc.'s 'BBB' IDR reflects the stable cash flow from the company's global industrial property portfolio that contributes towards fixed-charge coverage appropriate for the rating, strong asset quality, and excellent access to capital. The rating is tempered by leverage that remains elevated for the rating though expected to decline principally via improving fundamentals. The company endeavors to match-fund acquisitions and development expenditures with proceeds from dispositions and fund contributions, a strategy that materially impacts corporate liquidity. Contingent liquidity is strong as measured by unencumbered asset coverage of unsecured debt.
Improving Cash Flow
The vast majority of PLD's earnings are derived from property-level net operating income (NOI), which is complemented by the company's investment management income. During the third quarter of 2013 (3Q'13), cash same-store NOI (SSNOI) increased by 1.8% and cash rental rates on leases signed in the quarter increased 0.4% from in-place rents, a leading indicator for 2014 SSNOI growth.
Lease expirations are elevated in the near term, with 2.5% of pro rata base rents expiring in 4Q'13 followed by 16% in 2014 and 18.1% in 2015; however, the current strength of the industrial real estate market mitigates most of the risk and allows such expirations to be an opportunity for additional growth. Fitch expects PLD's SSNOI growth will be 1.5% in 4Q'13 followed by 2.5% in 2014 and 2015 based largely on positive net absorption. Operating portfolio occupancy was 93.9% as of Sept. 30, 2013, up from 93.7% as of June 30, 2013 and down slightly from 94% as of Dec. 31, 2012.
Pro forma for the recent issuance of $500 million 3.35% senior notes due 2021 and tender offers (including an any and all debt tender offer and maximum tender offer) as well as the EUR700 million 3% senior notes due 2022 and repurchase of 5.875% notes due 2014, third-quarter 2013 pro rata fixed-charge coverage is appropriate for the 'BBB' rating at 2.0x compared with 1.9x in 2Q'13 and 1.7x in 1Q'13. Fitch defines pro rata fixed-charge coverage as pro rata recurring operating EBITDA (excluding gains and losses on asset sales) less pro rata recurring capital expenditures less straight-line rent adjustments divided by pro rata interest incurred and preferred stock dividends.
Fitch's base case anticipates that coverage will approach 2.5x over the next 12-to-24 months due to expected low single-digit SSNOI growth, which is strong for the 'BBB' rating. On a consolidated basis, 3Q'13 pro forma fixed-charge coverage was 2.0x including recurring cash distributions from unconsolidated entities (1.5x excluding recurring cash distributions from unconsolidated entities) compared with 1.8x (1.5x excluding recurring cash distributions from unconsolidated entities) in 2012.
Prologis had $46.9 billion of assets under management as of Sept. 30, 2013. The company's large platform limits the effects of any one region's fundamentals to the overall cash flows. PLD derived 83.5% of its 3Q'13 NOI from Prologis-defined global markets (56.8% in the Americas, 20.2% in Europe, and 6.5% in Asia), and the remaining 16.5% of 3Q'13 NOI was derived from regional and other markets.
Private Capital Simplification
The company has reduced the total number of funds that it manages via consolidation and the purchase of assets upon closed end fund expirations. The majority of funds are infinite life, which eliminates take-out risk at the fund's maturity. In addition, the fund platform provides an additional layer of fee income and recurring cash distributions to cover PLD's fixed charges.
Notable 2013 transactions to simplify the platform have included a venture with Norges Bank Investment Management (Prologis European Logistics Partners Sarl or PELP) and the initial public offering and follow-on offering of Nippon Prologis REIT, Inc. (NPR), a Japanese REIT (J-REIT). In addition, Prologis recently announced the formation of Prologis China Logistics Venture 2 with HIP China Logistics Investments Limited; the venture's investment strategy is to build, acquire and manage logistics properties in China like Prologis China Logistics Venture 1.
Strong Asset Quality
PLD has a high-quality portfolio as evidenced by a focus on properties with proximity to ports or intermodal yards, cross-docking capabilities and structural items such as tall clearance heights. The portfolio has limited tenant concentration which is a credit strength, with only the top three tenants comprising more than 1% of annual base rent (ABR). PLD's top tenants at Sept. 30, 2013 were DHL (1.9% of ABR), CEVA Logistics (1.3% of ABR), and Kuehne & Nagel (1.3% of ABR).
Excellent Capital Access
The company's access to capital is strong as evidenced by the diversified capital structure which includes secured and unsecured debt from public and private sources, as well as preferred stock, common and private equity capital.
During the third quarter, Prologis raised $671.6 million of third-party equity for its open-ended funds, including: $398.4 million for Prologis European Properties Fund II (PEPF II); $180 million for Prologis Targeted U.S. Logistics Fund (USLF); and $93.2 million for PELP. Additionally, PEPF II issued a 2.75% coupon EUR300 million unsecured bond in the Eurobond market subsequent to the quarter's end.
In April 2013, Prologis completed a public offering of common stock, generating approximately $1.4 billion in net proceeds, which were used predominantly for new and current investments. The J-REIT also completed a follow-on offering subsequent to its IPO. PLD did not directly benefit from the newly raised proceeds; however, the offering will allow the J-REIT to fund additional asset purchases from PLD, which would in turn support PLD's corporate liquidity. The company also recently established an ATM program through which it may issue up to $750 million of common stock, though it has yet to utilize this program. Proactive Liability Management
In addition to recent U.S. dollar and Euro denominated bond offerings, tender offers, and debt repurchases, Prologis upsized its global credit facility in July 2013 to $2 billion from $1.65 billion and improved all-in pricing to LIBOR plus 130 bps, a reduction of 40 bps from the prior global credit facility. The company also recast its Japan revolver, upsizing this facility to JPY45 billion from JPY36.5 billion.
Development Track Record
Development is a core tenet of PLD's business model, and through multiple property cycles, Prologis has developed over a thousand properties at mid-to-high teen percentage margins. Development improves the quality of the portfolio, creates value via the entitlement, construction and leaseup of new properties and enables PLD to realize cash gains on the contribution of the stabilized developments to managed funds.
Credit concerns related to development include inherent cyclicality, potential for impairments, and effects on corporate liquidity. As evidenced by the past downturn, when leasing is insufficient to meet occupancy stabilization levels required for contribution, partially stabilized developments remain on PLD's balance sheet, reducing additional development expenditures until contributions occur. PLD's ability to cease development expenditures materially drives corporate liquidity.
Partially mitigating the aforementioned risks is the fact that the total development pipeline of approximately $2 billion is well below the peak of over $6 billion (including legacy Prologis and AMB Property Corporation). The pipeline's size is large on an absolute basis but manageable on a relative basis as PLD's share of cost to complete development represented 2.5% or pro rata gross assets as of Sept. 30, 2013. However, the pipeline entails moderate lease-up risk. Build-to-suit projects represented approximately 48.3% of development starts year-to-date through Sept. 30, 2013.
The pipeline should remain active in the coming years due to industrial real estate supply-demand dynamics. Demand for industrial REIT space is skewed toward larger and newer facilities from tenants such as e-commerce companies, traditional retailers, and third-party logistics providers. Conversely, new supply should remain in check as construction underway represents 0.4% of total stock compared with 1.5% during the previous upcycle, according to Property and Portfolio Research, Inc. However, PLD's ability to continue development and improve credit metrics is partially reliant on factors outside of management's control including accommodative investment sales and equity markets.
Sizeable Development Funding
Fitch's base case assumes $650 million of development starts for 4Q'13, of which PLD's share would be approximately 75%, followed by approximately $1.7 billion of annual starts in both 2014 and 2015, with assumed development yields in the 7.5% range. Fitch also assumes $2.65 billion of 4Q dispositions and contributions (primarily contributions in Europe and Japan and dispositions in the U.S. and Japan), of which PLD's share would be approximately 80%, followed by approximately $1.75 billion of dispositions and contributions in both 2014 and 2015 with assumed yields in the low 7% range. In the unlikely event that the company funds development principally with its global senior credit facility and long-term debt financings, leverage would increase. Continued funding with predominantly equity proceeds could have positive rating implications.
High Leverage for 'BBB' Expected to Decline
Fitch views pro rata leverage as more meaningful than consolidated leverage given PLD's willingness to buy back and/or recapitalize unconsolidated assets (e.g. interests in Prologis European Properties in 2011, as well as interests in Prologis Institutional Alliance Fund II and Prologis North American Industrial Fund III in 2013) and its agnostic view towards property management for consolidated and unconsolidated assets.
Third-quarter 2013 pro rata leverage was 7.9x compared with 7.7x in 2Q'13 and 8.1x in 1Q'13. The increase in 3Q stemmed from debt-financed acquisition and development activity. Fitch's base case assumes between 1.5% and 2.5% SSNOI growth over the next several years along with incremental NOI from development starts and acquisitions net of dispositions and contributions.
Under this base case, pro rata leverage would approach 7x by year-end 2014 and 6.5x by year-end 2015, which would be strong for the 'BBB' rating. Current leverage is high for a 'BBB' rating generally but appropriate given PLD's portfolio size and access to capital. Leverage may be choppy sequentially as the timing of dispositions and fund contributions may not match acquisitions and development starts in a linear manner. In a stress case not anticipated by Fitch in which SSNOI declines by levels experienced in 2009-2010, leverage would exceed 8x, which would be weak for a 'BBB' rating.
On a consolidated basis, 3Q'13 leverage was 7.9x including recurring cash distributions from unconsolidated entities (9.3x excluding recurring cash distributions from unconsolidated entities) compared with 8.2x (9.3x excluding recurring cash distributions from unconsolidated entities) in fiscal year (FY) 2012.
Match-Funded Liquidity Strategy
Fitch liquidity coverage is strong for the rating at 1.6x for the period Oct. 1, 2013 to Dec. 31, 2015. Fitch defines liquidity coverage as liquidity sources divided by uses. Liquidity sources include unrestricted cash, availability under revolving credit facilities pro forma for the 2021 and 2022 notes issuances, tender offer and debt repurchases, projected retained cash flows from operating activities, and proceeds from dispositions and contributions that have not yet closed but are expected to close in 4Q'13. Liquidity uses include pro rata debt maturities after extension options at PLD's option, projected recurring capital expenditures, and expected 4Q'13 acquisitions and development starts. Liquidity coverage would be weaker excluding 4Q'13 dispositions and contributions as liquidity sources and 4Q'13 acquisitions and development starts as liquidity uses, or if 2014-2015 acquisitions and development starts outpace dispositions and contributions. Assuming a 90% refinance rate on upcoming secured debt maturities, liquidity coverage would improve to 2.4x. As of Sept. 30, 2013, pro forma near-to-medium term debt maturities are staggered; 0.9% of pro rata debt matures during 4Q'13, followed by 6.6% in 2014 and 9.3% in 2015.
Prologis has strong contingent liquidity with unencumbered assets (3Q'13 estimated unencumbered NOI divided by a stressed 8% capitalization rate) to pro forma unsecured debt of 2.4x. When applying a stressed 50% haircut to the book value of land and 25% haircut to construction in progress, pro forma unencumbered asset coverage improves to 2.6x. In addition, the covenants in the company's debt agreements do not restrict financial flexibility. However, the company's AFFO payout ratio was 97.4% in 3Q'13, indicating limited liquidity generated from operating cash flow.
Preferred Stock Notching
The two-notch differential between PLD's IDR and preferred stock rating is consistent with Fitch's criteria for corporate entities with an IDR of 'BBB'. Based on Fitch research titled 'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis', available on Fitch's web site at 'www.fitchratings.com', these preferred securities are deeply subordinated and have loss absorption elements that would likely result in poor recoveries in the event of a corporate default.
The Stable Outlook reflects Fitch's expectation that liquidity coverage will remain around 1.0x, leverage will remain between 7.0x and 8.0x over the next 12 months and fixed-charge coverage will remain around 2.0x over the next 12 months.
The following factors may result in positive momentum in the rating and/or Outlook:
--Liquidity coverage including development sustaining above 1.25x (Fitch liquidity coverage is 1.6x when including dispositions and contributions as liquidity sources and acquisitions and development starts as liquidity uses);
--Fitch's expectation of pro rata leverage sustaining below 6.5x (pro rata leverage was 7.9x at 3Q'13);
--Fitch's expectation of pro rata fixed-charge coverage sustaining above 2.0x (pro rata coverage was 2.0x in 3Q'13 pro forma).
The following factors may result in negative momentum in the rating and/or Outlook:
--Liquidity coverage including development sustaining below 1.0x;
--Fitch's expectation of leverage sustaining above 7.5x;
--Fitch's expectation of fixed charge coverage ratio sustaining below 1.5x.
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