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March 20 (Reuters) - (The following statement was released by the rating agency)
Fitch Ratings expects to rate Financiere Gaillon 8 (FG8) at Long term Issuer Default Rating (IDR) ‘B(EXP)’ with Stable Outlook and its EUR370m senior unsecured notes at ‘B-(EXP)', with a Recovery Rating of ‘RR5’.
FG8 is a holding company with its sole asset an 88% stake in KBSA, one of the largest house builders in France with a solid operating track record. Although Fitch expects KBSA - at the operating company level - to be moderately leveraged at around 2.0x funds from operations (FFO) gross leverage the proposed EUR370m notes that refinance existing acquisition debt at FG8 maintain an aggressive capital structure.
The ratings reflect a high consolidated FFO gross leverage of around 6.2x with a modest de-leveraging profile. The proposed transaction combines a five-year refinancing of KBSA’s prior ranking bank facilities, ensuring solid liquidity and adequate debt service cover for note holders. However, refinancing risk remains high given its thin equity cushion and the inherently cyclical operating risk profile of a house builder. However, KBSA is well-positioned among competitors and has a prudent approach to house building, having efficiently managed down working capital requirements through cycles.
The expected IDR fully consolidates KBSA based on Fitch’s parent-subsidiary linkage criteria, given their close operational and strategic ties. Control of KBSA and the structuring of the proposed refinancing indicate a strong intention to use KBSA cash flow to service the proposed EUR370m notes. The proposed notes do not benefit from a KBSA guarantee, although note holders benefit from a pledge on KBSA shares. The notes are contractually and structurally subordinated to KBSA’s EUR150m prior ranking senior credit facilities resulting in weaker recovery expectations and Fitch assigning a ‘B-'/(RR5) instrument rating for the EUR370m notes.
The ratings are pending the completion of the notes issue and refinancing of KBSA’s bank loans. Failure to complete the refinancing according to plan would result in the withdrawal of the ratings. Final instrument rating will be contingent upon the receipt of final documentation conforming materially to information already received.
Modest De-leveraging Profile De-leveraging is expected with FFO gross leverage trending below 6.0x over the next three years. Fitch’s rating case estimates single-digit housing volume increases with stable operating margins and a mild increase in working capital requirements, resulting in overall yearly free cash flow.
Lacklustre French Market Recovery
Through-the-cycle the French housing market has shown less volatility than other European markets in both volume and price. Following a recovery in 2010 and 2011 driven by favourable tax regimes and low mortgage rates, 2013 marked a low point in volumes of new houses and a slow recovery is expected for 2014 onwards.
Low Margin Volatility
KBSA has below-average margins than other European house builders, although this is a function of a lower-risk house building business model. KBSA has a current policy of maintaining pre-sales rates above 60%, limiting downside price risk with the addition of improved working capital. Higher pre-sales ensure higher customer stage payments by the time large cash outflows are required for land acquisition. In France house builders such as KBSA use land options rather than outright acquisition of land bank. These options are typically only exercised if planning permission and a high pre-sales rate are obtained.
Fairly Low Working Capital
Land options limit development and volume risk, allowing KBSA to cancel a project with minimal cash outflows. KBSA has one of the lowest working capital requirements in the sector with a working capital/turnover ratio averaging 16% over the last four years. However, during 2007 and 2008 this ratio reached 32%, primarily driven by a lower pre-sales rate of around 30% meaning lower customer payments funding working capital requirements.
Maintaining Financial Discipline
KBSA management have a track record of maintaining high pre-sale rates. Under a growth scenario with strong house price inflation the trade-off between profitability and pre-sales becomes more evident. Increased margins can be achieved in a rising price environment by lowering pre-sale rates, albeit at the increased risk of exposing more working capital to a potential downturn. Any reversal of KBSA risk management’s policies would be viewed as a rating-negative.
KBSA is primarily focused on apartments across France, albeit skewed towards the Paris suburbs. Over the last decade it has remained a top five player with a stable market share of around 6%. The customer base is diversified across three broad groups, including institutional investors, individual investors (second home) and owner-occupiers (primary residence), limiting dependence on any one group. However, KBSA remains a price taker and volumes are inherently linked to the French housing market although structural under-supply provides long- term support.
Solid Liquidity; Bullet Risk
The proposed transaction provides a refinancing package for both FG8 and KBSA with no material debt maturities over the next five years. Liquidity is satisfactory with a high level of cash on balance sheet providing a cushion against seasonal working capital requirements that can be as high as EUR150m throughout the year. As a result KBSA has typically had a FFO net leverage significantly lower than gross leverage. A further working capital facility of EUR50m provides additional liquidity. The high FFO gross leverage of around 6.2x and a modest de-leveraging profile, combined with the bullet maturity, leave refinancing risk at FG8 a key rating weakness with the likely source of repayment from trade sales or IPO proceeds of KBSA.
Positive: Future developments that could lead to positive rating action include:
- Decrease in FFO gross adjusted leverage to below 5.0x and FFO interest cover above 2.5x on a sustained basis
- On-going prudent development with pre-sale rates above 50% and working capital/turnover ratio below 20%.
- Dividend cover (KBSA FCF/dividend up-streamed to FG8) above 2.0x on a sustained basis and sufficient maintenance of distributable legal reserves at KBSA
Negative: Future developments that could lead to negative rating action include: - Increased FFO gross adjusted leverage to above 6.5x and FFO interest cover below 2.0x on a sustained basis - Evidence of weakening risk management policies with pre-sale rates falling and increasing of working capital/turnover ratio above 20% - Dividend cover (KBSA FCF/dividend up-streamed to FG8) below 1.25x on a sustained basis