Feb 26 (Reuters) - (The following statement was released by the rating agency)
Fitch Ratings has affirmed SEGRO plc’s (SEGRO) Long-term Issuer Default Rating (IDR) at ‘BBB+’ and senior unsecured rating at ‘A-'. The Outlook on the Long-term IDR is Stable. The Short-term IDR has been affirmed at ‘F2’.
SEGRO’s performance and de-leverage profile during 2013 outperformed Fitch’s expectations driven by faster than expected non-core divestments, the joint venture (JV) transfer of its continental European portfolio and a broad improvement in the industrial asset class, which had previously lagged other commercial real estate segments. Fitch expects a defensive rental income profile to provide comfortable EBITDA net interest cover of above 2.0x into 2014 and 2015. Although the pace of net divestments is likely to fall, we expect the Fitch-adjusted loan-to-value ratio (LTV) to stabilise at around 50%.
Non-Core Asset Disposals
SEGRO announced a strategy in 2011 to sell GBP1.6bn of non-core properties over five years. Following the disposal of GBP0.6bn during 2013 only GBP0.4bn of non-core properties remain ahead of Fitch’s expectations. These disposals have been combined with a rebalancing of the portfolio towards prime London and Thames Valley logistics and warehouse space. SEGRO has one of the largest and best located industrial portfolios in the UK and is a key player in Europe.
New Continental Europe JV
The creation of SEGRO European Logistics Partnership (SELP) through the transfer of its wholly owned continental European logistics portfolio into a 50/50 JV with the Public Sector Pension Investment Board (PSPIB) of Canada is a strong rating positive. Although it reduces its wholly owned portfolio by around GBP0.8bn, the sale proceeds aid deleveraging, improve liquidity and introduce third-party capital to allow SEGRO to grow in Continental Europe where its market position is not as strong.
Stable Contractual Rental Income
The weighted average lease length at FY13 of 8.9 years (6.7 years to first break), modest vacancy rates of 8.5%, low levels of tenant insolvencies, around 70% tenant retention rates and an improvement in the letting market going into 2014 underpin the defensive nature of cash flow generation. Fitch expects operational performance to improve with a more efficient cost base following rationalisation of the portfolio.
Asset and Liabilities Matched
With long-term average lease lengths contractually locking in a stream of cash flow, SEGRO has a conservative approach to matching debt obligations. The average debt maturity profile is 8.7 years and having issued bonds out to 2035 is on average longer than most peers. This is an important credit positive for such a capital-intensive industry, as it means that interest coverage can be protected. The average cost of debt is 4.5% (4.6% at FY12) and 76% of net debt is fixed rate.
Positive Outlook for Industrial Assets
Fitch forecasts an improved rental and investment market into 2014 and 2015 with SEGRO’s industrial assets having only started a broad base recovery in 2013. Property valuations on the completed wholly owned portfolio increased 4.1% from 2013. Continental European assets are likely to trail the UK. Industrial assets are further supported by favourable structural trends such as increased requirements for warehousing and distribution of internet driven retail and the continued repositioning of old industrial space into data centres and offices.
Improving Financial Metrics
SEGRO’s credit metrics through-the-cycle have lagged other Fitch investment grade rated REITs. This is largely attributed to a slower recovery in industrial real estate when compared with other UK REITs focused on office or retail assets that have benefited from earlier and faster recoveries driven by safe haven flows into prime London property. SEGRO’s Fitch-adjusted LTV (net debt/investment properties) is expected to stabilise at around 50%.
Achieving Financial Target
SEGRO’s long-term target to reduce leverage to 40% look through LTV is likely in the near term reaching 42% at FY13. Fitch adjusted net debt/EBITDA has fallen from 8.9x at FY12 to 7.1x at FY13 and expected to remain at similar levels. Financial metrics are in line with Fitch’s investment grade rated EMEA REITs, averaging a LTV of 40% and net debt/EBITDA of 7.5x.
SEGRO has transferred part of its investment property portfolio into JVs although the completed wholly owned portfolio still remains at a critical mass at GBP2.7bn and arguably better quality following the non-core divestment plan. SEGRO’s senior unsecured bondholders remain subordinated to these JV assets. However, this strategy is compensated by improved credit metrics and liquidity and provides dividend income of GBP24m at FY13. In aggregate, off balance sheet (equity accounted) JVs are modestly leveraged with a Fitch adjusted LTV of 39% at FY13. Fitch-adjusted EBITDA includes only 50% of JV dividends as a conservative measure as the property assets are funded by (non-recourse) secured debt, including restrictive covenants.
SEGRO has cautiously expanded its development programme with a total of 18 pre-let developments approved contracted or under construction at FY13. The total committed development programme is around GBP89m (capital expenditure to completion) and around 60% pre-let. This is still modest in comparison with pre-2007 levels and compared with rated peers. Following years of limited development across the sector, SEGRO is well placed to benefit as one of the few large players that has the financial headroom and a well-positioned land bank to increase development.
Liquidity improvements are driven by debt reduction from sale proceeds with all bank credit lines now undrawn and entire gross debt of GBP1.7bn now fully bond funded. Only GBP208m of bond debt matures in the next four years. Cash on balance sheet of GPB234m and undrawn committed lines available of GPB733m provide comfortable headroom. Around GPB300m of these committed undrawn lines mature over the next two years. Furthermore, there is around GPB131m of deferred consideration within the next two years from PSPIB as part of the SELP transaction.
Positive: Future developments that could lead to positive rating action include:
- Material improvement in SEGRO’s sector or geographical diversification.
- Increased coverage ratios to Fitch adjusted EBITDA net interest cover above 2.5x.
-Fitch adjusted LTV (net debt/investment properties) below 40% and LTV (net debt/investment properties and JV share) below 30%.
Negative: Future developments that could lead to negative rating action include:
-Fitch adjusted EBITDA NIC below 1.75x on a sustained basis.
-Fitch adjusted LTV (net debt/investment properties) above 55% and LTV (net debt/investment properties and JV share) above 45% on a sustained basis.
-Liquidity score below 1.25x (committed undrawn facilities plus cash divided by debt maturities and committed capex) over 18-24 months.