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Rating action

Scope Ratings GmbH (Scope) has today downgraded the issuer rating of Germany-based residential real estate developer Euroboden GmbH to B from B+. Scope has also downgraded the senior unsecured debt rating to B+ from BB-. Both ratings have been placed under review for a possible downgrade.

Rating rationale

Scope’s previous expectation of an increase in leverage and decrease in debt protection materialised, triggering the downgrade. The deterioration in these metrics has been driven by lower demand, delays in project execution and persisting inflation, which caused a weaker-than-anticipated operating performance.

As anticipated, the unfavourable macroeconomic environment significantly affected Euroboden’s metrics, which deteriorated beyond Scope’s previous expectations, to a Scope-adjusted EBITDA of EUR 7.2m (EUR 16.8m expected) as of 2022 financial year end, driven by a 41% decrease in revenue YoY.

The placement under review for possible downgrade is based on the lack of visibility on Euroboden’s project development, given the difficult economic environment and persisting uncertainty on the German real estate market, which might lead to further deterioration of the credit metrics.

The business risk profile (assessed at B+, unchanged) continues to reflect Euroboden’s relatively small size and the geographical concentration around its two core markets, Munich and Berlin, as well as its focus on residential development. Poor diversification is a major cause of the drop in operating profit as residential developers are especially exposed to macroeconomic headwinds. Moreover, the absence of recurring income leaves the company highly dependent on the pipeline execution and demand. However, the business risk profile still benefits from high-quality assets, with a focus on A locations and outstanding materials and design. Scope believes that despite delays in expected profit, assets will continue to largely hold their value.

Scope expects that profitability as measured by the company’s Scope-adjusted EBITDA margin and levered internal rate of return will not recover in FY 2023 as a result of investors and home buyers being in a wait-and-see mode until sponsors accept lower rates of return and long-term interest rates stabilise. Euroboden has provided Scope with a cash flow plan for April 2023 to December 2024, which shows the company’s reliance on a handful of projects to generate operational cash flow that could cover debt repayments, including the repayment of a EUR 40m bond maturing in September 2024. Scope notes that the largest projects might not be realised on time or the sales price may not meet current expectations, due to the persisting low demand and uncertainty on the timing of a full market recovery, forcing the issuer to cancel or delay projects to meet liquidity needs. Delays in the execution of the project pipeline prolong the recovery of operational cash flow to a level that allows interest payments to be served without using the available cash cushion.

The re-assessment of the issuer’s financial risk profile to B- from B is driven by a weakening interest cover, which in 2022, following the drop in EBITDA, fell below 1.0x (0.8x as at end-September 2022) and is expected to stay below 1x in 2023, given the large portion of loans with floating interest rates and the unpredictable cash flow typical of residential real estate development.

Lower sales and rising debt have resulted in higher leverage, with Scope-adjusted debt/EBITDA rising to 42x at year end September 2022 compared to 8.9x a year earlier. Scope expects this ratio to remain high in FY 2023 but below 40x ranging between 9x and 16x in the medium term if the issuer succeeds in selling its projects. However, Scope factors in the high business volatility and the difficulty in predicting results beyond 2023. The higher debt burden is partially mitigated by a still adequate Scope-adjusted loan/value ratio, sustained at around 50%, in line with Scope’s previous base case, providing additional headroom for external financing.

Scope considers Euroboden’s liquidity as adequate for the upcoming months. While liquidity still suffers from substantial short-term debt and volatile free operating cash flow, it benefits from open committed credit lines (EUR 19m as at end-March 2023) and from the discretionary nature of most projects, ensuring flexibility in cancelling or postponing the start, should liquidity be insufficient.

The fact that liquidity issues could quickly escalate and Euroboden’s high dependence on few projects to repay its EUR 40m senior unsecured bond maturing in September 2024 weigh down the rating.

Under review for a possible downgrade

Scope will closely follow the updates on the projects, expected to bring in substantial cash flow, and will resolve the under review status as soon as possible.

An upgrade is remote and would require Scope-adjusted debt/EBITDA to be sustained at below 15.0x and Scope-adjusted EBITDA interest cover to remain above 2x at all times. The improvement in both credit metrics could occur if Euroboden implemented a successful project execution strategy, supported by improved cost efficiency and a moderate investment strategy, driving up EBITDA substantially.

A rating confirmation could occur if liquidity sustained at or above 100% at all times and interest cover would be well above 1x through the cycle. A rating confirmation would reflect Scope’s expectation that the issuer, despite the current market pressure, will remain well positioned in its domestic market as a premium real estate home builder and that assets value would hold up against potential crises, underpinned by a high-end design and attractive locations, which are less risky for investors during crises.

A downgrade of at least one notch could occur if the Scope-adjusted EBITDA/interest cover remained below 1.0x or if liquidity weakened. This could happen if: i) the German real estate market downturn lasted longer than expected and Euroboden failed to compensate for its effects and/or ii) Euroboden failed to deliver its projects and further delays in projects’ execution continued to put pressure on liquidity.

Long-term debt rating

Following the downgrade and the under-review placement of the issuer rating, Scope has downgraded the senior unsecured debt rating to B+ from BB- and placed it under review for possible downgrade.

Based on a hypothetical default scenario referencing most recent data on property values (September 2022) and liabilities (March 2023), including reasonable discounts on the company’s asset base as well as the likely volatility in the company’s capital structure on its path to default, Scope assumes an ‘above average’ recovery allowing for a rating one notch above that of the issuer, subsequently leading to a downgrade of the senior unsecured debt rating to B+.

Stress testing & cash flow analysis
No stress testing was performed. Scope Ratings performed its standard cash flow forecasting for the company.

Methodology
The methodologies used for these Credit Ratings and/or Outlooks, (General Corporate Rating Methodology, 15 July 2022; European Real Estate Rating Methodology, 25 January 2023), are available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other Services’, published on https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://scoperatings.com/governance-and-policies/regulatory/eu-regulation. Also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope Ratings’ definitions of default and Credit Rating notations can be found at https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Guidance and information on how environmental, social or governance factors (ESG factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The Outlook indicates the most likely direction of the Credit Ratings if the Credit Ratings were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The Rated Entity and/or its Related Third Parties participated in the Credit Rating process.
The following substantially material sources of information were used to prepare the Credit Ratings: public domain, the Rated Entity and Scope Ratings' internal sources.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting the Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and/or Outlooks and the principal grounds on which the Credit Ratings and/or Outlooks are based. Following that review, the Credit Ratings were not amended before being issued.

Regulatory disclosures
These Credit Ratings and/or Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and/or Outlooks are UK-endorsed.
Lead analyst: Claudia Aquino, Associate Director
Person responsible for approval of the Credit Ratings: Philipp Wass, Managing Director
The Credit Ratings/Outlooks were first released by Scope Ratings on 28 May 2015. The Credit Ratings/Outlooks were last updated on 30 September 2022.

Potential conflicts
See www.scoperatings.com under Governance & Policies/Regulatory for a list of potential conflicts of interest disclosures related to the issuance of Credit Ratings.

Conditions of use/exclusion of liability
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