11. Apr 2017 Rating news – Cross-sector
Scope downgrades STERN to B+ and its bond rating to BB+; Outlooks Stable
The rating action is primarily driven by the company’s increased execution risk, raising uncertainties on the bond’s refinancing in 2018.
Scope Ratings (Scope) has today downgraded the issuer rating of Stern Immobilien AG (STERN) to B+ from BB- as well as the rating of STERN’s bond to BB+ (due in May 2018 with a coupon of 6.25%) from BBB-. The Outlook is Stable.
The downgrade is primarily driven by increased execution risk, as the bond’s repayment is strongly dependent on the successful disposal of STERN’s development pipeline, reflecting Scope’s limited visibility. That leads to increased uncertainties regarding the refinancing of the bond in 2018.
A positive rating driver is, among others, the company’s substantial decrease in leverage at YE 2016 in line with Scope’s expectations. This is a result of successful disposal activity in 2016, thanks to a high-quality and liquid pipeline of development projects.
The rating is constrained, however, by ongoing stretched and volatile liquidity as a result of STERN’s high portion of short-term debt, thereby increasing dependence on external financing. Furthermore Scope views negatively STERN’s limited size and full exposure to the cyclical real estate development market, as these aspects cause a higher sensitivity to unforeseen shocks and uneven cash flow.
The bond’s collateral consists of i) shares in STERN’s subsidiary (Stern Real Estate AG), and ii) a full recourse to STERN, whose balance sheet includes high-quality liquid assets. This security significantly raises the credit risk of the bond above that of the issuer.
Key rating drivers
Small player in residential real estate development. With a total asset volume of approximately EUR 70m at YE 2016 (2015: EUR 91m; 2014: EUR 75m), STERN is a relatively small company in the German, Turkish and Romanian real estate sectors. This is also evident in the company’s negligible shares of below 1% in its core markets. STERN’s small size not only causes a higher sensitivity to unpredictable shocks and stronger cash flow volatility, but also means less of an opportunity to benefit from economies of scale.
Volatile cash flows due to concentrated development pipeline. The direct consequence of having a small proportion of property development activity is ‘lumpy cash flows, with free cash flows fluctuating between EUR 30m forecasted for 2016 and negative EUR 20m in 2013. Scope expects this volatility to continue, triggered by STERN’s concentrated development pipeline, with the main project accounting for ca. 15% of total expected exit proceeds. This modest pipeline diversification might further affect future cash flows if projects are delayed or suffer cost overruns.
Solid diversification with an ‘A’-located, liquid development portfolio. STERN’s geographical diversification is modest, with a development pipeline generating total expected exit proceeds of 79% in Germany, 12% in Turkey, and 9% in Romania. STERN focuses on ‘A’ locations in these countries, as Munich and Istanbul respectively take up 43% and 12% of the expected exit proceeds. Scope believes STERN’s development portfolio is solidly diversified, especially as these markets exhibit different demand patterns and growth prospects.
Full exposure to cyclical real estate market. STERN is highly exposed to inherent cyclicality in the real estate market, with approximately 97% of its 2016 revenue linked to development activities. Scope judges this exposure as credit-negative.
Relatively high profitability. STERN’s profitability is higher than many of its ‘pure developer’ German peers’, with a forecasted 25% EBITDA margin in 2016 (2015: 26%; 2014: 6%; 2013: 31%). Scope expects continued volatility for this margin, albeit at above 20%.
Moderate leverage. The company reduced its leverage as at YE 2016, to a Scope-adjusted debt (SaD)/EBITDA of well below 6.0x and loan/value ratio (LTV) of below 50%, thanks to the reduction of SaD by EUR 28m. Thus, the LTV is in line with the rating-conditional range of 45-55%. LTV is expected to remain at similar levels, while SaD/EBITDA is expected to fluctuate depending on project starts and disposals.
EBITDA interest cover back to a sufficient level of above 3.0x. With the successful disposal of three projects in 2016, STERN was able to increase debt protection (as measured by EBITDA interest cover) to a level that supports the assigned financial risk profile. Holding that level in the future – as expected – is however at risk of further successful disposal of STERN’s development pipeline.
Liquidity and debt structure
A high 58% of debt does mature until YE 2017. Of the EUR 30m of debt due in 2017 (EUR 11m of project financing; EUR 19m of rolling credit lines and overdrafts), EUR 19m is expected to be repaid from the exit proceeds of STERN’s projects. However, uncertainties over timely disposals leave the risk that a remainder will depend on the extension of overdrafts. Scope judges STERN to be capable of managing the risk connected to this overdraft extension as both have regularly been extended in the past.
As a result of STERN’s financing structure, with 40% of debt consisting of rolling credit lines and overdrafts, its adjusted liquidity is expected to be below 100% in 2016 (2015: 110%). The ratio is volatile and driven by changes in the previous year’s working capital. This is attributable to the build-up of its project pipeline. Scope believes liquidity risk is manageable with regards to overdrafts and rolling credit lines, but sees increased refinancing risk for the bond maturing in May 2018 because it is dependent on the successful disposal of developed assets.
Scope believes that the high sensitivity towards delays in disposal activity – as evidenced by the use of the reserve account to pay the bond’s interest in 2016 – is not adequately addressed by the company’s management of its liquidity situation. The reserve account was replenished as at 30 June 2016.
The bond’s credit quality is tightly linked to STERN’s own credit quality and performance, which limits the likelihood of the bond’s rating substantially exceeding the company’s issuer rating. However, given the hidden reserves disclosed by STERN and a well-located development portfolio, Scope considers that a potential recovery could be well above market average, ultimately allowing for an issue rating of BB+.
The Outlook is Stable, based on Scope’s expectations of an ongoing prolongation of STERN’s short-term credit lines/bank overdraft or successful refinancing. Furthermore Scope expects current leverage, as measured by LTV, to remain between 45% and 55%, while disposal activities support a recurring EBITDA of above EUR 5m p.a. for the upcoming years. Scope’s rating case scenario further incorporates the deferral of dividend payouts to main shareholders until the bond’s successful repayment.
A negative rating action would be considered if the company’s activities and financial metrics did not adhere to Scope’s rating case scenario, particularly if liquidity measures deteriorated.
A positive rating action might be warranted if STERN managed to reasonably address the refinancing of the bond in May 2018, by securing either sufficient cash reserves or an executed refinancing concept.
Information pursuant to Regulation (EC) No 1060/2009 on credit rating agencies, as amended by Regulations (EU) No. 513/2011 and (EU) No. 462/2013
The party responsible for the dissemination of the financial analysis is Scope Ratings AG, Berlin, District Court for Berlin (Charlottenburg) HRB 161306 B, Executive Board: Torsten Hinrichs (CEO), Dr. Stefan Bund.
The rating analysis has been prepared by Philipp Wass, Lead Analyst
Responsible for approving the rating: Olaf Tölke, Committee Chair
Rating history - Stern Immobilien AG
(Date | Rating action | Rating)
18 March 2016 I Initial Rating I BB- I Stable
Rating history - Stern Immobilien AG - Secured Corporate Bond 6.25% 2013/18
(Date | Rating action | Rating)
18 March 2016 I Affirmation I BBB- I Stable
13 March 2015 | Downgrade | BBB- I Stable
17 September 2014 I Review for possible downgrade I A- I n/a
26 June 2014 I Affirmation I A- I Stable
30 April 2013 I Initial Rating I A- I Stable
The rating outlook indicates the most likely direction of the rating if the rating were to change within the next 12 to 18 months. A rating change is, however, not automatically ensured.
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