The downgrade reflects Adler’s increase in Loan-to-Value (“LTV”) to 71% in 2013 from 33% in 2012. The increase is driven by Adler’s mostly debt-financed acquisitions in 2013. With acquisitions to continue in 2014, Scope does not expect Adler to deleverage significantly over the short to medium term.

The rating is supported by Adler’s solid profitability with an EBITDA margin expected to reach 60% in 2014. Adler’s improving geographical diversification is factored into the rating. Other positive rating drivers include Adler’s granular customer structure and its relatively stable operating cash flows. These positive rating factors are partly offset by Adler’s relatively high leverage, its still very small market shares in its core markets and some execution risk in disposal activities.

KEY RATING DRIVERS
It is Adler’s strategy to increase its residential portfolio to circa 45,000 units by YE2015. This follows the acquisitions of 7,600 units in 2013 and circa 17,000 units YTD 2014.
As of June 2014 Adler’s portfolio is spread over approximately 50 cities, mainly located within North-Rhine Westfalia, Lower Saxony and Saxony (accounting for 70% of total rental income). However, six out of Adler’s 10 largest markets (85% of rental income as of Q1 2014) are exposed to expected market declines going forward. The impact on Adler is somewhat mitigated by its lower average rents per SQM comparing to market rents in those regions. In addition, Adler’s customer diversification is considered to be good.

Due to Adler’s relatively aggressive growth strategy, Scope estimates Adler’s EBITDA margin and Return on Assets to increase in 2014 to about 60% (up from 25% in 2013) and 5% (2013: 2.4%) respectively. A negative impact on Adler’s rating may occur if these margins prove to be unachievable.

Due to its change in strategy and focus on residential property alone instead of developmental activities, Adler’s operating cash flows are expected to be less-volatile going forward. Scope sees this as a positive rating factor.

With an LTV of 71% in 2013, Adler’s leverage is higher than that of many of its peers. Scope expects no significant deleveraging over the short to medium term, as Adler’s free cash flow (after acquisitions according to Scope’s definition) is likely to be negative until 2015 due to the ongoing investment policy.

Due to the current portfolio composition, Adler has no significant market share in its core cities. Its market share in any of these cities does not amount to more than 2%.

LIQUIDITY AND DEBT STRUCTURE
Adler’s current liquidity profile is considered weak with cash and marketable securities available and accounts receivable totaling EUR 9.3m at YE2013. This covered just 28% of 2013 short-term debt totaling EUR 33.0m. This liquidity profile is expected to improve with profitability increases expected going forward.

Revenues from asset disposals account for almost 37% of total revenues in the next three years. It is important for Adler to succeed with this strategy to avoid negative free cash flows, as well as low gross interest coverage, which stood at 1.3x in 2013 (about 1.5x including interest income).

Adler’s access to bank debt and capital markets is considered adequate. Recent acquisitions of about 10,000 units in 2013 and Q12014 have been primarily financed via bank debt and the issuance of bonds or hybrid capital. Furthermore, Scope sees no refinancing risk during the next 12-18 months.

OUTLOOK
Adler’s outlook is stable.

Historical and future acquisitions are expected to help Alder achieve critical mass and to improve geographical diversification. However, it also involves some execution risk; especially with regard to Adler’s ability to successfully integrate recent and future acquisitions such as Estavis.

Scope will closely follow Adler’s future growth to assess the success in managing the ongoing integration process. Shaping the final portfolio and developing a size-adjusted, sustainable organizational basis is important for Adler to drive mid-term profitability.
 
REGULATORY DISCLOSURES

Important information
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

Responsibility
The party responsible for the dissemination of the financial analysis is Scope Ratings GmbH, Berlin, District Court for Berlin (Charlottenburg) HRB 145472, directors: Thomas Morgenstern, Florian Schoeller.
The rating has been prepared by Philipp Wass, Lead Analyst.
Responsible for approving the rating: Dr. Britta Holt, Committee Chair

Rating History
08.03.2013 BB outlook positive

Information on interests and conflicts of interest
The rating was prepared independently by Scope Ratings, but for a fee based on a mandate of the rated entity.

As at the time of the analysis, neither Scope Ratings GmbH nor companies affiliated with it hold any interests in the rated entity or in companies directly or indirectly affiliated to it. Likewise, neither the rated entity nor companies directly or indirectly affiliated with it hold any interests in Scope Ratings GmbH or any companies affiliated to it. Neither the rating agency, the rating analysts who participated in this rating, or any other persons who participated in the provision of the rating and/or its approval hold, either directly or indirectly, any shares in the rated entity or in third parties affiliated to it. Notwithstanding this, it is permitted for the above-mentioned persons to hold interests through shares in diversified undertakings for collective investment, including managed funds such as pension funds or life insurance companies, pursuant to EU Rating Regulation (EC) No 1060/2009. Neither Scope Ratings nor companies affiliated with it are involved in the brokering or distribution of capital investment products. In principle, there is a possibility that family relationships may exist between the personnel of Scope Ratings and that of the rated entity. However, no persons for whom a conflict of interests could exist due to family relationships or other close relationships will participate in the preparation or approval of a rating.

Key sources of information for the rating
Annual financial statements, annual reports of the rated issuer, external market reports, external market reports, data provided by the issuer or/and external data providers, website of the rated entity/issuer, research by Scope Group.
Scope Ratings considers the quality of the available information on the evaluated company to be satisfactory. Scope ensured as far as possible that the sources are reliable before drawing upon them, but did not verify each item of information specified in the sources independently.

Examination of the rating by the rated entity prior to publication
The rated entity has been given the opportunity to examine the rating action prior to publication. Following that examination, the rating was not modified.

Methodology
The methodology applicable for this rating (Corporate Rating Methodology published in March 2014) is available on www.scoperatings.com. The historical default rates of Scope Ratings can be viewed on 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’s default rating, definitions of rating notations and further information on the analysis components of a rating can be found in the documents on methodologies on the rating agency’s website.

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