Scope Ratings has today affirmed the EUR 20m secured corporate bond of Stern Immobilien AG (STERN) of BBB-, which is due in 2018 and has a coupon of 6.25%. The instrument rating is based on a Corporate Issuer Credit Rating of BB-. The rating outlooks are Stable.

The rating is supported by STERN’s solid portfolio diversification – assets are mainly in ‘A’ and ‘B’ locations with positive market perspectives – as well as relatively high profitability compared to peers. Another positive rating driver is the adequate FFO fixed-charge cover.

Negative rating factors include STERN’s concentrated development pipeline, negligible market shares in core markets, high and volatile net debt/EBITDA ratio, and relatively small size.

The bond benefits from a collateral security package of shares in STERN’s subsidiary in addition to a full recourse to STERN, whose balance sheet includes high-quality, liquid assets. This security significantly enhances the credit risk of the bond above the issuer’s.

KEY RATING DRIVERS

Small player in residential real estate development. With an total asset volume of EUR 95m at H1 2015 (2014: EUR 75m), STERN is a relatively small company in the German real estate sector, evident also in the negligible shares of below 1% in its core markets. STERN’s small size indicates not only a heightened sensitivity to unforeseen shocks, but stronger volatility in cash flows and fewer opportunities to benefit from economies of scale.

Volatile cash flows due to concentrated development pipeline. STERN’s small size and core focus as a property developer shows in its very ‘lumpy’ cash flows, with free cash flows fluctuating between EUR 4.0m (2011) and EUR -17.8m (2014). Scope expects this volatility to continue, triggered by STERN’s concentrated development pipeline, with the main project accounting for 12% of total expected exit proceeds. This modest pipeline diversification might further affect future cash flow generation if projects are delayed or suffer cost overruns.

Solid diversification with an ‘A’ located, liquid development portfolio. With a development pipeline generating 55% of total expected exit proceeds in Germany, 41% in Turkey and 4% in Romania, STERN shows modest geographical diversification. STERN focuses on ‘A’ locations in these countries: Munich takes up 53% of total expected exit proceeds and Istanbul has 41%. Scope believes STERN’s development portfolio is solidly diversified, especially as these markets show different demand patterns and positive growth perspectives.

Full exposure to cyclical real estate market. STERN is highly exposed to inherent cyclicality in the real estate market, with estimated 80% of 2015 revenue linked to development activity. Scope judges this as credit-negative.

Relatively high profitability. With an expected EBITDA margin of over 30% in 2015 (2014: 6.0%; 2013: 31.4%) which is expected to remain around 30% going forward, STERN’s profitability is relatively higher than many of its German peers, most of which are pure developers.

A comparatively high leverage. The company is highly leveraged, reflected in its comparatively high LTV of about 55% at H1 2015 and a high net debt/EBITDA of above 10x expected for 2015. Thus, the LTV is at the top of the rating-conditional range of 45-55%. Scope judges leverage levels to be credit-negative because it forces the company to rely more on external funding and on successfully disposing its projects.

Adequate FFO fixed-charge cover of over 1.0x expected for 2015 to improve above 2.0x in 2016. Despite the high debt levels (net debt/EBITDA basis), STERN profits from a comparatively low weighted average cost of debt. However, this low cost is partially offset by the, presumably, marginally weaker-than-expected operating result forecasted for 2015, which should also lead to a relatively weak FFO fixed-charge cover of greater than 1.0x. However, FFO fixed-charge cover is expected to increase above 2.0x in the next few years, showing STERN will be able to meet interest obligations.

Liquidity and debt repayments. STERN’s liquidity is forecast at a moderate 2.0x for YE 2015 (2014: -0.2x). However, this ratio is very volatile and was driven in previous years by changes in working capital when STERN was building up its development pipeline.

STERN’s ability to repay EUR 21m of debt in 2016 (2017: EUR 27m) depends either on its successful disposal of projects or continuous extension of overdrafts representing 28% (EUR 21m) of total debt.

BOND

The bond’s credit quality is tightly linked to STERN’s credit quality and performance, which limits chances of the bond’s rating substantially exceeding the Corporate Issuer Credit Rating (CICR) of STERN. But given the hidden reserves disclosed by STERN and a well-located development portfolio, Scope believes a potential recovery to be well above market average, ultimately allowing for BB+ issue rating.

OUTLOOK

The rating outlook is Stable. It is supported by the STERN’s development pipeline in the booming core markets of Munich and Istanbul.

A negative rating action would be considered if the company’s LTV exceeds 60% or if FFO fixed-charge cover does not increase substantially above 2.0x.

A positive rating action is remote given the current perspective. However, it would be considered if STERN significantly grows in terms of size and successfully manages to lower LTV to a sustainable level around or below 45%.
 

REGULATORY AND LEGAL 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 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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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 AG 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 AG or any companies affiliated to it. Neither the rating agency, the rating analysts who participated in this rating, nor 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

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Methodology
The methodologies applicable for this rating (Corporate Rating Methodology, Rating Methodology - European Real Estate Corporates) are 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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