Scope Ratings affirms IPSAK mbH bond rating at BBB, Outlook Stable

The BBB rating for IPSAK’s EUR 30m secured corporate bond (6.75% 2012/2019) is supported by the company’s high market share in residential developments in Kornwestheim/Ludwigsburg and Kassel and its sound recurring income position. Both of these factors partially mitigate the volatility of IPSAK’s development business. The company also has strong financial metrics with a comparably low loan/value ratio (LTV), strong EBITDA interest cover and solid liquidity.

Negative rating factors include IPSAK’s small size, heavy reliance on top customers, concentrated development pipeline focussing on only a few regional markets, and key person risk.

The bond rating benefits from over-collateralisation of 1.9x.

Business risk profile

Industry risk for IPSAK is considered high, as the company is exposed to the highly cyclical real estate industry with its main business segments comprising the leasing and management of office, residential and retail properties as well as the development of residential buildings. IPSAK also has some exposure to the office and convention & exhibition sub-segments. Scope has a positive short-term credit view of the industry but highlights its sensitivity to changes in the political environment, economic conditions and interest rates.

With a total consolidated asset value of EUR 133m and funds from operations of EUR 20m in 2016, IPSAK is a small property company in the highly fragmented German real estate market. The company’s size and market positioning imply enhanced sensitivity to unforeseen events, greater cash flow volatility and higher key person risk.

Small size leads to limited geographical diversification focussing on a few regional markets. IPSAK’s portfolio is situated in the cities of Kassel (75% of investment volume), Ludwigsburg (8%) and the town of Kornwestheim belonging to the district of Ludwigsburg (17%). These are classified as ‘B’ or ‘C’ locations by Scope and are currently benefitting from the booming German real estate market, with strong demand from tenants and investors spilling over from ‘A’ locations. Scope does not believe that this level of diversification is sufficient to offset adverse market movements, especially as both markets follow the same demand patterns. However, the company’s focus is partially mitigated by its position as one of the market leaders for residential developments in Kassel and Kornwestheim/Ludwigsburg, where it has an estimated market share of 20%. In addition, IPSAK also profits (via its parent company IMMOVATION AG) from a 20-year track record for its unique selling proposition, namely the restoration of listed buildings. In Scope’s view, this track record represents a competitive advantage at property auctions and regarding the successful completion of such projects. The company’s overall dominant market position ensures high project visibility in their respective markets, supporting its business-to-consumer business model and resulting in high pre-sale rates for new developments of up to 100%.

IPSAK has a very concentrated development pipeline with three projects in its portfolio at present. This situation may negatively affect future cash flow generation if demand weakens or if projects are delayed or suffer from cost overruns. However, the granularity of the project pipeline (510 apartments), high pre-sale rates (e.g. 100% for the 120 apartments to be built in Kornwestheim) and a large degree of cost certainty (gained by using EPC contractors) partially mitigate associated risk. Furthermore, an expected recurring income position of around EUR 8m for the period to 2019 creates a sound foundation of operating cash flows, partially offsetting development business volatility. Diversification is relatively poor with regard to sources of recurring income, with the top three tenants providing 57% of rental income. Nevertheless, this lack of diversification is partly offset by the excellent credit quality of some of these occupants, reducing the risk of tenant default.

Financial risk profile

IPSAK has sufficient debt protection, fluctuating between 1.8x and 2.6x of EBITDA interest cover over the last couple of years. Although 2016 saw a hike of 9.3x due to the disposal of the company’s Heidenheim portfolio, we anticipate EBITDA interest cover to remain at the upper end of the historical bandwidth close to 2.5x. Supported by the company’s recurring income position, minimum EBITDA interest cover (excluding development activity) of above 1x indicates that IPSAK is likely to meet its interest expenses going forward. However, debt protection is likely to vacillate depending on the execution of the company’s development pipeline.

The company’s cash flow has been volatile and characterised by the expansion of business activities since 2012. Accordingly, free operating cash flow has (FOCF) fluctuated between a negative EUR 21m in 2013 and EUR 52m over the last financial years. Scope expects this volatility to persist, fuelled by the company’s development activities (IPSAK’s main business segment) for which cash in- and outflows are not necessarily matched over the lives of the projects. Furthermore, IPSAK suffers from a concentrated project pipeline, amplifying the volatility inherent in the real estate development business model. There is a high likelihood of negative cash flows from operations going forward, potentially driven by the expected purchase of new properties for projects in the next years as well as an increase in working capital over the next years, should projects be delayed.

As expected, IPSAK’s LTV dropped to below 50% as at YE 2016. This reduction was predominately due to the disposal of the company’s Heidenheim portfolio in 2016, helping to decrease Scope adjusted debt (SaD) by EUR 30m. Going forward we anticipate the LTV to remain below 50%, backed by high pre-sale rates of up to 100% and an available cash position of EUR 12.5m at YE 2016. Both of these factors limit the need for external financing to cover working capital-related cash outflows expected in 2017.

The company’s SaD/EBITDA of above 10x since 2012 reflects the company’s three-fold business model (real estate development, commercial real estate and the supply of power/heating) with stable recurring income allowing for higher leverage. We forecast SaD/EBITDA to fall to around 8x going forward with positive free operating cash flow from 2018 on helping to further deleverage.

Liquidity

IPSAK’s liquidity is forecasted at above 100% for 2017. In detail, the company has sufficient coverage for EUR 5.8m of debt due in 2017; negative cash flow from operating activities of around EUR 2m forecasted for 2017 via EUR 12.5m of cash available at YE 2016; and an already executed extension for EUR 4.4m of maturing debt.

Further debt of EUR 1.2m is due in the period up to YE 2018. We anticipate that IPSAK will be able to redeem this debt using its operating cash flows.

However, the company faces substantial refinancing risk in 2019, with the EUR 30m corporate bond due in December 2019. Scope does not believe that IPSAK will have the means to redeem this debt in full using cash available at that point in time. Consequently, from Scope’s point of view, IPSAK will have to partially rely on external financing to repay its corporate bond.

However, the company will also be able to make use of its unencumbered asset position. One of IPSAK’s subsidiaries (IPSAK Energie GmbH) operates as a heat and power supplier for the Salamander Areal building in Kornwestheim. IPSAK Energie GmbH is fully equity-financed and is the only possible heat supplier for the Salamander Areal. IPSAK plans to draw credit lines for this subsidiary if needed. Scope estimates the potential credit at approximately EUR 7m to 8m (based on 6x SaD/EBITDA / IPSAK Energie EBITDA of EUR 1.2m for 2016).

Scope highlights the dividend distribution of more than EUR 10m in 2016 to IPSAK’s parent company IMMOVATION AG, using cash surplus from the sale of the Heidenheim portfolio. IPSAK also added EUR 8m of its profits in 2016 to its retained earnings.

Scope acknowledges the commitment made by IPSAK’s parent company IMMOVATION AG to keeping distributable profits at IPSAK – if needed – to strengthen the company’s internal financing power. 

Bond

Scope considers the pledged assets of: i) a second-lien mortgage on the Salamander Areal valued at EUR 82.1m in 2015 (the beneficiary of the first-lien mortgage is bank debt of EUR 27.5m at YE 2016); and ii) the fixed deposit account of EUR 2m to be sufficiently robust collateral to secure the recovery of funds for bond investors in a default scenario, even if the market value of the Salamander Areal should decline by 25% or more. This solid collateral partially delinks the bond’s credit quality from the credit quality and performance of IPSAK.

Outlook

IPSAK’s Stable Outlook for its EUR 30m corporate bond is driven by the company’s solid recurring income stream generated by its letting, power and heat generation activities. This enhances the visibility of future cash flows and affords robust financial metrics with an EBITDA interest cover of over 2.2x and an LTV of below 50% going forward. 

A negative rating action may be taken if the company’s leverage were to increase to an LTV of above 50% or EBITDA interest cover were to fall below 2.2x, both on a continuing basis.

A positive rating action may be considered if IPSAK: i) successfully manages to lower its LTV to a sustainable level of around or below 30%; and ii) keeps funds from operations sustainably above EUR 7m.

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 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 - IPSAK mbH - Bond 2012/19 – 6.750% (ISIN DE000A1RFBP5) 
(Date | Rating action | Rating)
21 September 2017 I Affirmation I BBB I Stable
16 September 2016 I Affirmation I BBB I Stable
17 September 2015 I Affirmation I BBB I Stable
18 September 2014 I Downgrade I BBB I Stable
17 September 2014 I Review for possible downgrade I A- I na
29 November 2013 I Downgrade I A- I Stable
3 December 2012 I Initial Rating I A I na

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.

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 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
• Prospectus
• Website of the rated entity
• Annual financial statements
• Annual reports/semi-annual reports of the rated entity
• Information provided on request
• Data provided by external data providers
• Valuation reports
• External market reports
• Press reports / other public information
• Interview with the rated entity

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
Prior to publication, the rated entity was given the opportunity to examine the rating and the rating drivers, including the principal grounds on which the credit rating or rating outlook is based. The rated entity was subsequently provided with at least one full working day, to point out any factual errors, or to appeal the rating decision and deliver additional material information. Following that examination, the rating was not modified.

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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