The B issuer rating for EUROBODEN, a real estate developer with a focus on the high-quality segment, is supported by the company’s: i) ‘A’-located and highly liquid properties in its development portfolio; ii) positive growth prospects in its core markets of Munich and Berlin; iii) profound market knowledge; iv) high profitability compared with the industry average; and v) strong brand recognition that enables off-market deals.

The issuer rating is negatively affected by EUROBODEN’s position as a small niche player in high-quality residential property development and its volatile cash flows. The full exposure to the cyclical real estate market and dependence on external financing are also credit-negative. In addition, Scope believes key person risk still exists due to the contribution of the CEO, who is also the company’s owner and founder. However, EUROBODEN took measures, such as the appointment of a second managing director and the enlargement of the secondary management level to reduce operational dependence on the founder.

Scope understands that EUROBODEN is going to issue a new EUR 25m bond (2017/2022 ISIN/WKN: DE000A2GSL68/A2GSL6) in November 2017. According to the company, the proceeds from the bond issuance will be used to: i) refinance the EUR 15m bond maturing in July 2018 (2013/18 ISIN/WKN: DE000A1RE8B0/A1RE8B); ii) finance existing and new projects; and iii) repay existing bank debt. From Scope’s point of view, this bond issuance will not change the company’s indebtedness, with Scope adjusted debt (SaD) expected to be in line with previous forecasts.

Holders of the EUR 15m bond (2013/18 ISIN/WKN: DE000A1RE8B0/A1RE8B) have the option to participate in an offer to exchange their bonds for ‘new-bonds’ (2017/2022 ISIN/WKN: DE000A2GSL68/A2GSL6) at par (1:1) receiving a 2% premium.

Once the EUR 15m bond (2013/18 ISIN/WKN: DE000A1RE8B0/A1RE8B) has been successfully refinanced, the company is likely to benefit from a better liquidity position.

Business risk profile

Industry risk for EUROBODEN is assessed to be very high, as the company is exposed to the highly cyclical real estate industry. Its core activity consists of developing residential real estate. Scope’s short-term credit view for the industry is positive but accompanied by increasing sensitivity against changes in politics, economic conditions and interest rates.

With total assets of EUR 84m at end-March 2017 (EUR 162m incl. Scope adjusted hidden reserves of EUR 78m) and funds from operations (FFO) of EUR 4m for the year to March 2017, EUROBODEN is a small company, but exhibits strong growth in the highly fragmented market of German real estate developers. Size is expected to grow further in the next two years thanks to the larger project pipeline, which grew to EUR 450m as of September 2017 from EUR 302m at YE 2015. EURBODEN’s activities focus on niche, high-quality residential real estate development, a market characterised by elastic demand and generally volatile prices. The company’s limited size and market position also indicate a heightened sensitivity to unforeseen shocks and stronger volatility in cash flows, particularly as EUROBODEN is highly exposed to inherent cyclicality in the real estate market, with 84% of its revenues linked to development activity, which Scope judges as credit-negative.

EUROBODEN’s cash flow volatility is exacerbated by its concentrated pipeline of 11 development projects, the largest of which represents 26% of expected future turnover. This very modest diversification might affect future cash flows if projects suffer delays or cost overruns. However, Scope believes asset prices and demand in EUROBODEN’s core markets, Munich and Berlin, will keep growing after average prices in both markets rose by 75% from 2011. This trend looks set to continue, however at a slower pace (Deutscher Wohnimmobilienmarkt: Ende des Booms - aber kein Crash), owing to the lack of new apartments and the strong growth expected for both cities. These factors could strengthen the company’s business model in the coming years In addition, the development portfolio’s assets are situated predominately in the ‘A’-rated locations of Munich and Berlin. Scope believes this supports the fungibility and liquidity of its properties and lowers potential price haircuts in a distressed sales scenario.

EUROBODEN’s profitability has remained stable: EBITDA margin rose to 15% in 2016 from 9% in 2015. Scope believes this margin will generally remain above 10%, supported by the 20% EBITDA margin for the last 10 projects, along with the high-quality development pipeline. The company’s project-related EBITDA margin of 20% is higher than many of its peers’. Scope anticipates a stable project-related EBITDA margin of around 20%, which is supported by the firm’s profound market knowledge and brand recognition that enables off-market deals.

Financial risk profile

EUROBODEN’s EBITDA interest cover stood at a sufficient 3.4x for the last 12 months (LTM) up to end-March 2017. This is expected to remain above 1x. However, this ratio will fluctuate, depending on the on-time delivery and disposal of projects. If projects are delayed, EUROBODEN may have to rely on external financing to cover interest payments. Scope believes external financing is readily available, thanks to i) the committed, undrawn credit lines which can be drawn on without restrictions and ii) the hidden reserves, which allow the further step-up of existing credit lines.

The company’s cash flow generation was volatile, with negative free operating cash flow (FOCF) driven by the expansion of business over the last four years. Scope expects FOCF to continue to be negative at least for the next two years, owing to the expectation of further growth, as well as to the nature of real estate development, the company’s core activity. Thus cash in- and outflows are not necessarily matched during the lifetime of each project. Furthermore EUROBODEN suffers from its small size, which creates a ‘chunky’ project pipeline. The latter amplifies the volatility inherent to EUROBODEN’s business model.

At the end of March 2017, the company’s LTV stood at 40% (including Scope-adjusted hidden reserves of EUR 78m). As a consequence of the upscaling of the company’s indebtedness Scope-adjusted debt (SaD) increased by EUR 34m since end-September 2015 to EUR 65m, driven by the acquisition of new properties and the financing of the development of existing projects. Scope expects a further increase of SaD by another EUR 30m to 40m in the next 12 months to finance existing and new projects. However, LTV is projected to remain below 50% going forward, which is adequate for a developer of this size and leaves enough headroom for the company to increase leverage to cover construction costs. Scope does not believe that the company will be able to significantly reduce its leverage over the next few years.

The company’s SaD/EBITDA of 9x (end-March 2017) implies a level commensurate with a B financial risk profile. The ratio was and will continue to be volatile. However, Scope judges this volatility to be typical for a developer, with projects not looked at and financed in annual tranches but over the whole development period.

Liquidity

EUROBODEN’s liquidity – subject to substantial fluctuations in the past – is expected to stay below 100% for the next two years. Scope does not believe that the company will be able to repay the EUR 76m of debt due in the next 24 months only by using operational cash flow and available cash. In detail: EUR 45m of debt is due in 2017/18; this is not covered by the EUR 10m in cash available at end-September 2017 and the EUR 14m in undrawn credit lines. The company will therefore have to rely on external funding to redeem maturing debt. However, if EUROBODEN achieves operational success, with pre-sale rates above 50% – supported by the market environment – by delivering on time and on cost, as well as making disposals at targeted prices, the extension of credit facilities for project debt should be possible as and EUROBODEN will be able to manage related refinancing risk. This is demonstrated by the company’s ability to either refinance or repay almost 100% (EUR 12m) of debt due in 2016/17 by 31 March 2017 and also to gain bank agreement by 2 October 2017 to the refinancing of EUR 20m of debt due in 2017/18 including additional credit lines worth EUR 25m.

Consequently, refinancing related to EUROBODEN’s corporate bond (2013/18 I EUR 12m drawn as at 30/09/2017) is likely and only partly dependent on the successful placement of the new bond to be issued in November 2017. Once the (2013/18) bond has been successfully refinanced, the company is likely to benefit from an enhanced liquidity position.

Bond 2013/18 – 7.375% I ISIN DE000A1RE8B0

As the bond is unsecured, its credit quality is tightly linked with EUROBODEN’s credit quality and performance. However, as EUROBODEN has disclosed hidden reserves, and has a development portfolio with very well-located assets, Scope believes the bond’s potential recovery is well above market average, lifting the bond’s rating two notches above the issuer rating.

Bond 2017/22 – 6.000% I ISIN DE000A2GSL68

The preliminary BB- rating on the ‘new bond’ is based on the assumption of a full placement of EUR 25m of new bonds (2017/2022 ISIN/WKN: DE000A2GSL68/A2GSL6) by end-November 2017 and a full repayment of the EUR 15m bond (2013/18 ISIN/WKN: DE000A1RE8B0/A1RE8B) by end-January 2018.

As the bond is unsecured, its credit quality is closely linked to EUROBODEN’s credit quality and performance. However, as EUROBODEN has disclosed hidden reserves of EUR 78m as at end-September 2017, and has a development portfolio with very well-located assets, Scope believes the bond’s potential recovery is well above market average, lifting the bond’s rating two notches above the issuer rating.

Outlook

The rating Outlook is Positive, supported by EUROBODEN’s high-quality development pipeline in the still-booming core markets of Munich and Berlin. The Positive Outlook incorporates Scope’s expectation that the EBITDA interest cover remains sustainably above 1.0x, that project-related profitability will remain at EBITDA margins of between 15% and 20%, that the EUR 450m project pipeline will be successfully executed in the next few years and that the repayment of the EUR 15m bond (2013/18 ISIN/WKN: DE000A1RE8B0/A1RE8B) due in July 2018 is likely.

A negative rating action is possible if the company’s LTV exceeded 60%, if EBITDA interest cover did not remain substantially above 1.0x on a sustained basis, or if the company’s access to bank financing weakened.

Scope could consider a positive rating action if EUROBODEN managed to maintain its LTV below 50% and if its unsecured debt is refinanced in 2018.

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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: Werner Stäblein, Committee Chair

Rating history - EUROBODEN GmbH
(Date | Rating action | Rating)
29 May 2017 I Affirmation I B I Stable
27 May 2016 I Affirmation I B I Stable
28 May 2015 I Initial Rating I B I Stable

Rating history - EUROBODEN GmbH - Bond 2013/18 – 7.375% (ISIN DE000A1RE8B0)
(Date | Rating action | Rating)
29 May 2017 I Affirmation I BB- I Stable
27 May 2016 I Affirmation I BB- I Stable
28 May 2015 I Initial Rating I BB- 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.

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. The issuer has participated in the rating process.
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
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• Annual financial statements
• Annual reports/semi-annual reports of the rated entity
• Information provided on request
• Data provided by external data providers
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• 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 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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