Rating action

Scope Ratings affirms ADLER Real Estate AG’s (ADLER’s) issuer rating of BB and senior unsecured debt rating of BB+. The rating Outlook has changed to Positive.

Rating rationale

ADLER’s BB issuer rating remains unchanged as it continues to benefit from a supportive business risk profile. This is attributed to the company’s scale, which was achieved despite Germany’s fragmented, low-risk residential real estate industry, and its well-diversified portfolio in terms of geographies and tenants.

The rating is constrained by the addition of exposure to the higher-risk development and commercial real estate segments as well as by leverage which is still comparably high.

ADLER's 2017 credit metrics have improved in line with expectations

ADLER developed in line with Scope expectations for 2017 supported by the higher than expected like-for-like growth of rent amounting to 3.8% (1.5% in FY 2016), the disposal of its trading business subsidiary ACCENTRO and the successful restructuring of debt. The company’s credit metrics for 2017 are as follows:

• EBITDA interest cover up to 1.6x from 1.4x for FY 2016,
• Loan/value ratio down to 59% from 61% at YE 2016 and
• Scope-adjusted debt (SaD)/EBITDA up to 16.6x from 15.4x for FY 2016.

In early 2018 ADLER returned to a dynamic growth trajectory with the proposed acquisition of 70% + one share of the share capital of BCP. This followed a period with a more cautious strategy focussing on consolidation and the internalisation of property-related services which resulted in improving credit metrics. On 3 April ADLER settled the acquisition of BCP. The acquisition was financed by cash only and reflects a total purchase price of EUR 550m. The purchase is judged to be beneficial for the company’s business risk and financial risk profile.

Scope’s rating scenario assumes the following:

• The acquisition of 70% of shares in BCP
• The roll-over of BCP’s debt
• One-off integration costs of EUR 1m in 2018
• EUR 3m in synergies from 2019 on
• Like-for-like rental growth of 2.2% (2018) and 2.1% (2019)
• The disposal of ADLER’s non-core portfolio by YE 2019 at book value
• Disposals from BCP’s development pipeline with 100 units in 2018 and more than 300 units in 2019
• An increase in operational expenses by 2% per year
• Fair value gains of EUR 90m per year reflecting organic rental growth
• Capital expenditure of EUR 860m in 2018 including the BCP acquisition and EUR 360m in 2019
• No dividend distribution

Rating drivers

Credit-positive:

• Medium-sized German residential real estate company with good access to debt and capital markets. A significant improvement, based on YE 2017, in the company’s total assets (by EUR 1.6bn to around EUR 5.4bn incl. BCP) as well as funds from operations (by EUR 30m) and the number of apartments (up to 62,000) is likely to support further economies of scale.
   
• Enhanced granularity of the residential tenant base due to the addition of 12,000 residential units from BCP with an almost constant ‘top five city’ exposure of 32%. Scope believes that ADLER’s diversification in terms of both geography and tenants demonstrates its ability to partially offset cash flow volatility arising from economic cycles, industry dynamics, regulatory changes and a loss of single tenants.
   
• Increasing exposure to ‘A’ and ‘B’ locations with exposure to Berlin, Leipzig, Hanover, Dortmund, Bremen and Kiel rising to 29% from 19% as at YE 2017, also leading to improved occupancy rates of 92%, up from 91% in YE 2017 (including non-core portfolio). In addition, the company’s exposure to markets with at least stable demand going forward rose by 4 pp up to 74%. These factors allow a better assessment of the liquidity of the company’s property portfolio and the stability of tenant demand going forward, thus further limiting potential price haircuts or negative market value adjustments.
   
• The EBITDA margin is expected to increase to 45-50% for 2018. This forecasted margin upswing is based on: i) EUR 3m in property and asset management-related synergies (run-rate) following a successful acquisition at an expected cost of EUR 1m; ii) anticipated further economies of scale backed by the complementary footprint of the acquired portfolio and the finalised full internalisation of key operational functions; as well as iii) the higher profitability of the added retail portfolio.
   
• Improving debt protection expected to stabilise above 1.9x going forward as a consequence of the EBITDA contribution of the BCP acquisition as well as a further reduction in the weighted average costs of debt to an estimated 2.5% (ADLER: 2.7% I BCP: 2.0% both at YE 2017).

Credit-negative:

• Greater industry risk as a consequence of added exposure to the higher-risk development and commercial real estate segments (representing an estimated 21% and 25% of BCP’s gross asset value respectively).
   
• Introduction of a retail portfolio into the company’s business exposes ADLER to the ongoing transformation of the German retail landscape. This is, however, largely mitigated by the portfolio’s high occupancy rate of 97% and a weighted average unexpired lease term of around nine years.
   
• High pre-sale rate of 83% for developments under construction mitigates the risk associated with property development. The remainder of the development pipeline is expected to be added to ADLER’s balance sheet upon completion, thus further improving the company’s portfolio quality.
   
• Leverage is still comparably high with the loan/value ratio increasing to above 60% following the acquisition of BCP (YE 2017: 59%) and SaD/EBITDA rising to over 18x (YE 2017: 16.6x). Leverage is not expected to decline in 2018 given forecasted negative free operating cash flows as a result of the return to dynamic growth. However, we have a positive view of the management’s commitment to reducing the loan/value ratio to below 55%. A disposal of the acquired retail portfolio could potentially lower the company’s indebtedness and consequently its leverage as measured by its loan/value ratio.

Liquidity

Scope assesses ADLER’s liquidity as adequate despite its expectation that the all-cash acquisition of BCP will force free operating cash flows into negative territory and also result in a substantial increase in short-term debt from BCP’s balance sheet (EUR 183m). However, as the acquisition of BCP was fully debt financed using a bridge loan with a tenor of over one year, liquidity remains adequate at 1.6x. In detail:

            Position                                       Q4 2017

• Unrestricted cash                         EUR 465m
• Open committed credit lines        EUR 70m
• Free operating cash flow (t+1)     EUR 214m¹
• Short-term debt (t+1)                   EUR 478m²

Given the company’s current leverage with a loan/value ratio of 60%, its strong, well-established relationships with banks, and the recurring income producing nature of its operations, we believe that the refinancing of short-term debt should be possible in 2018. Furthermore, EUR 33m of BCP’s debt was already refinanced in Q1 2018 and advanced negotiations with regard to the refinancing of loans amounting to EUR 54m should be finalised by the end of Q2 2018 according to the company. In addition, ADLER also benefits from an unencumbered asset position of over EUR 1bn.

1) Excluding discretionary spending fully financed as at April 2018.
2) Excluding EUR 33m of BCP debt which has already been refinanced.

Outlook

The Outlook for ADLER is Positive and incorporates Scope’s expectation of the short-term improvement of the company’s business risk profile with a significant increase in size following the acquisition of BCP, leading to higher diversification and economies of scale with EBITDA margins forecasted around 50% for 2018. The Outlook also reflects Scope’s expectations of a mid-term improvement in the company’s financial risk profile, with EBITDA interest cover increasing to above 1.9x from 2018 on, and stable leverage as measured by a loan/value ratio forecasted at around 60% for 2018. However, Scope believes that ADLER is likely to reduce loan/value to below 55% in the next 12 to 18 months by taking measures such as the potential disposal of BCP’s retail portfolio which would strengthen ADLER’s focus on remaining a residential pure-play company.

Rating-change drivers

A negative rating action is possible if debt protection, as measured by EBITDA interest cover, decreased below 1.5x or if the company’s access to external financing weakened.

A positive rating action could be warranted by a further improvement in ADLER’s financial risk profile, i.e. if EBITDA interest cover were to remain above 1.9x and the loan/value ratio were to fall below 55%, both on a continuing basis.

Stress testing & cash flow analysis
No stress testing was performed. Scope produced its standard cash flow forecast for the company.

Methodology
The methodologies used for this rating and rating outlook (Corporate Rating Methodology; Rating Methodology: European Real Estate Corporates) are available on www.scoperatings.com.
Historical default rates of Scope Ratings can be viewed in the rating performance report on https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA Please also refer to 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 definition of default as well as definitions of rating notations can be found in Scope’s public credit rating methodologies on www.scoperatings.com.
The rating outlook indicates the most likely direction of the rating if the rating were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The rated entity and/or its agents participated in the rating process.
The following substantially material sources of information were used to prepare the credit rating: public domain, the rated entity, third parties and Scope internal sources.
Scope considers the quality of information available to Scope on the rated entity or instrument to be satisfactory. The information and data supporting Scope’s ratings originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the rating or outlook action, the rated entity was given the opportunity to review the rating and/or outlook and the principal grounds on which the credit rating and/or outlook is based. Following that review, the rating was not amended before being issued.

Regulatory disclosures
This credit rating and/or rating outlook is issued by Scope Ratings GmbH.
Lead analyst: Philipp Wass, Director
Person responsible for approval of the rating: Werner Stäblein, Executive Director
The ratings/outlooks were first released by Scope on 25.07.2016. The ratings/outlooks were last updated on 26.02.2018.

Potential conflicts
Please see www.scoperatings.com for a list of potential conflicts of interest related to the issuance of credit ratings.

Conditions of use / exclusion of liability
© 2018 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Analysis GmbH, Scope Investor Services GmbH and Scope Risk Solutions GmbH (collectively, Scope). All rights reserved. The information and data supporting Scope’s ratings, rating reports, rating opinions and related research and credit opinions originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data. Scope’s ratings, rating reports, rating opinions, or related research and credit opinions are provided ‘as is’ without any representation or warranty of any kind. In no circumstance shall Scope or its directors, officers, employees and other representatives be liable to any party for any direct, indirect, incidental or other damages, expenses of any kind, or losses arising from any use of Scope’s ratings, rating reports, rating opinions, related research or credit opinions. Ratings and other related credit opinions issued by Scope are, and have to be viewed by any party as, opinions on relative credit risk and not a statement of fact or recommendation to purchase, hold or sell securities. Past performance does not necessarily predict future results. Any report issued by Scope is not a prospectus or similar document related to a debt security or issuing entity. Scope issues credit ratings and related research and opinions with the understanding and expectation that parties using them will assess independently the suitability of each security for investment or transaction purposes. Scope’s credit ratings address relative credit risk, they do not address other risks such as market, liquidity, legal, or volatility. The information and data included herein is protected by copyright and other laws. To reproduce, transmit, transfer, disseminate, translate, resell, or store for subsequent use for any such purpose the information and data contained herein, contact Scope Ratings GmbH at Lennéstrasse 5 D-10785 Berlin.

Scope Ratings GmbH, Lennéstrasse 5, 10785 Berlin, District Court for Berlin (Charlottenburg) HRB 192993 B, Managing Director(s): Dr. Stefan Bund, Torsten Hinrichs.