Rating action

Scope Ratings upgrades its issuer rating on EUROBODEN GmbH to B+ from B. Senior unsecured debt, consisting of one bond (ISIN: DE000A2GSL68) is upgraded to BB from BB-. The Outlook is Stable.

Rating rationale

The B+ issuer rating on EUROBODEN, a real estate developer with a focus on the high-quality segment, is supported by the company’s: i) ‘A’ location, highly liquid properties; ii) good 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 allowing it to make off-market deals.

The issuer rating is negatively affected by EUROBODEN’s position as a small niche player in high-quality residential property development as well as its volatile cash flows. 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 managing directors, both of which are the company’s owners. However, EUROBODEN has taken measures, such as the enlargement of the secondary management level, to reduce operational dependence on these two individuals.

The BB rating for EUROBODEN’s unsecured corporate bond reflects Scope’s view that the recoupment of this investment is highly probable, thanks to the company’s disclosure of hidden reserves and the excellent locations of the properties in its development portfolio.

Scope’s rating scenario assumes the following:

• Decrease in market prices of up to 10.0% by FY 2019/20
• Increase in material costs of up to 12.5% by FY 2019/20
• Increase in operational expenses of 2% per annum
• Drawdown of new debt always with a weighted average tenor of 18 months
• Interest rate for new and floating debt to increase by 50 bp per year
• Dividend payout of the lower of the following: 20% of net profit or EUR 2m
• Capex in 2017/18: EUR 2m I 2018/19: EUR 16m I 2019/2020: EUR 55m

Rating drivers

Credit positive

• The lack of supply in EUROBODEN’s core markets of Munich and Berlin, as well as the strong German economy, are expected to support stable demand over the next few years. This should bolster EUROBODEN’s further topline growth which is also backed by an expanding project pipeline of EUR 480m (+7% YoY August 2018).
• EUROBODEN has increased visibility in Berlin and Munich with c. 200 and 130 apartments in its project pipeline in each city respectively. Together with EUROBODEN’s excellent market knowledge and improved brand awareness, this enhanced visibility should benefit the company’s standing in both markets, further heightening its ability to sign off-market deals.
• Scope believes that EUROBODEN’s ‘A’ located development portfolio supports its price stability and fungibility, thus reducing potential price haircuts in a distressed sales scenario. It also allows EUROBODEN to benefit from project-related profitability above that of peers with net profit margins forecasted to be around 20%.
• EUROBODEN benefits from a moderate loan/value ratio (LTV) of below 50% (end-March 2018: 48%), which is expected to remain at this level going forward. The adequate leverage for a developer of this size provides the company with some headroom to: i) cover construction costs by increasing indebtedness; or ii) buffer moderate market value declines in its portfolio. The adequate leverage, also expressed by fairly stable Scope-adjusted debt (SaD)/EBITDA of between 10x to 12x, plus the relatively low weighted average cost of debt (c. 3.00%) equip the company with sufficient EBITDA interest cover which is expected to remain substantially above 1.0x (last twelve months to end-March 2018 1.5x) going forward.

Credit negative

• EUROBODEN is a small-sized company in a highly fragmented market. Small size leads to more volatile cash flows and limited economies of scale. In addition, the company’s focus on the niche market of high-quality, high-price residential real estate in Munich keeps EUROBODEN exposed to more elastic demand and potential margin deterioration.
• As a result of the company’s size, EUROBODEN still suffers from: i) a concentrated development pipeline of 15 projects with around 350 apartments; and ii) limited geographical diversification focusing on Munich (74% of expected sales) and Berlin (19%). Scope believes that decent pre-sale ratios of 15% to 60% for projects currently under development, as well as invoicing according to the German real estate agent and commercial construction regulation (MaBV), partially mitigate the risk of a shortfall in liquidity posed by high working capital allocation to these projects. Furthermore, Scope acknowledges the steady increase in EUROBODEN’s development pipeline which stood at EUR 480m in August 2018 (+7% YoY) as well as the company’s ambition to diversify further by expanding its pipeline. The latter is demonstrated by a significant rise in the number of employees responsible for acquisitions. However, continuous growth anticipated going forward will keep free operating cash flows in negative territory. As a consequence, EUROBODEN will remain dependent on the availability of external financing.
• Scope views negatively EUROBODEN’s full exposure to the cyclicality of the real estate market with almost all sources of revenue directly linked to the company’s development activity. With the portfolio additions in Kitzbühel and Aschheim (close to Munich), which are either income producing or will be build-to-hold, Scope expects recurring income to grow to around EUR 2.5m, but not before FY 2022/23.
• Key-person risk remains, associated with the managing directors holding 100% of EUROBODEN’s shares. However, EUROBODEN has taken measures, such as the enlargement of its secondary management level, to reduce operational dependence on both of these individuals.

Liquidity

Scope believes that EUROBODEN’s liquidity is weak but improving. In detail:

            Position                                  FY 2017/18E

• Unrestricted cash                        EUR 32m
• Open committed credit lines        EUR 19m
• Free operating cash flow (t+1)    EUR 26m
• Short-term debt (t+1)                   EUR 85m

           Coverage 0.9x

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 debt due in the next 13 months using free operating cash flow and available cash. A forecasted EUR 85m of debt is due in 2018/19, which is not covered by a forecasted EUR 32m in cash available at end-September 2018 and EUR 19m of undrawn credit lines (since August 31st an additional EUR 7m are available). The company will therefore have to rely on external funding to redeem maturing debt. However, if EUROBODEN achieves operational success, by attaining pre-sale rates above 50% – supported by the market environment – and by delivering on time and on cost, as well as by making disposals at targeted prices, the extension of credit facilities for project debt should be possible and the company will be able to manage related refinancing risk. This is evidenced by EUROBODEN’s ability to refinance almost 100% its EUR 15m (2013/18) bond eight months before its maturity in July 2018. In addition, EUROBODEN managed to extend secured financing at least one year prior to maturity. With a broadening pool of lenders, Scope believes the company enjoys moderate access to external financing.

Senior unsecured debt

In November 2017 EUROBODEN issued a EUR 25m bond with a five-year tenor (ISIN DE000A2GSL68). Scope’s recovery analysis indicates an ‘excellent recovery’ which translates into an instrument rating of BB. Recovery is based on a hypothetical default scenario in FY 2018/19 including a 34% haircut applied to EUROBODEN’s assets, reflecting a market value decline representing one standard deviation in the German property price index as well as liquidation costs of c. 26% for the assets and 10% for insolvency proceedings.

Outlook

The Outlook for EUROBODEN is Stable and incorporates a further but more muted growth of the company’s topline and development portfolio without impairing its credit metrics. Specifically, Scope anticipates an LTV remaining around 50%and ongoing adequate access to capital markets and bank debt to finance short-term debt positions.

Rating-change drivers

A positive action would require the company to grow significantly in size, as measured by its development pipeline, leading to greater diversification and more stable cash flows, while leverage as measured by the company’s LTV would have to decrease to below 40% on a sustained basis. Both of these possibilities are judged to be remote at present. A negative rating action is possible if the company’s LTV were to exceed substantially 50%, or if the company’s access to bank financing weakened.

To access the rating report, click here.

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

Methodology
The methodologies used for this rating and rating outlook (Corporate Rating Methodology 2018; Rating Methodology: European Real Estate Corporates 2018) 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/cerepweb/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: Olaf Tölke, Managing Director
The ratings/outlooks were first released by Scope on 28.05.2015. The ratings/outlooks were last updated on 06.10.2017.

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.

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