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Rating action

Scope Ratings affirms ADLER Real Estate AG’s issuer rating of BB and senior unsecured debt rating of BB+. The rating Outlook remains Positive.

Rating rationale

ADLER’s BB issuer rating remains unchanged because it continues to benefit from a supportive business risk profile. This is based on the company’s scale (achieved despite Germany’s fragmented residential real estate industry, that entails low risk), its well-diversified portfolio in terms of geographies and tenants, its improving asset quality and its sufficiently high debt protection.

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

Scope’s rating scenario assumes the following:

• Like-for-like growth at the upper end of a 2.5%-3.0% range per annum
• Occupancy to reach 95% by YE 2020
• Disposal of the remaining retail portfolio in 2019 for EUR 300m-EUR 325m
• Inflation of costs at 1.5% in 2019 and 2020
• Interest rate for newly issued debt to increase by 50 bp based on current weighted average cost of debt from 2020 on
• Repayment of all three Brack Capital Properties N.V. (BCP) debentures and the 2015/20 EUR 300m bond in Q2 2019
• Growth rate of portfolio’s fair values in line with rental growth
• No dividend payments with exception for minority shareholders

Rating drivers

Credit positive

• ADLER has around 61,000 residential units (EUR 5.8bn of assets as at end-December 2018) spread across the middle and northern parts of Germany and an almost constant ‘top five city’ exposure of 33%. This affords the company a decent diversification of geographies and tenants, which Scope believes enhances its ability to offset cash flow volatility arising from economic cycles, industry dynamics, regulatory changes, and the loss of individual tenants. The size the company has achieved also provides good access to debt and capital markets, with EUR 2.0bn of debt issuances in the last two years.
   
• In Scope’s view, ADLER benefits from its exposure to the German residential real estate market, which has low cyclicality and stable tenant demand. With the addition of BCP’s portfolio in April 2018, ADLER enlarged its presence in regions with at least stable demand to 75%. This expansion allows the company to benefit from relatively strong like-for-like growth in rental income (3.4% as at YE 2018) and increasing occupancy rates (94% as at YE 2018). With the completion of its largest development scheme ‘Wasserstadt Mitte’ in Berlin, ADLER will be able to improve the share of its portfolio in sought-after regions (regions with population growth of above 7.5% up to 2025) to 17% by rental income, up from 11% as at YE 2018. Together with the committed increase in investments in its portfolio (EUR 40m to EUR 50m of additional capex), Scope expects this to lead to a further improvement in the company’s asset quality, with vacancy falling to around 5% by YE 2020 and like-for-like growth of rents in line with German peers.
   
• ADLER has demonstrated its ability to improve profitability up to a Scope-adjusted EBITDA margin of above 60% for the FY 2018, from below 50% in 2017. Profitability was supported by economies of scale with ADLER becoming a fully integrated residential real estate corporate. The addition of BCP’s retail portfolio following the acquisition also increased profitability. Scope expects this to fade over the course of this year as a consequence of the expected disposal in 2019. Consequently Scope forecasts profitability around 60%.
   
• Debt protection, as measured by EBITDA interest cover, improved to a moderate 2.4x at end-December 2018, from below 1.6x the year before. This was due mainly to the redemption of high-yielding liabilities (EUR 200m of the 2015/20 bond; coupon: 4.75%) financed by the issuance of EUR 800m in capital market debt in April 2018 as well as the inclusion of BCP’s comparatively low-yielding debt in Q2 2018. Debt protection should remain at around 2.0x going forward. This is backed by relatively stable EBITDA from ADLER’s letting business as well as a further restructuring of the company’s liability side, aimed at reducing the weighted average cost of debt, which stood at 2.0% in April 2019.

Credit negative

• The company’s exposure to the higher-risk retail business (6.5% of gross asset value as at end-March) and to development (14%) weigh negatively on its industry risk. Its retail business suffers from a very concentrated tenancy structure as well as the ongoing transformation of the German retail landscape. However, both are largely mitigated by: i) tenants’ reasonably strong credit quality; ii) a relatively long weighted average unexpired lease duration of 8.5 years; and iii) a 97% occupancy rate (all as at end-December 2018). Scope judges the company’s exposure to the development segment as significant, with a development pipeline of EUR 1.7bn to be completed up to 2025/26 (5,100 units). Nevertheless, Scope believes that execution risk is manageable with one large-scale project almost finalised and due to be delivered in 2019 (‘Wasserstadt Mitte’). Most of ADLER’s remaining projects are located in ‘A’ cities, ensuring high liquidity and the benefits afforded by the ongoing supply-demand imbalance in these areas.
   
• The partially debt financed acquisition of BCP in 2018 led to a steep increase in the company’s indebtedness. Consequently, ADLER’s loan/value ratio stood at 64% at YE 2018, which was 3 pp above Scope’s expectations as at April 2018 (61%). Nonetheless, Scope views positively management’s commitment to reducing loan/value to a sustainable level of below 55%, underpinned by a further EUR 107m reduction in interest-bearing liabilities in the first three months of 2019 using exit proceeds from the sale of parts of its retail portfolio. Further deleveraging is expected to be supported by the disposal of the remaining retail portfolio (gross asset value of EUR 300m) in 2019 together with stable operating performance. However, deleveraging will not occur as fast as Scope expected in April 2018 which leaves the company exposed to unfavourable changes with regard to liquidity on capital markets and/or interest rates. However, Scope does not expect either of these possibilities to materialise in 2019.

Liquidity

ADLER’s liquidity is judged to be adequate. In detail (position: YE 2018 I 2019E):

Unrestricted cash: EUR 78m I EUR 449m
Open committed credit lines: EUR 0m I EUR 0m
Free operating cash flow (t+1): EUR 588m I EUR -21m
Short-term debt: EUR 184m I EUR 135m

Coverage: 3.6x I 3.2x

Debt due in 2019 is expected to be comfortably covered by the company’s internal liquidity with EUR 310m of secured cash inflows from disposals of the non-core portfolio and parts of the retail portfolio. Furthermore, ADLER largely addressed its refinancing in 2020 (EUR 435m) with a bond issuance of EUR 400m in April 2019. Scope believes that ADLER has good access to capital markets, given the company’s current leverage with a loan/value ratio of 60% (including debt reduction from asset sales in December 2018 and March 2019), its strong, well-established relationships with banks and the recurring income producing nature of its operations. Scope further believes that the refinancing of the EUR 1.2bn of debt maturing in 2021 should be a manageable risk, because ADLER benefits from an unencumbered asset position of approx. EUR 1.3bn, providing headroom of around EUR 0.9bn under financial covenants to source secured funding.

Senior unsecured debt

Scope’s recovery analysis signals an ‘above average recovery’ which translates into instrument ratings of BB+. Recovery is based on a hypothetical default scenario in FY 2020 with the company’s liquidation value amounting to EUR 3.2bn. This value is based on a 34% haircut applied to ADLER’s assets, reflecting a market value decline of one standard deviation of the German property price index as well as liquidation costs of approx. 26% for assets and 10% for insolvency proceedings. This compares to secured financing of a forecasted EUR 1.7bn as well as an unsecured EUR 2.1bn in bonds.
Scope does not rate the debentures issued by BCP (EUR 116m) because they are not irrevocably guaranteed by ADLER. The company has announced that it will use the proceeds of the EUR 400m bond issuance in April 2019, which are in excess of the EUR 300m needed to repay the 2015/2020 bond (XS1211417362), to repay BCP’s debentures. Scope therefore believes that these debt instruments will be repaid in Q2 2019. Change of Control covenants for BCP’s debentures have been waived after the acquisition by ADLER in April 2018.

Outlook

The Outlook for ADLER is Positive and incorporates Scope’s expectation that the company’s business risk profile will continue to improve, benefitting from the further upscaling of asset quality, measured by higher occupancy, like-for-like growth of rents above inflation rates and the addition of assets (‘Wasserstadt Mitte’) in strong locations. ADLER’s business risk profile will also benefit from improving profitability, with EBITDA margins forecasted around 60%. The Outlook further reflects Scope’s expectation that ADLER’s financial risk profile will improve. Scope anticipates that EBITDA interest cover will stay above 1.9x, and that leverage as measured by the company's loan/value will decline to around 55% within the next 12-18 months.

Rating-change drivers

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

A positive rating action could be warranted by an 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 performed its standard cash flow forecasting 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 the entities rated by 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: Olaf Tölke, Managing Director
The ratings/outlooks were first released by Scope on 25.07.2016. The ratings/outlooks were last updated on 12.04.2018.

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
© 2019 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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