The latest information on the rating, including rating reports and related methodologies are available on this LINK*.

Rating action

Scope Ratings has today affirmed its B+ issuer rating on EUROBODEN GmbH. Senior unsecured debt assigned at BB, EUR 25m bond (ISIN: DE000A2GSL68) rating has been affirmed at BB while the EUR 30m bond to be issued (ISIN: DE000A2YNXQ5) is rated (P)BB. The Outlook remains 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.

The BB ratings for EUROBODEN’s unsecured corporate bonds reflects Scope’s view that the recoupment of these 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:

• New debt always short-term except for the EUR 25.7m signed in H1 2018/19 or for drawings on existing loans
• Decrease in market prices of up to 7.50% by FY 2019/20
• Increase in material costs of up to 12.50% by FY 2019/20
• Rise in operational expenses of 1.50% per annum
• Increase in interest rate for new and floating debt by 50 bp per year (weighted average interest rate as at May 2019: 2.32%)
• Dividend payout of 20% of net profit or EUR 2m (the lower of the two)
• Capex/acquisition of new projects in FY 2018/19: EUR 38m I FY 2019/2020: EUR 32m

Positive rating drivers

• The lack of supply in EUROBODEN’s core markets of Munich and Berlin, as well as the stable German economy, are expected to support stable demand over the next few years. This should bolster EUROBODEN’s further top-line growth which is also backed by an expanding project pipeline of EUR 0.6bn (+25% YoY including already acquired projects with the transfer of property not executed as at August 2019).
   
• EUROBODEN has increased visibility in Berlin and Munich with around 330 and 120 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 at around 20%. However, Scope expects EUROBODEN’s ability to crystallise significant hidden reserves accumulated in the past to decrease as strong demand impacts its acquisition pipeline. Projects added more recently are expected to be less profitable in terms of net margins.
   
• EUROBODEN benefits from a moderate loan/value ratio (LTV) of 37% as at end-March 2019, which is expected to return to past levels of around 50% going forward with cash earnings from the disposal of two projects in Munich used to acquire new projects. Scope judges an LTV of 50% to be adequate for a developer of this size as it 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 (approx. 2.32%) give the company sufficient EBITDA interest cover. This is expected to remain substantially above 1.0x (last twelve months to end-March 2019 9.1x) going forward.

Negative rating drivers

• EUROBODEN is a small-sized company in a highly fragmented market. Small size leads to more volatile cash flows, a greater sensitivity to unforeseen shocks 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 550 apartments; and ii) limited geographical diversification focusing on Munich (64% of expected sales) and Berlin (21%). Scope believes that decent pre-sale ratios of 30% to 70% 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 0.6bn in August 2019 (+25% YoY) as well as the company’s ambition to diversify further by expanding its pipeline. 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 3.2m (+28% YoY), but not before FY 2021/22. Scope does not anticipate the share of recurring income to increase to an extent that it will cover recurring operational expenditure.
   
• 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 considers liquidity to be weak. In detail:

Position: YE 2018 I YE 2019E

Unrestricted cash: EUR 9.5m I EUR 10.3m
Open committed credit lines: EUR 15.0m I EUR 28.5m
Free operating cash flow (t+1): (EUR 20.2m) I (EUR 5.8m)
Short-term debt: EUR 40.9m I EUR 61.0m

Coverage: 0.1x I 0.5x

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. In detail: a forecasted EUR 61.0m of debt is due in 2019/20, not covered by a forecasted EUR 10.3m of cash available at end-September 2019 and EUR 28.5m in undrawn credit lines as at August 14, 2019. The company will therefore have to rely on external funding to redeem maturing debt. However, Scope believes EUROBODEN will be able to manage related refinancing risk. This is evidenced by EUROBODEN having managed to extend all short-term secured financing credit facilities well before maturity. Scope believes the company has moderate access to external financing and a broadening pool of lenders.

Senior unsecured debt

In November 2017, EUROBODEN issued a EUR 25m bond with a five-year tenor (ISIN DE000A2GSL68). In October 2019 EUROBODEN intends to issue a new, EUR 30m bond maturing in 2024 (ISIN: DE000A2YNXQ5). 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 2019/20 with a company liquidation value of EUR 165m. This value is based on a haircut of approx. 40% 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 approx. 26% for the assets and 10% for insolvency proceedings. This compares to secured financing of a forecasted EUR 93m as well as the unsecured EUR 55m bonds.

Outlook

The Outlook for EUROBODEN is Stable and incorporates further growth of the company’s top line (forecasted by Scope to reach EUR 100m by YE 2018/19) and its development portfolio without impairing credit metrics. Specifically, Scope anticipates an LTV remaining around 50% and EBITDA interest cover substantially above 1.0x as well as 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 approach 60% or if access to bank financing weakened.

*The link was added on 30 August 2019. It was not included in the initial publication from 15 August 2019.

Stress testing
No stress testing was performed.

Cash flow analysis
Scope performed its standard cash flow forecasting for the company.

Methodology
The methodologies used for this rating and/or 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 definitions of default and rating notations can be found at https://www.scoperatings.com/#governance-and-policies/rating-scale.
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, Executive 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 09.10.2018.

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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