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Rating action

Scope Ratings affirms its B+ issuer rating of FCR Immobilien AG (FCR). The Outlook is Stable. Secured debt consisting of two bonds (ISIN: DE000A2BPUC4 and DE000A2G9G64) is affirmed at BB-. Scope assigns a BB- rating to the new secured bond issued (ISIN: DE000A2TSB16). The ratings for the following bonds (ISIN: DE000A1YC5F0 and DE000A12TW80) have been withdrawn given their full repayment as at end-April 2019 and end-June 2019.

Rating rationale

Positive rating drivers include the company’s geographically well diversified property portfolio within regions that are expected to have stable tenant demand, leading to predictable recurring income from those tenants with moderate credit quality. Successful trading activity with total sales of EUR 44m in 2018 and 2019 YTD (representing a 55% premium on the corresponding book value) has helped keep debt protection sufficiently high.

The rating is constrained, however, by the company’s small size which results in a lack of economies of scale. Furthermore, Scope has a negative view of both FCR’s dependence on its trading activities to secure sufficient coverage of operational and financial expenses, and of its low-quality assets which could lead to substantial price haircuts in a distressed sales scenario. Scope also views negatively FCR’s weakening access to external financing, especially debt and equity capital markets. This drove leverage up earlier than expected with the company’s loan/value ratio increasing to above 60% as at YE 2018.

The bonds benefit from a pledge on investment properties at a value representing the bonds’ outstanding nominal and the interest payable up to the bonds’ maturity. Scope expects an ‘above average’ recovery. The security therefore improves credit risk for the bonds over that of the issuer.

Scope’s rating scenario assumes the following:

• Like-for-like growth of rents incl. vacancy reduction of 1.6% per annum
   
• Disposals of properties for EUR 67.5m in the period to YE 2020 at a premium of 25% above their current book value. Associated loss in rental income of around EUR 2m per annum
   
• Expansion capex of EUR 70m for 2019 and 2020 at 6.5% initial yield on net rental income
   
• Inflation of costs at 1.5% in 2019 and 2020
   
• Interest rate for newly issued and floating debt to increase by 50 bp based on current weighted average cost of debt
   
• Dividend representing EUR 0.35 per share for 2018 (payable in 2019) and 50% of German GAAP result for 2019 (payable in 2020)

Rating drivers

Credit positive

• Good geographical diversification with assets spread across Germany (84% of net rental income as at YE 2018) and some exposure to Italy (5%), Austria (1%) and one residential development in Spain allowing the company to partially benefit from different demand patterns, thus stabilising rental cash flows.
   
• Relatively stable rental cash flows are further supported by largely robust tenant demand as FCR’s investments in retail parks and local amenities centres benefit from limited competition with strict rules for zoning and planning. This ensures that existing food retail locations will remain viable in the medium term.
   
• The aforementioned is evidenced by almost stable occupancy that stood at 84% as at end-December 2018, improving the weighted average unexpired lease term that stood at 5.3 years, representing a strong 1.7 year increase compared to YE 2017. Both provide good visibility on the company’s future cash flow generation from recurring rental income.
   
• The moderate credit quality of tenants representing 25% of rental income partially mitigates relatively high tenant concentration (the top three account for 36% of rental income) and moderate tenant industry diversification with cyclical exposure (21%). However, 30% of rental income as at YE 2018 stems from discounters (21% of which J.A.Woll-Handels mbH) which tend to be more cyclical and thus more prone to defaults than other sales formats.
   
• Successful trading activity with total sales of EUR 44m in 2018 and 2019 YTD (representing a 55% premium on the corresponding book value under German GAAP) help to keep debt protection sufficiently high at 2.4x in YE 2018. However, EBITDA interest cover is heavily dependent on asset disposals as the company has a recurring EBITDA interest cover of around 1x.

Credit negative

• Still small company with total assets of around EUR 250m (+59% YoY) according to the issuer and funds from operations of EUR 6m (+100%) for YE 2018. The company’s size limits access to capital markets, in Scope’s view. However, ambitious growth plans with net expansion capex of EUR 375m up to 2020 should help to support visibility to tenants and investors once successfully executed. At the same time, aggressive growth leads to persistently negative free operating cash flow and dependence on external financing. Scope considers the latter to have weakened, as demonstrated by limited success in issuing capital market debt and especially capital market equity. The new EUR 30m 2019/24 bond had an issuance volume of only two-thirds of the targeted amount four months after its placement and only one-third of the capital increase was subscribed to within the initial subscription period in Q1 2019.
   
• The unbalanced financing of the company’s aggressive growth took its toll on leverage earlier than expected with the loan/value ratio increasing to above 60% by YE 2018. Scope believes that FCR will not be able to significantly reduce leverage in the coming months, with aggressive growth being pursued using available financing. The rating agency expects FCR to continuously benefit from its ability to crystallise hidden reserves for properties acquired, either through fair value uplifts (+30% for executed acquisitions in 2019) or disposals (+55% for properties sold in FY 2018), allowing it to keep leverage between 60% and 70%.
   
• Relatively weak asset quality as the portfolio suffers from a high economic age of about 30 years resulting in fairly low attractivity to tenants and high capex needs. In addition, the asset portfolio is predominately in illiquid ‘D’ locations, which might lead to a drop in properties’ fair values when the current cycle ends.
   
• Volatile and comparatively low EBITDA margin as a result of business model with high associated operating expenses and limited economies of scale.

Liquidity

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

Unrestricted cash and equivalents: EUR 3m I EUR 2m
Open committed credit lines: EUR 0m I EUR 0m
Free operating cash flow (t+1)*: EUR 13m I EUR 7m
Short-term debt: EUR 8m I EUR 6m

Coverage: 2.0x I 1.4x

*Free operating cash flow excl. net discretionary expansion capex of EUR 49m for 2019 and EUR 37m for 2020. Free operating cash flow incl. net proceeds from executed asset sales of EUR 11m in 2019

Secured debt

As at end-August 2019 FCR had EUR 59m in secured bond debt outstanding. All bonds benefit from a pledge on investment properties at a value representing the bonds’ outstanding nominal and interest payable up to the bonds’ maturity. This could positively impact recovery rates in a default scenario. According to Scope’s methodology and reasonable discounts on the company’s asset base (as described below), the rating agency expects an ‘above average recovery’ for all bonds issued. This warrants a one-notch uplift on the company’s issuer rating of B+.

Recovery is based on a hypothetical default scenario in FY 2020 with the company’s liquidation value amounting to EUR 214m. This value is based on a 36% haircut applied to FCR’s assets, incorporating market value declines commensurate with a ‘BB’ rating case as well as liquidation costs of approx. 26% for assets and 10% for insolvency proceedings. This compares to secured bank financing of a forecasted EUR 173m (first rank) and EUR 70m in secured bonds.

Outlook

The Outlook for FCR is Stable and incorporates Scope’s expectation that leverage, as measured by FCR’s loan/value ratio, will remain between 60% and 70% (2018P: 63%) within the coming years. Scope also incorporates more stable debt protection of around 1.7x supported by a growing portfolio of income-producing properties, further successful disposal activity and ongoing adequate liquidity.

Rating-change drivers

A negative rating action would be possible if EBITDA interest expense were to fall below 1.7x on a sustained basis or loan/value ratio reaches 70% or if access to external finance weakened.

A positive rating action could be warranted if EBITDA interest expense cover were to increase to over 1.7x on a sustainable basis predominately supported by recurring EBITDA, while leverage as measured by the company’s loan/value ratio decreased to around 50%.

Stress testing & Cash flow analysis
No stress testing was performed and 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 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: Werner Stäblein, Executive Director
The ratings/outlooks were first released by Scope on 17.05.2018.

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
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