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Rating action

Scope assigns a first-time issuer rating of B+ to Appeninn Holding Nyrt., a real estate company active in Hungary. The Outlook is Stable. Senior unsecured debt is rated BB-.

Rating rationale

Appeninn Holding is an exchange-traded Hungarian real estate company predominantly active in Budapest and focused on a buy-and-hold strategy regarding office and retail properties.

The B+ issuer rating on Appeninn benefits from i) a very high occupancy rate of 97% as at September 2019, reflecting tenant demand for its inner-city locations, ii) its exposure to the second-tier investment market of Budapest and iii) relatively high EBITDA margins of around 70%. The company’s debt protection has been strong and is forecasted to improve to above 3.0x, in addition to a moderate and decreasing leverage (loan/value ratio of 46% as at 2018), driven by a modest equity/cash flow-driven expansion.

Rating constraints include Appeninn’s small scale, which leads to greater sensitivity to unforeseen shocks and cash flow volatility, its weak geographical and tenant diversification, a very short weighted average unexpired lease term (WAULT) providing limited visibility, and insignificant market shares with a somewhat dated portfolio.

Scope’s rating scenario assumes the following:

• Execution of management’s strategy to clean up portfolio by selling EUR 11.5m non-core properties in 2019, factoring in a discount of 10% to market values
• Replacement of a further EUR 10m in non-core office stock with EUR 10m in prime office space; prime yields from Cushman&Wakefield used
• Acquisition of EUR 15m of retail exposure in Hungary/CEE in 2020 and EUR 5m of retail exposure in 2021
• 3.2% inflation rate for operational expenditures
• Unsecured bond issuance in Q4 2019 (EUR 60.6m, 2.6% fixed coupon) to replace all outstanding debt; no further secured debt issued
• Tax rate : 9% corporate tax; 2% business tax
• No dividends paid for 2018-22

Positive rating drivers

• Strong and improving debt protection (EBITDA interest coverage forecasted above 3.0x) and moderate and decreasing leverage in Scope’s base case scenario
• Very high occupancy rate as at September 2019 of 97% thanks to desirable inner-city locations
• Exposed to second-tier investment market with healthy demand from tenants
• Relatively high EBITDA margins of between 65% and 72%, but vulnerability due to constant reletting pressure

Negative rating drivers

• Relatively small property company (compared to Western peers), resulting in high sensitivity to unforeseen shocks and volatile cash flows
• Weak diversification in terms of geographies and high tenant concentration risks
• Very short WAULT at 2.2 years providing limited visibility in cash flows and a constant dependency on reletting with the associated high turnover costs
• Small market shares in an increasingly competitive environment in combination with somewhat dated properties are likely to result in declining rental income or increased capex spending

Liquidity

Scope considers liquidity to be adequate. In detail:

Position: YE 2018 I YE 2019E

Unrestricted cash: EUR 0.9m I EUR 7.7m
Open committed credit lines: EUR 0.0m I EUR 0.0m
Free operating cash flow (t+1): EUR 15.9m I EUR 33.4m
Short-term debt: EUR 7.8m I EUR 0.0m

Coverage: 2.2x I non-outstanding short-term debt

Liquidity is adequate, with unrestricted cash and free operating cash flow (excluding discretionary spending for acquisitions) exceeding short-term debt. Appeninn plans to refinance all of its outstanding debt with an unsecured 10-year bond in Q4 2019. This means there will be no short-term debt left at year-end 2019 or going forward.

Senior unsecured debt

Scope’s recovery analysis factors in Appeninn’s low WAULT, its somewhat aged portfolio and the non-prime characteristics of some of its properties, which would weigh on attainable advance rates in a distressed sale scenario. Given these parameters, the agency arrived at an ‘above average’ recovery at the hypothetical point of default, based on a high amount of unencumbered assets to outstanding debt, allowing for a one-notch uplift. This translates into a BB- rating for senior unsecured debt.

Recovery is based on a hypothetical default scenario occurring at year-end 2020, in which Scope assumes outstanding first-lien ranked debt (customer deposits) of EUR 1m and unsecured debt financing of EUR 60.6m.

In Q4 2019 Appeninn plans to issue a EUR 60.6m senior unsecured bond with a 2.6% coupon and a 10-year tenor. Scope’s rating scenario assumes that this bond is the only debt outstanding going forward – any changes to the company’s debt structure would be likely to impact the credit rating of the unsecured debt.

Outlook

The Outlook for Appeninn is Stable and incorporates: i) a successful portfolio clean-up with no significant discounts to current market values; ii) the successful placement of a HUF 20bn (EUR 60.6m) bond in Q4 2019 and the subsequent repayment of all currently outstanding interest-bearing debt; and iii) the execution of a moderate growth strategy in Hungary/CEE. Assuming an equity/cash flow-driven expansion going forward, the Stable Outlook foresees an EBITDA interest cover of above 3x and a loan-to-value (LTV) ratio of below 50%.

Rating-change drivers

A positive rating action would require a significant improvement in Appeninn’s business risk profile. This could be through a growth in size and a strengthening of market position, increased geographical and tenant diversification of the portfolio, and more cash flow visibility through longer WAULTs while sustaining the loan/value ratio below 50%.

A negative rating action would be possible in the event of an unsuccessful repositioning or a change in strategy, leading to a deterioration in leverage to above 60%, or if the bond asset ratio were to fall below 1.7x.

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

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 rating was not requested by the rated entity or its agents. The rated entity and/or its agents participated in the rating process. Scope had access to accounts, management and/or other relevant internal documents for the rated entity or related third party. The following substantially material sources of information were used to prepare the credit rating: public domain, the rated entity, the rated entities' agents, 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 Thomas Faeh, Executive Director
Person responsible for approval of the rating: Olaf Tölke, Managing Director
The ratings/outlooks were first released by Scope on 1 October 2019.

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. Scope Ratings GmbH, Lennéstraße 5, 10785 Berlin, District Court for Berlin (Charlottenburg) HRB 192993 B, Managing Directors: Torsten Hinrichs and Guillaume Jolivet.