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Rating action

Scope Ratings has assigned first-time issuer rating of A- to Vonovia S.E. and its financing subsidiary Vonovia Finance B.V. The senior unsecured debt rating is A-, the subordinated (hybrid) debt rating is BBB, and the short-term rating is S-1. The Outlook is Stable.

Rating rationale

Vonovia’s strong business risk profile is the key driver for the assigned rating. Vonovia is Europe’s largest residential real estate corporate with excellent access to capital and investment markets, a well-diversified portfolio spread across German, Austrian and Swedish metropolitan areas as well as high tenant diversification which, in turn, supports stable rental cash flows. Furthermore, economies of scale and high occupancy rates of over 97% across the company’s portfolio support relatively high and stable profitability. Vonovia’s financial risk profile benefits from its relatively low Scope-adjusted loan/value ratio and from its diversified debt structure and unencumbered asset position of 53% at end-September 2019, allowing the company to weather potential changes in the lending environment.

The rating is constrained by Vonovia’s leverage levels, as measured by its Scope-adjusted debt to Scope-adjusted EBITDA, which make it vulnerable to adverse market movements. The rating is also held back by Vonovia’s still-existing but weakening focus on the German market with associated regulatory risk, as well as its high expansion capex leading to negative free operating cash flows going forward.

Rating drivers

Credit positive

• Exposed to low-risk, regulated residential real estate industry, which decouples rental growth from consumer price index and GDP development
• Tier 1 real estate corporate – largest residential landlord in Europe with around 420,000 pro-forma (including Hembla AB) apartments in Germany (85%), Austria (6%) and Sweden (9%) valued at approximately EUR 50.3bn – leading to stable cash flows supported by good diversification and economies of scale
• Well-diversified portfolio spread across German, Austrian and Swedish metropolitan areas with positive demographics and a highly diversified tenant portfolio of average credit quality
• Portfolio locations and improving condition of properties, backed by substantial increase in investments since 2013 (EUR 1.4bn anticipated for FY 2019), have led to comparably high like-for-like rental growth of around 4% for the last three years as well as high and stable occupancy of above 97% supporting cash flow predictability
• Stable profitability with a Scope-adjusted EBITDA margin of 71% for the last twelve months to end-September 2019 in line with peers, driven by economies of scale and increasing like-for-like rental growth
• Strong debt protection with Scope-adjusted EBITDA interest expense cover of greater than 4x going forward (last twelve months to end-September 2019: 4.4x) backed by growing EBITDA, leveraging scaling effects and market-driven reduction of interest rates
• Relatively low Scope-adjusted loan/value ratio of 42% at end-September 2019 forecasted to remain below 50% even if market values drop significantly
• Excellent access to external financing, benefitting from highly diversified debt structure and financial headroom with unencumbered assets of 53% at end-September 2019

Credit negative

• Negative free operating cash flow since FY 2017 forecasted to remain below par in the next two years, driven by total capex (including spending on the investment programme and acquisitions) of an anticipated EUR 4.1bn in 2019 and another EUR 2.5bn in 2020, leaving Vonovia dependent on external financing. However, an estimated two-thirds of capex in 2020 is judged to be of a discretionary nature and could thus be withheld if necessary.
• Exposed to regulatory risk as predominately focused on Germany (84% of net rental income forecasted for end-December 2019), but intensified European roll-out has helped to reduce Vonovia’s dependence on German regulatory framework
• Weak SaD/EBITDA, which is forecasted to peak in 2019 at around 16x, but is expected to remain around 14x in the next few years

Liquidity

Vonovia’s liquidity is judged to be adequate. In detail (position: YE 2018 / 2019E):
Unrestricted cash: EUR 0.5bn / EUR 0.5bn
Open committed credit lines: EUR 1.1bn / EUR 1.1bn
Free operating cash flow (t+1)¹: EUR 1.6bn / EUR 0.6bn
Short-term debt²: EUR 2.0bn / EUR 2.1bn

Coverage: 1.6x / 1.0x

Scope believes that liquidity will remain adequate in the short to medium term with sufficient headroom provided by: i) a relatively high share of unencumbered assets (53% as at end-September 2019) in combination with Vonovia’s financial policy; as well as ii) excellent access to capital markets and good banking relationships with a variety of potential funding sources.

Outlook

The Outlook for Vonovia is Stable and incorporates Scope’s view that credit metrics will remain constant with a loan/value ratio at the lower end of the 40%-45% bandwidth and Scope-adjusted debt/EBITDA of around 14x. Scope expects Vonovia’s policy of financing total capex (investments and acquisitions) with 50% of equity on average to support these levels going forward. Furthermore, the agency acknowledges the increasing share of rental revenues generated outside of Germany, which is forecasted to reach over 15% by YE 2019 – following the successful execution of the Hembla AB acquisition in Q4 2019. Scope expects the share of non-domestic revenue to remain at around 15% going forward, as Vonovia is likely to continue the European roll-out started in 2018 and allocate a higher amount of capex to the Swedish portfolio from 2020 onward. Profitability, as measured by Vonovia’s Scope-adjusted EBITDA margin, should reach 75% by 2020.
Scope’s rating scenario assumes the following:

• Like-for-like growth of rents in 2020: 3.5%
• Privatisation units sold in line with book value in 2020
• Increase in value-add business EBITDA of 20% per year
• Inflation of operational expenditure at 1.5% for 2020
• Interest rate increase of 50 bp per annum for newly issued debt in 2020
• Fair value gains reflecting organic rental growth and no further yield compression
• 100% acquisition of shares in Hembla AB by YE 2019, without any P/L contribution for 2019
• Continuing investment programme with spending of EUR 1.4bn in 2019 and EUR 1.6bn in 2020
• Expansion capex (acquisitions) of EUR 2.7bn in 2019³  and EUR 0.9bn in 2010
• Dividend payments in 2020: 70% of 2019’s FFO
• 50% equity credit for EUR 1.0bn hybrid bond and related interest payments

Rating-change drivers

A negative rating action would be possible if Vonovia’s loan/value ratio increased to above 45% on a sustainable basis. This could be triggered by either i) a change in financial policy that allows for higher leverage, or ii) a significant drop in portfolio value following an adverse change in regulations governing the company’s core market of Germany.

A positive rating action is considered unlikely but could be warranted if Vonovia’s loan/value ratio were to decrease to below 40% and its Scope-adjusted debt to Scope-adjusted EBITDA were to fall to around 8x, both on a sustained basis. Vonovia could achieve this if it changes its capital allocation, lowering expansion capex and shareholder remuneration to focus on debt repayments.

1 Please note that Scope excludes discretionary expansion capex from its calculation of liquidity, as these investments will only be made if external financing is available. Thus, free operating cash flow for the purpose of liquidity only incorporates mandatory capital expenditure of EUR 0.8bn for modernisation, refurbishment and new developments in FY 2019. This is based on the assumption that an average of around 40% of capital expenditure is committed the year before or is already under construction. Free operating cash flow includes executed asset sales, namely the disposal of shares in Deutsche Wohnen S.E. in January 2019.

2 Scope also excludes the EUR 0.7bn hybrid bond from the company’s short-term debt position, as only the issuer benefitted from a call option in 2019 (executed as at April 2019).

3 EUR 0.45bn for the acquisition of 2,340 units by Viktoria Park in Q1 2019 and EUR 1.87bn for 100% acquisition of shares in Hembla AB; EUR 0.1bn squeeze-out Viktoria Park; remainder strategic acquisitions.

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(s) 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 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: Thomas Faeh, Executive Director
The ratings/outlooks were first released by Scope on 13 December 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.

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