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Rating action

Scope Ratings has today affirmed the BB+/Stable issuer rating for Deutsche Konsum REIT-AG. Senior secured debt rating for the EUR 40m bond (ISIN: DE000A2G8WQ9) affirmed at BBB and the senior unsecured debt rating affirmed at BBB-.

Rating rationale

The affirmation of the ratings is driven by the further successful growth of the issuer’s real estate portfolio during the last 12 months. As at 14 February 2020, the portfolio now holds 166 properties (pro-forma basis, up by 57 properties) with 904,100 sq m of gross leasable area (+46% YoY) and an annualised rental income of EUR 64.4m (+53% YoY). Acquisitions have focused on further exposures to the non-cyclical food retail and DIY (do-it -yourself) segments, with top portfolio tenants including Edeka Group (+55% in annualised rental income since February 2019), the Schwarz-Group (+68%) and Hellweg Group. Strong growth has improved DKR’s position as a landlord of major tenants in Germany (e.g. 71 lease contracts with Edeka Group). DKR also recently established a significant foothold in the economically strong region of Bavaria (estimated 6% of pro-forma gross leasable area) with the acquisition of 26 grocery stores, which should help to further stabilise rental cash flows.

However, DKR’s increased size has not improved cash flow diversification materially, with the top three tenants still contributing a high 39% (-4pp YoY) of annualised rent. This is unlikely to change significantly going forward, with the company expected to maintain an exposure to defensive, consolidated retail end-markets (food-retail and do-it-yourself), with 72% of pro-forma annualised rent being non-cyclical. The portfolio additions also did not change asset quality, with stable levels of the weighted average unexpired lease term (pro-forma: 5.3 years) and the occupancy rate (pro-forma: 90%). However, Scope expects DKR’s increased size to benefit occupancy rates going forward via a reduction in the share of non-stabilised assets. The higher occupancy is also forecasted to drive future, medium-term profitability, with Scope-adjusted EBITDA margin to pass 70%, as indicated by the improved EPRA cost ratio, which decreased by 2pp to 26.4% as at end-September 2019.

The strong portfolio growth was also executed without impairing credit metrics. This was evidenced by the stable loan/value ratio of 49% (+/-0 pp YoY) and improved EBITDA interest cover of 7x for the last 12 months to end-December 2019 (+1x YoY). Stable leverage benefitted from EUR 31m in equity issuances (September 2019) as well as fair value gains of EUR 31m for the 2018/19 financial year. Property acquisitions yet to be transferred (EUR 139m) will be financed by available cash and equivalents of EUR 45m and underwritten bank loans of EUR 116m, both as at February 2020. To keep leverage stable, DKR plans to increase its capital after the next annual general meeting in March 2020 using authorised capital. This capital increase is likely to be approved as the EUR 16m increase announced in January 2020 was fully subscribed but was not carried out only because of a documentation error (lock-up period for the previous bookrunner). 

Liquidity

DKR’s liquidity is judged to be adequate. In detail (2018/19):

Unrestricted cash: EUR 25.6m
Open committed credit lines: EUR 0.0m
Free operating cash flow (t+1): EUR 10.9m
Short-term debt: EUR 11.5m
Coverage: 3.2x

Outlook and rating-change drivers

The Outlook for DKR is Stable and incorporates Scope’s expectation that DKR’s asset base will grow, via around EUR 220m in expansion capex for FY 2019/20, leading to annualised rental income of around EUR 70m by end-September 2020. Scope anticipates further expansion to be financed with equal amounts of debt and equity, keeping the loan/value ratio below 55%, while debt protection, as measured by EBITDA interest cover, is expected to remain above 4x.

A negative rating action is possible if the loan/value ratio reaches above 55% on a continued basis, leading to DKR losing its tax-exempt REIT status. This could happen if property prices drop and DKR cannot address the increased leverage via asset disposals or equity issuances, resulting in a weakened ability and willingness of the main shareholder to support capital increases either actively or passively.

A positive action would require a significant growth in total assets and gross leasable area, leading to greater diversification by geographies and tenants.

Long-term and short-term debt instrument ratings

Senior secured debt

DKR issued a EUR 40.0m bond in May 2018 with a six-year term (2018/24) and a coupon of 1.80% (ISIN: DE000A2G8WQ9). The bond benefits from a first-ranking mortgage on 15 properties, which were valued at EUR 85.4m as at September 2019. The structure’s overcollateralisation is adequate, with an issue-specific loan/value ratio of 43%. This positively influences recovery rates in a default scenario. According to Scope’s methodology and reasonable discounts on the company’s asset base (as described below), a ‘superior’ recovery in a default scenario is expected, thus allowing for a two-notch uplift on the company’s issuer rating of BB+.

Senior unsecured debt

Scope’s recovery analysis signals ‘above-average recovery’, which translates into instrument ratings of BBB-. Recovery is based on a hypothetical default scenario in FY 2020/21 with the company’s liquidation value amounting to EUR 610m. This value is based on an 8% haircut applied to assets, reflecting a BBB category stress according to Scope’s methodology as well as liquidation costs of approx. 23% for assets and 10% for insolvency proceedings. This compares to secured financing of a forecasted EUR 426m, a fully drawn unsecured credit line of EUR 50m as well as the unsecured EUR 37m in convertible bonds and the EUR 70m straight bond. Recovery is sensitive to the advance rate used and DKR’s portfolio is judged to be illiquid. Scope therefore limits its up-notching on the issuer rating.

The DKR’s Scope-adjusted unencumbered asset ratio amounts to 1.7x at end-December 2019 (pro-forma¹), thus allowing a maximum uplift of the debt class to BBB category.

¹ Includes: i) EUR 171m in property values (acquired but not transferred up to end-December 2019); ii) EUR 91m in bank debt to be drawn to finance these purchases; and iii) EUR 68m cash and cash equivalents available

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/or rating outlook(s) (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 31 May 2018. The ratings/outlooks were last updated on 25 February 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
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