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Rating action

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

Rating rationale

Even with cash flow forecasted to deteriorate in 2020 owing to ongoing Covid-19 lockdowns in Europe, Scope expects the coronavirus pandemic to have limited impacts on the issuer’s business model and credit metrics.

The rationale is based on the relatively low share of non-essential retail, implicitly evidenced by the 70% rent collection rate reported by DKR as of April 2020 [1]. According to the issuer, rental payments have been deferred and will be collected once tenants resume business. Scope anticipates negative like-for-like rental growth for the financial year ending September 2020, only of between negative 5%-10%. This assumption is driven by i) the affected tenants, mostly more robust large chain stores; and ii) Germany lifting some restrictions on store closures on 20 April 2020 [2]. Profitability, as measured by Scope-adjusted EBITDA margin, is forecasted at below 70% for FY 2019/20, in view of expectations of increased non-recoverable costs and lower rental growth. However, the Scope-adjusted EBITDA margin should return above 70% in FY 2020/21, based on i) the expected recovery in cash flow once Covid-19-related impacts fade; and ii) increased economies of scale as the company continues to pursues its growth strategy.

Given the recent increase in debt issuance and the limited short-term potential for fair value appreciation [3], leverage is expected to exceed Scope’s forecasted level from February, with the loan/value (LTV) ratio set to breach by end-September 2020 the 55% threshold required to retain REIT status [4]. To address this, the company is unlikely to sell assets and is more likely to increase equity, given that 16 million new shares in authorised capital were resolved on during the annual general meeting (March 2019). Going forward, Scope expects deleveraging to resume in line with the company’s publicly announced target of around 50%.

Liquidity remains adequate. EUR 46m of available cash (as at end-March 2020) and the anticipated break-even Scope-adjusted free operating cash flow (excluding discretionary spending) of EUR 11m will be able to cover the EUR 12m in short-term debt due in FY 2019/2020.

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 65m by end-September 2020. Scope anticipates further expansion to be financed with equal amounts of debt and equity, though the latter is likely to be deferred given the current capital market environment. This will keep LTV below 55% in the medium term, while debt protection, as measured by EBITDA interest cover, is expected to remain above 4x.

A negative rating action is possible if LTV 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 LTV 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 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 LTV 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’ for senior unsecured debt, which translates into a rating of BBB-. Recovery is based on a hypothetical default scenario in FY 2020/21 with a EUR 579m company liquidation value. 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 364m, a fully drawn unsecured credit line of EUR 50m as well as the unsecured EUR 37m in convertible bonds and the EUR 110m in straight bonds. 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-forma ), thus allowing a maximum uplift of the debt class to the BBB category.

Rating driver references
Short description of the source Hyperlink to this source
1. DKR press release
2. Agreement of German federal states and the Federal Republic of Germany on Corona measures
3. Scope research, 6 April 2020 
4. G-REIT law

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 these ratings and/or rating outlook (Corporate Rating Methodology, 26 February 2020; Rating Methodology: European Real Estate Corporates, 17 January 2020) are available on https://www.scoperatings.com/#!methodology/list.
Information on the meaning of each rating category, including definitions of default and recoveries can be viewed in the “Rating Definitions - Credit Ratings and Ancillary Services” published on https://www.scoperatings.com/#!governance-and-policies/rating-scale. 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. Guidance and information on how Environmental, Social or Governance factors (ESG factor) are incorporated into the rating can be found in the respective sections of the methodologies or guidance documents provided on https://www.scoperatings.com/#!methodology/list.
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, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0 .
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 27 February 2020.

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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