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Rating action

Scope Ratings has assigned a first-time issuer rating of BBB-/Stable to Klövern AB.

Rating rationale

Klövern’s business risk profile (rated: BBB) is the primary driver of the assigned rating. The portfolio of around 350 properties, with a total gross leasable area of 2.5 million square metres, translates into decent diversification in terms of tenants and locations, enhancing its resilience to cash flow volatility caused by economic cycles, industry developments, regulatory changes, or the loss/default of single tenants. It also affords good access to capital, proven by regular issuances and bank loans in various currencies. Klövern’s moderate or dominant position in most areas (first/second in regional capitals and within the top 10 in Stockholm and Gothenburg) is credit-positive, providing visibility to new tenants and flexibility to the changing needs of existing ones. This leads to tenant retention, more stable occupancy and reduced capex needs linked to tenant fluctuations. Moderate geographical outreach across three countries with a recently streamlined foothold in Sweden (85% of assets by fair value, concentrated in ‘A’ locations) along with two international exposures with Copenhagen (7%) and New York (8%) benefits the rating through the focus on large and liquid markets classified as ‘A’ cities by Scope. This is likely to result in good fungibility in times of distress, meaning any haircuts on the portfolio would be limited. Tenant industry diversification is good, with no dominant industries in the portfolio and a relatively low exposure to tenants most vulnerable to Covid-19 impacts (assessed at 14% of portfolio tenants).

The business risk profile is constrained by the relatively short WAULT of 3.6 years, which exposes Klövern to ongoing re-letting risk; in light of Covid-19, this could lead to lease extensions and new contracts being subject to reduced rental levels. Somewhat mitigating this risk are i) the observed stability of the company’s WAULT, being in line with Nordic peers’; and ii) the average length of Klövern’s tenancies at 15 years. The company’s strategy – acquiring properties in inner-city/near-city locations with below-par occupancy with the potential for property development – results in a low occupancy rate relative to peers of 90%, which holds the rating back, though the effect is tempered by the stability of the rate over the last decade. This strategy also leads to profitability, as measured by the Scope-adjusted EBITDA margin, of 60-65%, which is at the lower end of the peer group, as the developing portfolio incurs higher non-recoverable service charges and higher investment/maintenance expenses.

Klöverns’ financial risk profile (rated: BB+) benefits from its historically strong debt protection, as measured by the Scope-adjusted EBITDA interest cover, helped by floating rates (of which at least 90% are hedged). Scope expects interest cover to remain above the 2.2x rating threshold going forward (though expected to dip below the threshold in 2020 due to Covid-19). Klövern refinanced SEK 5bn of its debt in recent weeks at pre-pandemic interest rates (2.4% on average across all debt instruments), underlining its strong position with banks and giving comfort that interest coverage will not deteriorate significantly going forward. Klövern’s leverage, as measured by the Scope-adjusted loan/value (LTV) ratio, is constraining the rating somewhat. However, Scope highlights the significant reduction in leverage during 2019 due to portfolio streamlining, from the high 50s (%) to the mid-low 50s (currently at 54%), and the company intends to keep these levels. Scope-adjusted debt to Scope-adjusted EBITDA has remained elevated at above 13x in the period analysed, and Scope’s rating case does not expect a significant reduction in this ratio going forward.

Klövern’s liquidity is judged to be adequate with cash sources exceeding short-term debt by 1.4x in 2020. The company has historically relied on short-term funding and its strategy for short-term liquidity needs is to draw on revolving/cheque credit facilities or issue commercial paper under the SEK 4bn programme. In a second step, the company replaces short-term instruments with secured bank loans/bonds with a pledge in real estate. The company’s reported secured LTV of 34% gives ample room to increase debt on existing properties, based on the usual framework of a maximum 60% LTV on bank loans in case the short-term market stops and prevents further refinancing. In addition, the company’s revolving credit facilities cover the unsecured part of upcoming maturities; Scope considers the likelihood of banks not refinancing the company’s secured loans to be low.

Outlook and rating-change drivers

The Outlook for Klövern is Stable and incorporates a continuation of the company’s growth in its core markets of Sweden, Copenhagen and New York, with capital expenditures and acquisitions amounting to SEK 3.3bn in 2020 and SEK 2.7bn in 2021. Scope expects the negative financial effects of Covid-19, built into its analytical base case, to fade during 2021, with rents returning to pre-crisis levels in 2022. Scope-adjusted LTV (currently 54%, accounting for a 50% equity credit on the hybrid bond) is also expected to improve, while a recovery in EBITDA will benefit debt interest coverage.

A negative rating action is possible if LTV increases towards 60% on a sustained basis. This could be driven by an increase in interest-bearing debt through highly debt-financed acquisitions or re-mortgaging, or by a more severe Covid-19 effect leading to a stronger-than-expected revision of rental prospects and, in turn, lower asset values.

A positive rating action could be warranted by deleveraging, with an LTV of below 50% on a sustained basis, supported by break-even free operating cash flow. This could be driven by less debt-funded capex, a positive development of current ongoing development projects and a less severe impact of Covid-19 resulting in fair value appreciation.

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: Thomas Faeh, Executive Director
Person responsible for approval of the rating: Philipp Wass, Executive Director
The ratings/outlooks were first released by Scope on 10 June 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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