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Rating action

Scope Ratings GmbH (Scope) 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

DKR further strengthened its position as the biggest niche player in basic German retail. In the 12 months ending December 2020 it added 39 properties (191,280 sq m in gross leasable area; EUR 208m in fair values) and another eight properties (70,800 sq m; EUR 68m) were either transferred or notarised ¹. The increase in scale supports DKR’s standing with its main tenants and its access to capital (EUR 51m capital increase in May 2020 ²) and investment markets. However, the pace of DKR’s acquisitions has slowed significantly since February 2020. This is due to a standstill in the transaction market during the peak of the Covid-19 crisis along with higher competition for food retail properties, with deep-pocketed investors turning towards essential retail due to the sector’s relative resilience through the crisis. Thus, Scope anticipates acquisition to reach EUR 100m-150m (circa EUR 115m acquired up to April 2021) in FY 2020/21 if DKR adheres to its investment criteria, which have been lowered compared to those in the last financial year.

Tenant concentration, while high, slightly reduced to end-December 2020. The top three tenants represent 34.8% of annualised rental income of the pro-forma portfolio (-4pp YoY) ¹. The high concentration is driven by the issuer’s focus on concentrated retail sectors like food retail and DIY (59% of annualised rental income of the pro-forma portfolio) ¹. However, these sectors have been resilient against the Covid-19 shock; only small tenants have been hit hard and these contribute a small share of DKR’s rental income. In FY 2019/20, rent deferrals represented 2% of annualised rental income ³. Scope believes the pandemic’s full economic impact will become apparent in 2021 as government support is unwound. Also, German retail was subject to more prolonged lockdowns in 2021 to date than in 2020. Nonetheless, DKR’s exposure to essential retail somewhat protects its cash flow against a pronounced drop from either new lockdowns and/or tenant defaults. As such, Scope forecasts rental cash flow (from rent abatements, impairments or tenant defaults) to drop only by 5%-10% against contractual agreed rents for FY 2020/21. This follows Scope’s understanding that DKR is likely sharing the burden faced by retailers due to restrictions on their operations. As such, the Scope-adjusted EBITDA margin is forecast at 60%-65% in FY 2020/21 (FY 2019/20: 65%; - 4pp YoY) and will not return to close to 70% in the next 12 to 18 months. However, once Covid-19 no longer has an impact on DKR’s tenants, margins are forecast to return to 65%-70%, reflecting Scope’s view of the overall resilience of DKR’s cash flows against the accelerated transformation of European retail due to the pandemic.

The resilience of essential retail is shown by the company’s ability to keep key portfolio performance indicators – the weighted average unexpired lease term, at 5.5 years for the pro-forma portfolio (as at mid-February), and the occupancy rate, at 90% based on gross leasable area ¹ – stable since mid-2018, underpinning the good locations of DKR’s assets and good access to tenants.

DKR’s debt protection, as measured by Scope-adjusted EBITDA interest cover, has remained above 4x (12 months ending December 2020: 4.7x), thanks to its ability to keep cost of debt stable at 1.9% ¹ and despite the ongoing aggressive, externally financed growth. The latter also led to a major increase in Scope-adjusted debt, to EUR 464m as at end-December 2020 from EUR 344m from a year before. Strong cash generation will help to keep Scope-adjusted EBITDA interest cover above 4x, thanks to DKR’s defensive portfolio characteristics, which mitigate risks arising around tighter market conditions with increased competition and thus narrowing acquisition yields, as well as inflationary pressures that are driving up interest rates.

Leverage has been stable with a Scope-adjusted loan/value ratio of 53% as at end-December 2020. This is broadly in line with the company’s financial policy to keep this ratio at a maximum of 50%. Scope does not foresee a change in leverage for the time being as: i) acquisitions will be subject to balanced financing to adhere to G-REIT regulation (minimum equity ratio of 45%), through capital increases, fair value appreciations, capital recycling and bank/capital market debt; and ii) Scope foresees no drop in property values (in contrast with the overall sub-sector, commercial real estate companies with a high exposure to essential retail will remain resilient in terms of cash flow, rental growth and, thus, property values).

Scope anticipates below-par liquidity in FY 2020/21, due to the Covid-19 impact on cash generation and the mandatory dividend. Sources of liquidity (unrestricted cash of EUR 0.2m as at 30 September 2020 and forecasted Scope-adjusted free operating cash flow of EUR 2.8m for 12 months ending September 2021) do not cover short-term debt of EUR 20.9m as at end-September 2020. However, Scope believes the liquidity risk is manageable due to headroom provided by i) EUR 111m in a fully unencumbered investment property; ii) a EUR 25m revolving, undrawn credit facility of its main shareholder, Obotritia Capital KGaA; iii) a EUR 81m portfolio of short-term loans to associates ³ that can be called at any time; and iv) EUR 7m of investments in loan facilities (callable at any time with funds released within 10 business days) ³. In addition, the company’s adherence to a maximum loan/value ratio of 55% as part of its status as a German real estate investment trust (G-REIT) supports access to external financing through the cycle.

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 150m in expansion capex for FY 2020/21, leading to annualised rental income of EUR 72m-76m by end-September 2021. Scope anticipates further expansion to be financed with equal amounts of debt and equity. This will keep the Scope-adjusted loan/value ratio below 55% in the medium term, while debt protection, as measured by Scope-adjusted EBITDA interest cover, is expected to remain above 4x.

A negative rating action is possible if the Scope-adjusted loan/value ratio reaches above 55% on a continued basis, leading to DKR losing its tax-exempt G-REIT status. This could happen if property prices drop and DKR cannot address the increased loan/value ratio via asset disposals or equity issuances (due to the main shareholder being less willing and able to support capital increases either actively or passively).

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

Long-term and short-term debt ratings

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 86.7m as at September 2020. The structure’s overcollateralisation is adequate, with an issue-specific loan/value ratio of 46%. This positively influences recovery rates in a default scenario. According to Scope’s methodology and discounts on the company’s assets (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+.

Scope’s recovery analysis for senior unsecured debt signals ‘above-average’ recovery, which translates into a rating of BBB-. This rate is based on a hypothetical default scenario in FY 2022/23 with a EUR 842m company liquidation value based on an 8% haircut applied to assets, reflecting a BBB category stress according to Scope’s methodology, and liquidation costs of around 23% for assets and 10% for insolvency proceedings. This compares to secured financing of a forecasted EUR 588m, a fully drawn unsecured credit line of EUR 25m as well as the unsecured EUR 37m in convertible bonds, EUR 110m in straight bonds and a EUR 10m Schuldschein loan. The recovery rate is sensitive to the advance rate. DKR’s portfolio is judged to be illiquid. Scope therefore limits its notching above the issuer rating on this debt class.

The DKR’s Scope-adjusted unencumbered asset ratio amounts to 1.9x at end-December 2020, thus allowing a maximum uplift of the debt class to the BBB category.

Rating driver references
1. Q1 2020/21 Financial results presentation 
2. Company news 15 May 2020
3. Annual report for the FY 2019/20

Stress testing & cash flow analysis
No stress testing was performed. Scope Ratings performed its standard cash flow forecasting for the company.

Methodology
The methodologies used for these Credit Ratings and Outlook, (Corporate Rating Methodology, 26 February 2020; Rating Methodology: European Real Estate Corporates, 15 January 2021), are available on https://www.scoperatings.com/#!methodology/list.
Scope Ratings GmbH and Scope Ratings UK Limited apply the same methodologies/models and key rating assumptions for their credit rating services, while Scope Hamburg GmbH’s methodologies/models and key rating assumptions are different from those of Scope Ratings GmbH and Scope Ratings UK Limited.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other 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 Credit Rating performance report at https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. 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 Ratings’ definitions of default and Credit 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 factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://www.scoperatings.com/#!methodology/list.
The Outlook indicates the most likely direction of the Credit Ratings if the Credit Ratings were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The Rated Entity and/or its Related Third Parties participated in the Credit Rating process.
The following substantially material sources of information were used to prepare the Credit Ratings: public domain, the Rated Entity and Scope Ratings’ internal sources.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting the Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and Outlook and the principal grounds on which the Credit Ratings and Outlook are based. Following that review, the Credit Ratings were not amended before being issued.

Regulatory disclosures
These Credit Ratings and Outlook are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and Outlook are UK-endorsed.
Lead analyst: Philipp Wass, Executive Director
Person responsible for approval of the Credit Ratings: Olaf Tölke, Managing Director
The Credit Ratings/Outlook were first released by Scope Ratings on 31 May 2018. The Credit Ratings/Outlook were last updated on 5 May 2020.

Potential conflicts
See www.scoperatings.com under Governance & Policies/EU Regulation/Disclosures 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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