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Rating action

Scope Ratings GmbH (Scope) has today affirmed its BB/Stable issuer rating on Summus Capital OÜ (Summus). Scope has also affirmed the BB rating for the senior unsecured debt category.

Rating rationale

The affirmation is driven by Scope’s expectation that Summus’ income-generating portfolio of commercial real estate will continue to show stable credit metrics despite increasing pressure on property values and interest coverage due to rising interest rates.

The business risk profile (assessed at BB) benefits from the issuer’s high-quality portfolio of assets in Baltic capital cities, which are second-tier investment markets with stable tenant demand. Scope-adjusted total assets grew slightly by 5% YoY to EUR 412m at end-2022. The addition of two properties (Depo DIY and Damme shopping centre) compensated for the disposal of a small production and warehouse building in Tartu. The company intends to continue to expand the portfolio in the next years, but rising interest rates will slow the pace due to the higher cost of capital and fewer opportunities in core markets. Scope therefore expects Summus’ geographical foothold to remain predominantly in the Baltic countries but with an increased presence in Latvia (40% of total rental income).

Summus buy-and-hold investment approach provides stable rental cash flows. The portfolio generated EUR 28m in net annual rental income in 2022, up 29% YoY. Scope expects that rental growth will remain resilient, supported by the portfolio’s high and stable occupancy rate and the inflation-linked contracts covering almost all rental income.

The portfolio had a high and stable occupancy rate of 97% as of June 2023. Although demand for office space is uncertain as some tenants are holding off on operational decisions, Scope expects Summus’ office portfolio to continue to enjoy robust demand. This is due to tenants’ preference towards best-in-class, energy-efficient space in prime locations –Summus’ office building properties have LEED or BREEAM environmental certifications. Regarding the retail portfolio (over 50% of rental income) Summus’ properties proved resilient during the Covid-19 pandemic with no significant impact on rent collections and footfall continues to recover.

Profitability, as measured by the Scope-adjusted EBITDA margin, was stable and above 80% as at end-June 2023. Scope foresees the EBITDA margin to remain stable in the next few years. In 2022, increasing energy costs put pressure on operations, but this has eased in the last months. Summus can pass on around 62% of utilities costs through lease agreements and most tenants with fixed-rate agreements pay for electricity consumption as measured by counters. In addition, Scope expects the inflation-driven rise in costs to be balanced out by corresponding rental growth as around 95% of lease contracts have an indexation clause.

The rating remains constrained by the company’s limited size and market shares, as Summus remains small in the European context and exposed to the retail segment. As such, Summus is highly exposed to unforeseen shocks and volatile cash flows, although this is partially mitigated by the portfolio’s weighted average unexpired lease term of about four years. While there are almost 400 letting agreements, tenant diversification is still modest, with the top 10 accounting for about 36% of rental income. Tenants are mainly small retail operators, exposing the company to major changes in consumer habits accelerated by the pandemic such as the shift to e-commerce.

Summus’ financial risk profile (assessed at BB) is driven by its moderate credit metrics. Debt protection, as measured by Scope-adjusted EBITDA interest cover, stood at 2.6x in December 2022 (2.3x for the 12 months to June 2023). Scope expects debt protection to remain above 2x on the back of stable operating cash flow and a relatively low average cost of bank financing (3.8% as at end-June 2023 excluding Euribor). Summus is exposed to interest rate risk as its bank loans pay variable interest rates (2.3%-2.9% + Euribor). This risk is partially mitigated by the company’s policy to have interest rate swaps on at least 50% of its loans (54% to Q2 2023) and its intention to partially increase the portion of fixed-rate debt. However, any new debt will bear higher interest rates, and the unhedged share of debt allows the pass-through of rate increases observed in the last months. Still, interest cover should remain above 2x, supported by the issuer’s inflation-linked revenue base.

Leverage, as measured by the Scope-adjusted loan/value ratio, stabilised as expected in a range of 50%-55% (end-June 2023: 52%), not considering outstanding subordinated loans from the shareholder (EUR 17.2m as at June 2023). Summus’ portfolio is exposed to market pressure that could lead to yield expansion, as the rising interest rates has led to uncertainty regarding property values (negative fair value of EUR 5.4m in 2022). However, Scope expects the portfolio value to remain resilient and foresees only minor adjustments of about 1%-2% by end-2024, driven by further yield widenings because of the potential lag of 12-24 months between a change in interest rates and its full reflection in property yields. Like-for-like rental growth in the next years – as the market will remain supportive – will likely compensate expected yield expansion. With indebtedness to remain broadly stable, Scope-adjusted loan/value ratio will remain at around 50% in Scope’s rating case.

Summus’ liquidity is adequate, supported by unrestricted cash (EUR 11.2m as at end-June 2023) and positive operating cash flow that covers short-term debt of about EUR 7m. Even if free operating cash flow turns negative due to investments in the next few years, capex is mostly discretionary and will be financed by available internal resources and financial debt.

As at June 2023, about 77.5% of the portfolio’s gross asset value is LEED or BREEAM-certified, including office buildings Park Town West and Park Town East and shopping centre Nordika, further 8.9% is in certification process. Summus’ medium-term goal is to have 95% of the portfolio BREAAM/LEED-certified. Summus also aims to optimise energy consumption in its buildings and to generate 69% of energy from renewables.

Outlook and rating-change drivers

The Outlook remains Stable and incorporates Scope’s expectation that rental growth will strengthen cash generation, supported by the occupancy rate remaining above 97% on average and the high share of inflation-linked leases. The rating case assumes the Scope-adjusted loan/value ratio will stay below 55%.

A positive rating action is possible if the Scope-adjusted loan/value ratio decreased to around 50% while the company significantly grew in size, thereby decreasing portfolio concentration. This could be achieved through new acquisitions financed with a higher share of equity relative to debt.

A negative rating action is possible if Scope-adjusted EBITDA interest cover decreased below 2.0x and/or leverage increased, indicated by a Scope-adjusted loan/value ratio towards 60% on a sustained basis. Leverage could rise if property values in the portfolio dropped considerably due to a shock in the Baltic real estate market, particularly regarding shopping centres, or if new properties are acquired via external financing with higher leverage than in Scope’s rating base case.

Long-term debt rating

Summus has a EUR 10m senior unsecured corporate bond in terms of capital market debt as at end-June 2023. The bond’s tenor is three years with a fixed coupon of 6.75% and payments made four times a year.

Scope’s recovery analysis is based on a hypothetical default scenario in FY 2024 with a company liquidation value based on a haircut of 25% to reflect liquidation costs, reasonable discounts to assets and cost related to insolvency proceedings. Scope expects an ‘above average’ recovery for Summus’ senior unsecured debt (EUR 10m) but notes the high sensitivity of the portfolio to property advance rates. Scope has therefore affirmed the debt class a rating of BB, in line with the issuer rating.

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/or Outlook, (General Corporate Rating Methodology, 15 July 2022; European Real Estate Rating Methodology, 25 January 2023), are available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
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-governance/definitions-and-scales. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://scoperatings.com/governance-and-policies/regulatory/eu-regulation. 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-governance/definitions-and-scales. 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://scoperatings.com/governance-and-policies/rating-governance/methodologies.
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, the Rated Entities' Related Third Parties 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/or Outlook and the principal grounds on which the Credit Ratings and/or Outlook are based. Following that review, the Credit Ratings were not amended before being issued.

Regulatory disclosures
These Credit Ratings and/or Outlook are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and/or Outlook are UK-endorsed.
Lead analyst: Rigel Scheller, Director
Person responsible for approval of the Credit Ratings: Thomas Faeh, Executive Director
The Credit Ratings/Outlook were first released by Scope Ratings on 3 September 2021. The Credit Ratings/Outlook were last updated on 5 September 2022.

Potential conflicts
See www.scoperatings.com under Governance & Policies/Regulatory for a list of potential conflicts of interest disclosures related to the issuance of Credit Ratings.

Conditions of use/exclusion of liability
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