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Rating action

Scope Ratings GmbH (Scope) has today downgraded the issuer rating of JSC Lisi Lake Development (LLD) to B- from B+ and revised the Outlook to Negative from Stable. Scope has also downgraded the senior unsecured debt rating to B from BB-.

Rating rationale

The downgrade is driven by the weaker operating performance in 2022 and H1 2023, which has led to deteriorating credit metrics, liquidity concerns as well as governance issues. The Outlook revision to Negative reflects the uncertainties surrounding the refinancing of the unsecured bonds maturing in December 2024 and the dependence on asset disposals to meet short term debt obligations.

The business risk profile (revised to B from B+) remains constrained by the company’s limited size as a residential property developer, with total Scope-adjusted assets of around GEL 687m (EUR 236m) at end-June 2023, weak geographic diversification, and high concentration of the project pipeline around Lisi Lake in Tbilisi. The last factor represents a cluster risk for the company’s future cash flows.

After significant administrative delays, a new permit for the Buknari project was obtained in December 2023, and construction is expected to start in Q1 2024. The addition of this project is beneficial to LLD’s diversification profile, as it will expose the company to different demand patterns and open up new revenue streams in the hospitality sector. However, Scope awaits tangible progress and actual revenue contribution (or pre-sale agreements) before considering the Buknari project as a mitigating factor for LLD’s concentration risk.

While the company’s reliance on continuous property sales without additional recurring income streams is credit-negative, Scope sees the revenue contribution from the sale of serviced plots (45% of total revenue as of H1 2023; 40% in 2022) as a mitigating factor, as it implies reduced development risk while providing attractive cash returns. The lack of recurring and more stable revenues is a natural consequence of LLD’s develop-to-sell model, but Scope acknowledges the company’s strategic ambition to grow a portfolio of income-generating assets, although the contribution of rental income remains minimal at around 2% of revenues in H1 2023. The project phasing and high pre-sale rate (between 59% and 100% at end-2023, based on sq m sold) largely mitigate development risks.

Profitability, as measured by the Scope-adjusted EBITDA margin turned negative in 2022 and H1 2023, demonstrating LLD’s high sensitivity to earnings volatility and changing business conditions, including cost overruns, the recognition of lower margin projects or foreign exchange headwinds. The weighted average internal rate of return for ongoing projects remains solid at around 34%.

The financial risk profile (revised to B from BB-) is characterised by the company’s conservative financial structure, although earnings volatility has led to pronounced swings in credit metrics. Debt protection has come under further pressure following the USD 10m bond issue in December 2022 as the related interests came into full effect in 2023. Interest cover is expected to remain volatile and highly dependent on the timely fulfilment of contract sales, leaving little headroom to withstand lower profitability and offset earnings volatility. Negative Scope-adjusted EBITDA in 2022 and H1 2023 led to below par interest cover and a spike in Scope-adjusted debt/EBITDA. Scope lacks visibility on the necessary improvement in operating performance required to ease the pressure on credit metrics, which are not commensurate with the current rating.

Scope finds comfort in the issuer’s ability to meet its interest payments given its sound cash generation linked to advance payments received from customers, which is supported by high pre-sale rates. With all its debt at fixed rates and denominated in USD, the company’s exposure to interest rate risk is minimal.

Debt levels remain moderate as the company decided not to issue the second tranche of USD 10m. No significant debt issuances are expected, and LLD’s indebtedness will be mainly driven by the funding of development activities, including the Buknari project, as well as the refinancing of existing liabilities.

Liquidity is inadequate and below par for the twelve months ending December 2024, with an anticipated shortfall of GEL 37.5m. The forecasted FOCF of GEL 14.3m in 2024 and GEL 5.6m of cash available as of end December 2023 would not be sufficient to cover the anticipated short-term debt of GEL 57.3m due until end 2024. With the upcoming maturity wall in December 2024, LLD heavily relies on partially refinancing its bond liabilities (seeking USD 10m or approximately GEL 27m) and on expected proceeds from land disposals. While Scope believes the timeframe for considering alternative financing options or full repayment is relatively limited, the significant share of unencumbered assets (approximately GEL 568m) can serve as a backstop for secured lending.

The rating assessment includes a negative rating adjustment of one notch stemming from governance issues (ESG factor: credit negative). Scope points to the lack of reliable planning and frequent alterations to the pipeline execution schedule or planned investments. These factors significantly reduce visibility and may indicate underlying operational issues.

One or more key drivers of the credit rating action are considered an ESG factor.

Outlook and rating-change drivers

The Negative Outlook reflects the risk that the issuer’s Scope-adjusted EBITDA interest cover ratio remains below 1x. Although Scope expects the company to prudently execute on its development pipeline, earnings volatility can lead to pronounced swings in credit metrics, which could impair the rating. The Negative Outlook also captures the uncertainties surrounding the refinancing of the senior unsecured bonds in December 2024, as indicated by below par liquidity.

A positive rating action (i.e. a revision of the Outlook back to Stable) would require the company to demonstrate a stable Scope adjusted EBITDA interest cover above 1x and a comprehensive refinancing plan for the senior unsecured liabilities due in December 2024. Further ratings upside could be warranted by an adequate liquidity or the removal of the one notch negative rating adjustment related to governance issues.

A downgrade could occur if the Scope-adjusted EBITDA interest cover ratio remained below 1x for a prolonged period. This could be triggered by the lack of substantial recovery in sales volumes and profitability, delays in the pipeline execution or a pronounced deterioration in the Georgian real estate market. A downgrade may also occur if the issuer is unable to present a tangible and comprehensive refinancing plan for the senior unsecured liabilities maturing in December 2024.

Long-term debt rating

Scope has downgraded JSC Lisi Lake Development’s senior unsecured debt rating to B from BB-. Scope expects an ‘above average’ recovery for outstanding senior unsecured debt in a hypothetical default scenario in 2024 based on LLD’s liquidation value. Given an unencumbered ratio asset ratio of well above 110%, the debt category rating also reflects the company’s large pool of assets not pledged as collateral.

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, 16 October 2023; 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 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 and/or Outlook 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: Fayçal Abdellouche, Specialist
Person responsible for approval of the Credit Ratings: Thomas Faeh, Executive Director
The issuer Credit Rating/Outlook was first released by Scope Ratings on 10 July 2018. The Credit Rating/Outlook was last updated on 3 February 2023.
The senior unsecured debt Credit Rating was first released by Scope Ratings on 8 February 2019. The Credit Rating was last updated on 3 February 2023.
 
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