Announcements Corporate Rating Alerts

GCR affirms Octodec Investments Limited’s Issuer ratings of A-(ZA)/A2(ZA), with a Negative Outlook maintained

Rating Action

Johannesburg, 1 July 2021 – GCR Ratings (“GCR”) has affirmed Octodec Investments Limited’s long and short term national scale Issuer ratings at A-(ZA) and A2(ZA) respectively. The ratings have been maintained on Negative Outlook.

Rated Entity / Issue

Rating class

Rating scale

Rating

Outlook / Watch

Octodec Investments Limited

Long Term Issuer

National

A-(ZA)

Negative Outlook

Short Term Issuer

National

A2(ZA)

Rating Rationale

The ratings for Octodec Investments Limited (“Octodec” or “the REIT”) balances the high concentration of its property portfolio and exposure to the inner-city market segments in which it operates, with its established expertise in the management of such assets. GCR notes the improvement in performance metrics since March 2021, but the negative outlook continues to signal the significant challenges in the South African property sector, particularly the inner-city segment, due to the ongoing pandemic-related disruptions.

The COVID-19 pandemic had a significant impact on Octodec’s profitability, as the closure of universities and colleges, coupled with work-from-home adversely impacted on demand, resulting in a steep increase in vacancies. With the start of universities delayed, the seasonal December vacancies persisted to March, as a result of which 1H FY21 rental income declined 10.8%. Positively, there has been a marked improvement in the residential occupancy in both Johannesburg and Pretoria since March 2021, indicating stronger 2H FY21 earnings. However, GCR remains concerned that earnings could fall short of projections because of the uptick in COVID-19 cases being evidenced during the third wave.

Whilst the net LTV ratio was reported at a review period high of 44% at 1H FY20, Octodec remains committed to reduce the ratio to/below 40%. Cash retention is being prioritized, whilst the sale of some non-core properties should help with reaching this target. Proactive management of the debt maturity profile has also been evidenced by the advanced refinancing of most short-term facilities. Octodec has also demonstrated vulnerability to short-term earnings pressure on gearing metrics, with the net Debt to EBITDA ratio rising to 5.8x at FY20 (FY19: 5.1x) and 6.4x at 1H FY21, whilst interest coverage weakened to 2x at 1H FY21. Whist GCR does expect net debt to EBITDA to improve to c.5.2x at FY21 and interest coverage to around 2.1x as earnings should continue to show improvement in 2H FY21, there is a risk that the challenging operating environment could constrain the pace of the recovery. Octodec’s long-standing banking relationships remain a positive consideration as it mitigates some funding pressure, enabling the REIT to secure a covenant relaxation for affected periods, if required. While GCR anticipates covenant headroom to remain low in FY21 and into FY22, major funders are expected to continue to provide the necessary support.

Cash preservation measures undertaken have supported Octodec’s liquidity profile. These include the FY20 partial dividend retention and limit on capital expenditure to essential requirements. The REIT also has around R315m in undrawn facilities. This compares to relatively low refinancing requirements. Accordingly, GCR estimates a robust liquidity coverage ratio in excess of 3.0x over the next 12 months, thereafter easing towards the 1.0x level due to some sizeable debt maturities falling due during FY22 and the assumption that larger dividend payments will resume. That said however, the REIT has already engaged funders with a view to refinancing the majority of the expiring facilities, which provides additional comfort to the liquidity assessment.

Octodec’s portfolio quality assessment is constrained by high concentration to properties in the inner cities of Pretoria and Johannesburg, although this is counterbalanced by a very granular asset and tenant profile. We also note that despite the largely short-dated weighted average expiry profile, high core vacancies (1H FY21: 18.2%) and exposure to SMMEs, Octodec continues to achieve sound tenant retention and asset performance. This is underpinned by strong processes and systems, which until recently, contained arrears at c.5% of rental income. Due to tenant relief support measures, GCR does not expect a spike in arrears in the short term, albeit that these measures will result in curtailed income.

GCR has included a positive peer adjustment to better reflect the credit strengths of Octodec, being the strong risk protocols underpinning its generally stable operating performance, which are not apparent in a review of traditional portfolio quality and performance metrics. That said, protracted earnings underperformance could see GCR remove this adjustment.

Outlook Statement

The Negative Outlook reflects GCR’s view that the ongoing COVID-19 pandemic could impede the recovery in earnings seen post March 2021. As a result, performance and funding metrics could remain at weaker levels for longer than expected.

Rating Triggers

The ratings could be negatively affected by: 1) a delayed recovery in earnings; 2) a sustained deterioration in leverage metrics, where the interest cover ratio remains below 2.1x and the LTV continues to exceed 40% over the rating horizon; and/or 3) a deterioration in the liquidity coverage ratio to below 1.0x.

An upward rating movement is not expected over the rating horizon, however a return to a Stable Outlook is dependent on improved property performance and gearing metrics over the rating horizon.

Analytical Contacts

Primary analyst

Eyal Shevel

Sector Head: Corporate & Public Sector Ratings Senior Analyst: Corporate & Public Sector Ratings

Johannesburg, ZA

Shevel@GCRratings.com

+27 11 784 1771

     

Secondary analyst

Lara Krug

Senior Analyst: Corporate & Public Sector Ratings

Johannesburg, ZA

Larak@GCRratings.com

+27 11 784 1771

     

Committee chair

Sheri Morgan

Senior Analyst: Corporate & Public Sector Ratings

Johannesburg, ZA

Morgan@GCRratings.com

+27 11 784 1771

Related Criteria and Research

Criteria for the GCR Ratings Framework, May 2019

GCR Rating Scales, Symbols and Definitions, May 2019

Criteria for Rating Real Estate Investment Trusts and Other Commercial Property Companies, May 2019

GCR Country Risk Scores, June 2021

GCR Corporate Sector Risk Scores, April 2021

Ratings History

Octodec Investments Limited

Rating class

Review

Rating scale

Rating class

Outlook

Date

Long Term Issuer

Initial

National

A-(ZA)

Stable Outlook

November 2014

Short Term Issuer

Initial

National

A1-(ZA)

Long Term Issuer

Last

National

A-(ZA)

Negative Outlook

July 2020

Short term Issuer

Last

National

A2(ZA)

Risk Score Summary

Rating Factors and Sub-factors

Risk scores

 

 
   

Operating environment

13.00

Country risk score

7.00

Sector risk score

6.00

   

Business profile

(1.00)

Portfolio quality

(1.00)

Management and governance

0.00

   

Financial profile

(1.50)

Leverage and capital structure

(1.00)

Liquidity

(0.50)

   

Comparative profile

1.00

Group support

0.00

Peer analysis

1.00

   

Total Risk Score

11.50

Glossary

Cash Flow

The inflow and outflow of cash and cash equivalents. Such flows arise from operating, investing and financing activities.

Concentrations

A high degree of positive correlation between factors or excessive exposure to a single factor that share similar demographics or financial instrument or specific sector or specific industry or specific markets.

Debt

An obligation to repay a sum of money. More specifically, it is funds passed from a creditor to a debtor in exchange for interest and a commitment to repay the principal in full on a specified date or over a specified period.

Debt Service Ratio

A measure of a company’s ability to service its interest and principal redemption costs, expressed as the ratio of earnings or cash flows over a period to the sum of interest and principal payments over the same timeframe.

Diversification

Spreading risk by constructing a portfolio that contains different exposures whose returns are relatively uncorrelated. The term also refers to companies which move into markets or products that bear little relation to ones they already operate in.

Exposure

Exposure is the amount of risk the holder of an asset or security is faced with as a consequence of holding the security or asset. For a company, its exposure may relate to a particular product class or customer grouping. Exposure may also arise from an overreliance on one source of funding. In insurance, it refers to an individual or company’s vulnerability to various risks

Interest Cover

Interest cover is a measure of a company’s interest payments relative to its profits. It is calculated by dividing a company’s operating profit by its interest payments for a given period.

Interest

Scheduled payments made to a creditor in return for the use of borrowed money. The size of the payments will be determined by the interest rate, the amount borrowed or principal and the duration of the loan.

Issuer

The party indebted or the person making repayments for its borrowings.

Leverage

With regard to corporate analysis, leverage (or gearing) refers to the extent to which a company is funded by debt.

Liquidity

The speed at which assets can be converted to cash. It can also refer to the ability of a company to service its debt obligations due to the presence of liquid assets such as cash and its equivalents. Market liquidity refers to the ease with which a security can be bought or sold quickly and in large volumes without substantially affecting the market price. 

Long Term Rating

See GCR Rating Scales, Symbols and Definitions.

Margin

A term whose meaning depends on the context. In the widest sense, it means the difference between two values.

Maturity

The length of time between the issue of a bond or other security and the date on which it becomes payable in full.

Portfolio

A collection of investments held by an individual investor or financial institution. They may include stocks, bonds, futures contracts, options, real estate investments or any item that the holder believes will retain its value.

Rating Outlook

See GCR Rating Scales, Symbols and Definitions.

REIT

Real Estate Investment Trust. A company that owns, operates or finances income-producing real estate.

Renewal

The re-establishment of the in-force status of a policy, the term of which has expired or will expire unless it is renewed.

Rent

Payment from a lessee to the lessor for the temporary use of an asset.

Risk

The chance of future uncertainty (i.e. deviation from expected earnings or an expected outcome) that will have an impact on objectives.

Short Term Rating

See GCR Rating Scales, Symbols and Definitions.

Weighted Average

An average resulting from the multiplication of each component by a factor reflecting its importance or, relative size to a pool of assets or liabilities.

Salient Points of Accorded Ratings

GCR affirms that a.) no part of the ratings process was influenced by any other business activities of the credit rating agency; b.) the ratings were based solely on the merits of the rated entity, security or financial instrument being rated; and c.) such ratings were an independent evaluation of the risks and merits of the rated entity, security or financial instrument.

The credit ratings have been disclosed to Octodec Investments Limited. The ratings above were solicited by, or on behalf of, the rated entity, and therefore, GCR has been compensated for the provision of the ratings.

Octodec Investments Limited participated in the rating process via face-to-face management meetings, teleconferences and other written correspondence. Furthermore, the quality of information received was considered adequate and has been independently verified where possible. The information received from Octodec Investments Limited and other reliable third parties to accord the credit ratings included:

  • the 2020 audited annual financial statements (plus four years of audited comparative numbers);
  • unaudited financial results for the six months to February 2021;
  • results presentations;
  • a breakdown of debt facilities, security schedules, and related counterparties at 31 May 2021.


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