Johannesburg, 6 December 2017 — Global Credit Ratings has today downgraded the national scale Issuer ratings assigned to Octodec Investments Limited to A-(ZA) and A1-(ZA) in the long term and short term respectively; with the outlook accorded as Stable.
SUMMARY RATING RATIONALE
Global Credit Ratings (“GCR”) has accorded the above credit ratings to Octodec Investments Limited (“Octodec”) based on the following key criteria:
The ratings downgrade reflects Octodec’s highly concentrated debt maturity profile, exacerbated by the challenging operating environment, which is likely to continue to place pressure on performance metrics.
Octodec’s ratings continue to be supported by its sound strategic execution in redeveloping properties to unlock value in the portfolio over time, with the direct portfolio value reaching R12.4bn at FY17, from R11.3bn post the Premium merger in FY15. That said, the REIT’s property portfolio displays a high degree of variability in asset quality and property fundamentals, although partially mitigating this is the fund’s strong positioning in targeted inner-city nodes and extensive expertise in this segment.
GCR has noted the highly concentrated debt maturity profile, displaying a weighted average of 1.4 years at year-end FY17 (FY16: 2.3 years). Notwithstanding the demonstrated ability to refinance facilities as required, with R1.1bn of expiring commercial paper and term debt already refinanced for FY18, R586m of this was only rolled for 12 months thus adding to the substantial R2.4bn of obligations due in FY19. Thus, the REIT faces further significant refinancing risk. GCR would expect to see a longer and smoother debt maturity profile being sustained going forward. Liquidity comfort is, however, provided by current unutilised facilities of R1.1bn, which would be sufficient to cover individual CP tranche rollovers (totalling R735m) for the remainder of FY18. Strong banking relationships and overcollateralisation of existing facilities adds further support, as it implies that facilities could be raised if necessary.
The R263m in equity raised in FY17 reflects sustained shareholder support, which helped ease the net LTV slightly to 38% (FY16: 39%). This remains just below the 40% threshold for highly rated REITs, but ranges above levels reported by a number of similarly rated funds. Net debt to operating income remained high at 507% in FY17 (FY16: 512%) and is likely to continue to trend in the 450%-550% range as the fund carries a sizeable portion of warehoused vacant space for potential redevelopment, whilst soft market conditions weigh on earnings.
Tempered by pressures on occupancy and rental rates in a challenging operating environment, Octodec’s rental income growth moderated to 4% in FY17 (FY16: 7.5%). Specifically, weakness in the residential portfolio, which evidenced a sharp spike in core vacancies to 7.2% in FY17, from levels below 4% previously, is of concern given that this is a key area for the development pipeline. Nonetheless, demand for Octodec’s assets is likely to remain satisfactory over the medium term, given the strategic locations in most cases, whilst the relative diversity of the property portfolio should provide a level of resilience.
Given rising utilities costs and in view of the REIT’s more administratively intense business model, operating margins are likely to remain under pressure, as tenants’ ability to absorb above-inflation cost escalations is further eroded in a weak economy. As such, profitability hinges on strong execution in respect of the management of the portfolio, particularly in view of the short term lease profile.
A rating upgrade would be contingent upon long term revenue and earnings growth, driven by sustained lower vacancies and improving tenant quality. The REIT would also need to demonstrate conservative gearing policies, strong liquidity and well staggered debt tenors. Octodec’s ratings could face further downward pressure if the debt profile remains concentrated in the short term. In addition, continued negative trends in portfolio performance due to persistent economic pressures that affect credit metrics, or higher gearing beyond expectations would warrant negative rating action.
|NATIONAL SCALE RATINGS HISTORY|
Initial rating (October 2014)
|Long term: A-(ZA)
Short term: A1-(ZA)
|Last rating (November 2016)
Long term: A(ZA)
Short term: A1(ZA)
|Senior Analyst: Corporate Ratings|
|Sector Head: Corporate Ratings|
APPLICABLE METHODOLOGIES AND RELATED RESEARCH
Global Master Criteria for rating corporate entities, updated February 2017
Global Criteria for Rating Property Funds, updated February 2017
Octodec Issuer rating reports, 2014-16
Premium Issuer rating reports, 2011-14
RATING LIMITATIONS AND DISCLAIMERS
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GLOSSARY OF TERMS/ACRONYMS USED IN THIS DOCUMENT AS PER GCR’S CORPORATE GLOSSARY
|Capital||The sum of money that is invested to generate proceeds.|
|Commercial Paper||Commercial paper is a negotiable instrument with a maturity of less than one year.|
|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.|
|Equity||Equity is the holding or stake that shareholders have in a company. Equity capital is raised by the issue of new shares or by retaining profit.|
|Gearing||With regard to corporate analysis, gearing (or leverage) refers to the extent to which a company is funded by debt and can be calculated by dividing its debt by shareholders’ funds or by EBITDA.|
|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.|
|Liquidity Risk||The risk that a company may not be able to meet its financial obligations or other operational cash requirements due to an inability to timeously realise cash from its assets. Regarding securities, the risk that a financial instrument cannot be traded at its market price due to the size, structure or efficiency of the market.|
|Long-Term Rating||A long term rating reflects an issuer’s ability to meet its financial obligations over the following three to five year period, including interest payments and debt redemptions. This encompasses an evaluation of the organisation’s current financial position, as well as how the position may change in the future with regard to meeting longer term financial obligations.|
|LTV||Principal balance of a loan divided by the value of the property that it funds. LTVs can be computed as the loan balance to most recent property market value, or relative to the original property market value.|
|Maturity||The length of time between the issue of a bond or other security and the date on which it becomes payable in full.|
|Operating Margin||Operating margin is operating profit expressed as a percentage of a company’s sales over a given period.|
|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.|
|Real Estate Investment Trust (REIT)||A REIT is a company that owns or finances income-producing real estate. REITs are subject to special tax considerations and generally pay out all of their taxable income as distributions to shareholders.|
|Refinancing||The issue of new debt to replace maturing debt. New debt may be provided by existing or new lenders, with a new set of terms in place.|
|Shareholder||An individual, entity or financial institution that holds shares or stock in an organisation or company.|
|Short-Term Rating||A short term rating is an opinion of an issuer’s ability to meet all financial obligations over the upcoming 12 month period, including interest payments and debt redemptions.|
SALIENT FEATURES OF ACCORDED RATINGS
GCR affirms that a.) no part of the rating 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; c.) such ratings were an independent evaluation of the risks and merits of the rated entity, security or financial instrument; and d.) the validity of the ratings is for a maximum of 12 months, or earlier as indicated by the applicable credit rating document.
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 credit ratings have been disclosed to, and contested by, Octodec Investments Limited, with no change to the rating decision.
The information received from Octodec Investments Limited and other reliable third parties to accord the credit ratings included:
• Reviewed provisional annual financial statements for FY17 (plus prior four years of comparative audited numbers)
• Draft integrated annual report FY17
• Investor presentations
• Treasury management report at 31 August 2017 and at 30 November 2017
• Breakdown of the property portfolio at FY17
The ratings above were solicited by, or on behalf of, the rated client, and therefore, GCR has been compensated for the provision of the ratings.
GCR downgrades Octodec Investments Limited’s rating to A-(ZA); Outlook Stable.