Johannesburg, 10 April 2017 — Global Credit Ratings has today upgraded the national scale Issuer ratings assigned to Fortress Income Fund Limited to AA-(ZA) and A1+(ZA) for the long and short term respectively; with the outlook accorded as Stable.
SUMMARY RATING RATIONALE
Global Credit Ratings has accorded the above credit ratings to Fortress Income Fund Limited (“Fortress”, “the REIT”, or “the fund”) based on the following key criteria:
The upgrade takes cognisance of the marked advance in the scale, positioning and financial flexibility of the REIT with the integration of Capital Property Fund (“Capital”), given that the transaction has now been fully bedded down. This bolstered the properties’ valuation to R28.7bn and total assets to R62.7bn at 1H FY17, from R7.4bn and R21.5bn respectively at FY15. While still identifying as a hybrid, Fortress has refined its strategy to focus on prime logistics and well-positioned retail properties. It will maintain a development pipeline as it accumulates logistics assets, albeit the related risk will be mitigated via relationships with established partners, long term triple net leases, and co-ownership of selected new builds with multinational tenants. Comfort was also taken from plans to continue to fund investments conservatively, given the strong growth path anticipated for the long term, with proceeds of property disposals also to be utilised in this regard.
Investments in offshore-focused real estate entities should largely counteract domestic systematic risks through the cycle, albeit exposures are expected to be managed conservatively to mitigate the effect of intermittent currency variability on free cash flows. Rapid capital accumulation by these real estate entities has notably improved the tradability of their shares, mitigating some investment risk.
Leases present a well-spaced expiry profile, which will continue to be enhanced by new long-term agreements and the disposal of certain assets. At c.50%, the contribution of ‘A’ grade tenants to contractual rentals is well below that presented by most highly rated REITs, although no single lessee accounts for more than 5% of GLA and rental income. The vacancy rate of 6% of GLA at 1H FY17 continues to show pressure from office and ancillary assets, which are being progressively traded out of the fund. Rising municipal costs, as well as pressure on office occupancies and rental rates, saw the net property expense ratio rise noticeably in 1H FY17. Coupled with the effects of a stronger Rand, this kept the combined operating margin below 100%. The fraught domestic operating climate where tenants’ all-in costs of occupancy continue to rise amidst weak demand and slow economic growth is likely to persist, constraining margin progression.
The Capital and Lodestone REIT (“Lodestone”) transactions were financed through the exchange of shares. As such, the advance in borrowings to R14.4bn at 1H FY17 from R4.2bn at FY15 mostly reflects the acquired REITs’ obligations brought onto the balance sheet. The LTV ratio remains low at 25%, and is expected to continue to trend below 35% in the medium term. This was considered in mitigation of rolling debt to EBITDA trending above the 400% upper limit for highly rated REITs over the rating horizon. Debt service ratios are within comfortable range, albeit gross interest cover is expected to continue to trend quite closely to the 2x threshold for highly rated funds. Ample untapped bank facilities at hand and the liquid securities portfolio enhance liquidity, while the sizeable unencumbered asset pool implies robust recoveries for unsecured noteholders. Comfort is also taken from conservative hedging policies.
Upward rating pressure could arise from the maintenance of a conservative profile and the proven ability to sustain strong cash flows through the cycle. Specifically, rolling debt to EBITDA and gross interest cover metrics comfortably trending within GCR’s threshold for highly rated funds would bode positively. However, the challenging local operating environment is expected to further constrain free cash flows in the REIT space, which coupled with socio-political shocks, could warrant negative rating action.
|NATIONAL SCALE RATINGS HISTORY|
|Initial rating (April 2012)|
|Long term: A-(ZA); Short term: A1-(ZA)|
|Last rating (April 2016)|
|Long term: A(ZA); Short term: A1(ZA)|
|Sector Head: Corporate & Public Sector Debt Ratings|
APPLICABLE METHODOLOGIES AND RELATED RESEARCH
Criteria for Rating Property Funds, updated February 2017
Criteria for Rating Corporate Entities, updated February 2017
Fortress Rating Reports, 2012-2016
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|Balance Sheet||Also known as Statement of Financial Position. A statement of a company’s assets and liabilities provided for the benefit of shareholders and regulators. It gives a snapshot at a specific point in time of the assets the company holds and how they have been financed.|
|Cash Flow||The inflow and outflow of cash and cash equivalents. Such flows arise from operating, investing and financing activities.|
|Credit Rating||An opinion regarding the creditworthiness of an entity, a security or financial instrument, or an issuer of securities or financial instruments, using an established and defined ranking system of rating categories.|
|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.|
|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.|
|Hedging||A financial risk management process or function to take a market position to protect against an eventuality. Taking an offsetting position in addition to an existing position. The correlation between the existing and offsetting position is negative.|
|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.|
|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.|
|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||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.|
|Margin||A term whose meaning depends on the context. In the widest sense, it means the difference between two values.|
|Multinational||A company that operates commercially in a number of countries outside of the one wherein it is based. Such companies are often listed on more than one stock exchange or have shares available via depository receipts.|
|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 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.|
|Risk||The possibility that an investment or venture will make a loss or not make the returns expected. There are many different types of risk including basis risk, country risk, credit risk, currency risk, economic risk, inflation risk, liquidity risk, market or systemic risk, political risk, settlement risk and translation risk.|
|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 POINTS OF ACCORDED RATINGS
GCR affirms that a.) no part of the ratings 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.
Fortress Income Fund 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 Fortress Income Fund Limited with no contestation of the ratings.
The information received from Fortress Income Fund Limited and other reliable third parties to accord the credit ratings include:
- the 2016 audited annual financial statements (plus four years/periods of comparative numbers);
- circulars and other SENS guidance to shareholders regarding the Capital Property Fund Limited and Lodestone REIT Limited acquisitions;
- condensed unaudited interim financial statements for the six months ended 31 December 2016;
- industry comparative data; and
- a breakdown of facilities available and related counterparties at 31 December 2016 and 28 February 2017.
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.