Czech Republic-Based Residential Real Estate Company RESIDOMO Assigned Preliminary #BB-# Outlook Stable

Stocks and Financial Services Press Releases Wednesday October 4, 2017 17:08
DUBAI--4 Oct--S&P Global Ratings

DUBAI (S&P Global Ratings) Oct. 4, 2017--S&P Global Ratings said today that it had assigned its preliminary 'BB-' long-term corporate credit rating to Czech property investment company RESIDOMO s.r.o. The outlook is stable.

We also assigned a preliminary 'BB-' issue rating to the €680 million proposed senior secured notes.

The final ratings will depend on our receipt and satisfactory review of all final documentation for the proposed €680 million senior secured bond issuance and the €20 million super senior secured revolving credit facility. Accordingly, the preliminary ratings should not be construed as evidence of final ratings. If we do not receive final documentation within a reasonable time frame, or if the final documentation departs from materials reviewed, we reserve the right to withdraw or revise our ratings. Potential changes include, but are not limited to, utilization of bond proceeds, maturity, size and conditions of the bonds, financial and other covenants, security and ranking of the bonds, and any remaining shareholder loan.

The preliminary rating reflects RESIDOMO's limited portfolio size, average asset quality, geographic concentration, and relatively substantial leverage. These are somewhat offset by the RESIDOMO's being one of the largest residential property companies in Central and Eastern Europe, its resilient presence in a fragmented market, stable operating margins, and improving occupancy. We also consider that completion of the capital structure refinancing will lead to leverage measures that we view as quite high for the industry.

RESIDOMO has a relatively small and geographically concentrated residential investment property portfolio in the Moravia-Silesia region of Czech Republic, comprising 43,100 apartments of 2.6 million square meters (sqm) and 1,800 commercial units. The total appraised value of the apartments was Czech koruna (CZK) 28.4 billion (€1.1 billion) as of June 2017.

Czech Republic has lower GDP per capita than its Western European neighbors, but the GDP growth rate is better, forecast at 2.8%-2.4% for 2017-2018. The Moravia-Silesia region is not the most affluent in the country, but it is highly industrialized focusing on automotives, machinery and manufacturing, information technology, and health care, among other sectors, and it generates 10% of the country's GDP. The region's residential rental market is quite fragmented, but RESIDOMO is the largest player, with a share of around 9%.

Deregulation of Czech Republic's residential rental market in 2010-2012 created room for rental rate growth and a liberal environment, since property owners can now charge rents at market rates, whereas rents were previously regulated. RESIDOMO did not raise all its rents immediately but has instead been following a rent increase program since 2011, agreed upon by 99% of its pre-deregulation tenants to ensure a smooth transition and maximize tenant retention. We believe the company still has significant scope to raise rents over the next three to five years, since rents on about 42.8% of the portfolio are at the post-regulated gradually increasing rate and therefore 12% lower than market rents. We anticipate that this proportion will reduce to about 30% by 2019-2020, in line with management's guidance. In addition, residential occupancy has steadily improved, reaching 91% as of June 30, 2017, compared with 89% in 2012, but it remains lower than the 95% average of European peers. Rents for RESIDOMO's overall portfolio averaged €3.2 per sqm at midyear 2017.

That said, we view RESIDOMO's operating dynamics as favorable, with no reliance on a single asset and a broad tenant base; tenants stay for more than 12 years on average. Post-deregulation lease contracts allow for rents to increase in line with the company's pre-agreed program, irrespective of market indicators such as GDP. In addition, market-rent leases are inflation indexed, as they are in most other European countries.

Over the past decade, RESIDOMO has spent CZK9.7 billion on value-enhancing maintenance and capital expenditures (capex) to reposition the portfolio for long-term growth through large one-time upgrade projects. There should therefore be a natural decline of capex in the future, and we project it at only about CZK500 million each year.

RESIDOMO's financial risk profile is underpinned by stable recurring cash flows and sound EBITDA interest coverage, but offset by relatively high adjusted debt. After the refinancing transactions, the company's EBITDA interest coverage ratio will likely exceed 2.0x in 2018-2019, much improved from 1.3x reported at year-end 2016, and will be a key factor for the rating. Additionally, after up to CZK4.7 billion (€180 million) of the existing shareholder loan is repaid by the proceeds of the new bond, we will classify the remaining CZK1.4 billion (€55 million) shareholder loan as equity and therefore exclude it from our leverage ratio calculations. We assume the company will enter into long-term hedging contracts to mitigate foreign exchange risk, since the proposed bond will be issued in euros, while revenues are generated in koruna.

Leverage is high, with the adjusted debt-to-debt plus equity ratio projected at 75% when the transaction closes this year, improving to only about 70% over the next 12-18 months. However, we expect the loan-to-value (LTV) ratio will strengthen to slightly below 60% from 60%-62% over that period. The discrepancy between the two ratios mainly relates to CZK4.7 billion of deferred tax liabilities linked to a onetime revaluation of properties on conversion from Czech generally accepted accounting principles to International Financial Reporting Standards in 2011.

We believe RESIDOMO's ultimate shareholders, Blackstone and Round Hill Capital, which we consider financial sponsors, are committed to the company, with no plans for divestment or dividends in the medium term. Their financial policy targets an LTV of about 55% in two to three years and EBITDA interest coverage comfortably above 2.0x at all times.

The stable outlook incorporates our expectation of increasing revenues from the residential property portfolio, improving occupancy rates, and stable operating performance, owing to healthy macroeconomic trends and RESIDOMO's efforts to reduce the share of previously regulated apartments to about 30% of the portfolio in the next two to three years from 42.8% as of June 30, 2017. We believe RESIDOMO should be able to maintain EBITDA interest coverage ratios higher than 1.8x and a debt-to-debt plus equity ratio of about 70% (excluding deferred tax liabilities). We project an LTV of 60%-62% at the transaction's close, gradually improving to slightly below 60% over the next 12-18 months.

An upgrade would depend on RESIDOMO's ability to reduce leverage and bring the debt-to-debt plus equity ratio (excluding deferred tax liabilities) to about 65%, representing an LTV of approximately 55%, with EBITDA interest coverage ratios staying comfortably above 2.0x.

We could lower the rating if we see a prolonged decline in operating stability, for example due to decreasing occupancy rates or inability to reduce the share of pre-deregulation rents. We would also consider a downgrade if RESIDOMO's EBITDA interest coverage stayed below 1.3x and the debt-to-debt plus equity ratio (excluding deferred tax liabilities) did not decrease to about 70% or the LTV to about 60%.


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