Correction: Fitch Rates STAG Industrial, Inc.'s $100MM Senior Unsecured Notes 'BBB'; Outlook Stable
Fitch Ratings has assigned a 'BBB' rating to STAG Industrial Operating Partnership, L. P's $100 million unsecured notes issued through a private placement on Dec. 15, 2015. The notes mature on January 5, 2023 and bear interest at a fixed rate of 3.98%. STAG Industrial Operating Partnership, L. P is a wholly-owned operating subsidiary of STAG Industrial, Inc. (STAG or the company). A full list of Fitch's ratings for STAG follows at the end of this release.
The Rating Outlook is Stable.
KEY RATING DRIVERS
The rating reflects STAG's credit strengths, which include strong leverage and fixed charge coverage metrics for the rating, excellent liquidity, a sizable unencumbered asset pool and improving access to unsecured debt capital. Fitch expects STAG to operate through the cycle with metrics that are appropriate for the 'BBB' rating, including leverage sustaining in the low-to-mid 5.0x range and fixed charge coverage in the mid-to-high 3.0x range.
The Stable Outlook reflects Fitch's expectation that STAG will maintain credit metrics over the rating horizon (typically one to two years) that are consistent with the 'BBB' rating, as well as our outlook for positive near - to medium-term industrial property fundamentals.
Strategy, Growth Pressuring SSNOI
Fitch expects STAG's same store net operating income (SSNOI) will decline at a low single digit rate through 2017 as occupancy losses offset solidly positive leasing spreads. STAG's strategy of acquiring 100% occupied single-tenant industrial buildings is the principal driver for its recent SSNOI declines. As the company grows larger and its acquisitions season, the law of large numbers essentially pulls STAG's portfolio occupancy rate closer to market (roughly 93% to 95%). Fitch expects the company's SSNOI performance to be uneven, and generally negative, until the company grows to a size where a majority of its portfolio has seasoned, which typically occurs after five years of ownership. However, STAG is generally compensated for this occupancy loss through higher going-in yields for acquisitions.
STAG's cash SSNOI declined by.4% during the third quarter of 2015 (3Q'15), in comparison to a decline of.6% in 3Q'14. The company's annualized cash SSNOI change has also been negative since 2013, with the cash SSNOI decline of 2.3% in 2014 and 2.2% in 2013. Positively, STAG retained 90.4% of its expiring leased square footage in 3Q'15, resulting in an year-to-date tenant retention rate of 73.8%.
Fitch projects the company will sustain leverage of approximately 5.0x during the next three years on an annualized basis that includes a full-year's impact of earnings from projected acquisitions. STAG's leverage was 5.0x based on an annualized run rate of recurring operating EBITDA for the quarter ending Sept. 30, 2015, which is strong for the 'BBB' rating. This compares with 5.3x on an annualized basis for the quarter ending Sept. 30, 2014. In addition, adjusting 3Q'15 earnings for the impact of partial period acquisitions would reduce STAG's leverage to 4.9x.
Improving Capital Access
STAG's issuances of senior unsecured notes in July 2014, December 2014 and February 2015 and now in December 2015, have been important milestones in the company's transition to a predominantly unsecured borrowing strategy, evidencing broader access to unsecured debt capital. The company also completed a $600 million refinancing of its unsecured revolving credit facility and term loans in December 2014. Prior to the company's inaugural private unsecured notes placement, STAG's unsecured borrowings were limited to three bank term loans, as well as drawdowns under the company's unsecured revolver. However, STAG's unsecured debt capital access remains somewhat less established pending an inaugural public unsecured bond offering and further private placement issuance.
Strong Fixed Charge Coverage
Fitch expects the company's fixed charge coverage to sustain in the mid-to-high 3.0x's through 2017. The low interest rate environment and higher capitalization rates for properties in secondary markets should allow STAG to continue deploying capital on a strong spread investing basis. STAG's fixed charge coverage was 3.5x for the quarter ended Sept. 30, 2015 and 3.4x for both year-ended Dec. 31, 2014 and 2013.
STAG maintains sufficient liquidity of $12.5 million in cash and $272 million remaining under its $450 million revolving credit facility. The company completed a $600 million refinancing of its unsecured bank debt in December 2014. The refinancing reduced its cost of fully committed unsecured bank debt to Libor + 1.41% from Libor + 1.66% and increased the weighted average term to 5.9 years from 3.8 years. STAG also increased its unsecured revolving credit facility capacity to $450 million from $300 million in September 2015. The revolver has an accordian feature that would increase the facility size to $800 million, subject to lender approval. The company has minimal debt maturities over the next several years.
STAG's unencumbered assets, defined as unencumbered NOI (as calculated in accordance with the company's unsecured loan agreements) divided by a stressed capitalization rate of 10%, covered its unsecured debt by 2.7x in 3Q'15, which is strong for the 'BBB' rating. The company's substantial unencumbered asset pool is a source of contingent liquidity that enhances STAG's credit profile.
Straightforward Business Model
STAG has not made investments in ground-up development or unconsolidated joint venture partnerships. The absence of these items helps simplify the company's business model, improve financial reporting transparency and reduce potential contingent liquidity claims, which Fitch views positively.
While the company may selectively pursue the acquisition of completed build-to-suit (BTS) development projects in the future, Fitch anticipates only a moderate amount of such activity by STAG on an ongoing basis. Fitch views the acquisition of completed BTS projects developed by third parties as less risky than the speculative development undertaken by some of STAG's industrial REIT peers.
Secondary Market Locations
STAG's growth strategy centers on the acquisition of single tenant industrial properties (warehouse/distribution and manufacturing assets). Its emphasis on relative value has predominantly led the company to acquire properties in secondary U. S. markets (based on size parameters defined below) through third party purchases and structured sale-leasebacks. Such transactions typically range in price from $5 million to $50 million and have higher going-in yields, stronger internal rates of return, and less competition from institutional buyers.
As of Sept. 30, 2015, the company's portfolio was primarily in secondary markets (64.8% of annualized base revenue), followed by primary markets (20.3%) and tertiary markets (14.9%). STAG defines primary markets as the 29 largest industrial metropolitan areas, which each have approximately 200 million or more in net rentable square footage. It defines secondary industrial markets as the markets which each have net rentable square footage ranging from approximately 25 million to approximately 200 million and tertiary markets as markets with less than 25 million square feet of net rentable square footage.
The company has minimal exposure to the major 'core' U. S. industrial and logistics markets, which include Chicago, Los Angeles/Inland Empire, Dallas - Fort Worth, Atlanta and New York/Northern New Jersey. Fitch views this as a credit negative, all else equal, given superior liquidity characteristics for industrial assets in 'core' markets in terms of financing capacity and transaction volumes.
Differentiated Strategy within Fragmented Market
STAG's owns less than 1% of the company-estimated $250 billion of single-tenant industrial assets in its markets, providing external growth opportunities in the company's target asset profile. The company focuses on the binary nature of the cash flow of individual, single-tenant, industrial properties and the opportunity for cash flow growth across markets, industries, segments and property sizes. STAG's differentiated business model thoughtfully considers leasing, asset management, credit and capital market funding, which Fitch views favorably.
Preferred Stock Notching
The two-notch differential between STAG's IDR and preferred stock rating is consistent with Fitch's criteria for a U. S. REIT with an IDR of 'BBB'. These preferred securities are deeply subordinated and have loss absorption elements that would likely result in poor recoveries in the event of a corporate default.
Fitch's base case rating assumptions for STAG include the following:
--SSNOI declines within a range of 1%-2% in 2015, 2016 and 2017;
--Acquisitions of $400 million, $550 million and $700 million in 2015, 2016 and 2017, respectively at cap rates of 8%;
--Dispositions of $50 million per year through 2017 at 10% cap rates;
--STAG funds its near-to-medium term external growth with roughly 60% equity and 40% debt financing;
--Adjusted funds from operations (AFFO) payout ratio around 95%-100%.
Although positive rating momentum is unlikely in the near-to-medium term, the following factors may have a positive impact on STAG's ratings:
--Leverage calculated on an annualized basis adjusted for acquisitions sustaining below 5.0x (leverage was 4.9x as of Sept. 30, 2015 after giving effect to partial period acquisitions);
--Further development of STAG's unsecured debt capital access;
--Fixed charge coverage sustaining above 4.0x (coverage was 3.5x as of Sept. 30, 2015).
The following factors may have a negative impact on the company's ratings and/or Outlook:
--Indications that STAG's property portfolio is not competing effectively within its markets, which could include below market leasing velocity and rent growth and weak SSNOI growth for seasoned acquisitions;
--Fitch's expectation for leverage sustaining above 5.5x;
--Fixed charge coverage sustaining below 3.0x;
--Unencumbered assets to net unsecured debt falling below 2.5x;
FULL LIST OF RATING ACTIONS
Fitch currently rates STAG as follows:
STAG Industrial, Inc.
--Issuer Default Rating (IDR) 'BBB';
--Preferred stock 'BB+'.
STAG Industrial Operating Partnership, L. P.
--Senior unsecured revolving credit facility 'BBB';
--Senior unsecured term loans'BBB';
--Senior unsecured notes 'BBB'.