Fitch Affirms Prologis' IDR at 'BBB'; Outlook Positive
OREANDA-NEWS. Fitch Ratings has affirmed the Issuer Default Ratings (IDRs) for Prologis, Inc. (NYSE: PLD) and its operating partnership Prologis, L.P. at 'BBB'. A full list of rating actions follows at the end of this release.
The Rating Outlook is Positive.
KEY RATING DRIVERS
The Positive Outlook reflects Fitch's expectation that the company's pro rata leverage will trend to between 6.0x-6.5x over the next 12-24 months, which would be consistent with a higher rating.
However, the company delayed its trajectory towards lower leverage upon the acquisition of the real estate assets and operating platform of KTR Capital Partners (KTR) announced in April 2015.
The company funded its portion of the KTR acquisition primarily with debt and proceeds from asset sales, whereas Fitch's expectation at the time of our April 2015 IDR affirmation with a Positive Outlook was that the company would fund the acquisition with debt and $1.5 billion of follow-on equity, resulting in significantly more and earlier projected delevering than what has actually occurred. Fitch had expected Dec. 31, 2015 consolidated leverage to be at 6.1x, as compared to the actual ratio of 6.3x on a fourth quarter 2015 (4Q'15) run rate basis.
Pro rata leverage was 7.0x on a 1Q'16 run rate basis. While we still expect this ratio to decline to between 6.0x-6.5x over the next 12-24 months, in April 2015 we had expected the company to have reduced leverage to this level by 2016-end. The maintenance of the Positive Outlook reflects Fitch's expectations that PLD is targeting lower leverage and also has the means to achieve it.
Adequate Liquidity; No Corporate Debt Maturities Until 2017:
Fitch anticipates that the company will match-fund its development expenditures with dispositions and contributions to managed vehicles. Timing differences and whether the company adjusts development starts appropriately if dispositions and contributions were to slow would determine whether the company experiences a liquidity shortfall. Maintaining sufficient liquidity before this match-funding strategy reduces the risks to unsecured bondholders during periods of capital markets dislocation.
The company's liquidity coverage ratio is 1.5x for the period April 1, 2016 to Dec. 31, 2017. Fitch defines liquidity coverage as liquidity sources divided by uses. Liquidity sources include pro rata unrestricted cash, availability under unsecured revolving credit facilities, and projected retained cash flows from operating activities after dividends. Liquidity uses include pro rata debt maturities after extension options at PLD's option, projected recurring capital expenditures, and pro rata cost to complete development.
Internally generated liquidity is good, as the company's adjusted funds from operations (AFFO) payout ratio was 79% for the trailing 12 months (TTM) ended March 31, 2016. Based on the current payout ratio, the company would retain over $225 million in annual cash flow.
Improving Fundamentals and Fixed Charge Coverage:
Positive net absorption continues to benefit Prologis' portfolio driven by e-commerce demand, while macro industrial indicators such as manufacturing activity, housing starts and homebuilder confidence indicate that demand may continue to outpace supply. However, U.S. dollar strengthening could negatively impact exports, placing some pressure on domestic demand.
The company's average net effective rent change on lease rollovers has averaged 12% since the beginning of 2015, up from 7.4% on average during 2014 and 4.5% on average in 2013. Occupancy was 96.1% as of March 31, 2016, down 80 basis points (bps) from year end 2015 but PLD's share of adjusted cash same-store net operating income (SSNOI) has grown by an average of 4.8% in each of the last five quarters.
Fitch projects rental rate growth in the mid-single digits that will support 2%-3% SSNOI growth over the next several years. This should result in fixed-charge coverage (FCC) exceeding 3.0x, which is adequate for the rating.
Pro rata FCC for the TTM ended March 31, 2016 was 3.0x, up from 2.8x in 2015 and 2.4x in 2014. Fitch defines pro rata FCC as pro rata recurring operating EBITDA less pro rata recurring capital expenditures less straight-line rent adjustments divided by pro rata interest incurred and preferred stock dividends.
Pro Rata Metrics More Descriptive:
Fitch looks primarily at pro rata leverage (pro rata net debt-to-pro rata recurring operating EBITDA) rather than consolidated metrics given Fitch's expectation that PLD may in the future support or recapitalize unconsolidated entities despite not being legally recourse to PLD, its agnostic view toward property management for consolidated and unconsolidated assets, and its focus on pro rata portfolio and debt metrics. Fitch believes the scale, size and importance of the strategic capital segment to PLD would incentivize the company to support these entities.
As a supplementary measure, Fitch calculates consolidated leverage as consolidated net debt-to consolidated recurring operating EBITDA plus Fitch's estimate of recurring cash distributions from unconsolidated co-investment ventures, since these cash distributions benefit unsecured bondholders. At March 31, 2016, consolidated run rate leverage was 6.1x; however, this supplementary measure may understate leverage given the inclusion of cash distributions from joint ventures but exclusion of the corresponding non-recourse debt.
Excellent Capital Access:
The company has issued $7.9 billion and EUR3.2 billion in unsecured bonds since 2009 (principally using the proceeds to refinance and repurchase bonds and for general corporate purposes) and $3.7 billion of follow-on common equity. The company also has a $750 million at-the-market (ATM) equity offering program, of which $535.2 million remains available for use. Additionally, Prologis' recently increased its global revolver commitments to $3.4 billion in availability.
Strategic capital is another important source of funding for PLD, as evidenced by the KTR transaction being completed via a partnership with Norges Bank Investment Management. The company rationalized and restructured certain of its investment ventures to increase the permanency of its capital (e.g., FIBRA Prologis and Nippon Prologis REIT) and reduce the inter-dependence over the past several years, which Fitch views favorably.
Weak Unencumbered Asset Coverage:
Prologis has weak contingent liquidity with a stressed value of unencumbered assets (4Q'15 unencumbered NOI divided by a stressed 8% capitalization rate) to net unsecured debt of 1.7x. When applying a 50% haircut to the book value of land held and a 25% haircut to construction in progress, unencumbered asset coverage improves to 2.0x. While Fitch recognizes that there are additional unencumbered assets held in the joint ventures, there could be factors that may limit or impede PLD's ability to access this contingent liquidity such as partner approval for asset sales or encumbrances, though PLD could sell its interest. As such, Fitch has not explicitly considered these assets in its unencumbered asset calculations.
Total Development Exposure Down; Consistent Speculative Development:
PLD's strategy of developing industrial properties centers on value creation and complements the company's core business of collecting rent from owned assets. After construction and stabilization, the company either holds such assets on its balance sheet or contributes them to managed co-investment ventures.
PLD endeavors to match-fund development expenditures and acquisitions with cash from dispositions or contributions of assets to the ventures. If the company does not anticipate disposition or contribution volumes, PLD management has stated that the company would scale back development starts and acquisitions accordingly, though the sector has a mixed track record of forecasting market cycles.
The company's development platform is substantially smaller today than in the previous upcycle with cost to complete equal to 3% of undepreciated assets at March 31, 2016 (2.4% pro rata) compared with 17.9% at year-end 2007 (19.5% pro rata). However, a considerable portion of development remains speculative at more than half of total development each of the last three years, which implies elevated lease-up risk. Fitch expects PLD's development strategy to remain consistent but the significant reduction in exposure to its development projects should provide some downside protection for bondholders.
Preferred Stock Notching:
The two-notch differential between PLD's IDR and preferred stock rating is consistent with Fitch's criteria for corporate entities with an IDR of 'BBB'. Based on Fitch research titled 'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis', 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 key assumptions within our rating case for the issuer include:
--2.5% annual SSNOI through 2018;
--$1.6 billion annual development starts through 2018;
--$220 million annual building acquisitions through 2018;
--$788 million annual contributions to co-investment ventures through 2018;
--$1.5 billion annual third-party dispositions through 2018;
--Secured debt maturing in 2016 repaid with senior unsecured bond issuance;
--No debt or equity financing other than the aforementioned unsecured bond through forecast period.
The following factors may result in an upgrade to 'BBB+':
--Fitch's expectation of pro rata leverage sustaining below 6.5x is Fitch's primary rating sensitivity (pro rata 1Q'16 run rate leverage was 7.0x);
--Fitch's expectation of consolidated leverage sustaining below 6.0x (consolidated 1Q'16 run rate leverage was 6.1x. Fitch defines consolidated leverage as net debt to recurring operating EBITDA including recurring cash distributions from unconsolidated entities to Prologis);
--Fitch's expectation of liquidity coverage sustaining above 1.25x (this ratio is 1.5x);
--Fitch's expectation of pro rata FCC sustaining above 2x (this ratio was 3.0x for the TTM ended March 31, 2016).
The following factors may result in negative action on the ratings and/or Rating Outlook:
--Fitch's expectation of pro rata leverage sustaining above 7.5x;
--Fitch's expectation of consolidated leverage sustaining above 7.0x;
--Fitch's expectation of liquidity coverage sustaining below 1.0x;
--Fitch's expectation of FCC sustaining below 1.5x.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings:
--IDR at 'BBB';
--Preferred stock at 'BB+'.
--IDR at 'BBB';
--Global senior credit facility at 'BBB';
--Senior unsecured notes at 'BBB';
--Multi-currency senior unsecured term loan at 'BBB';
Prologis Tokyo Finance Investment Limited Partnership
--Senior unsecured guaranteed notes at 'BBB';
--Senior unsecured revolving credit facility at 'BBB';
--Senior unsecured term loan at 'BBB'.
The Rating Outlook is Positive.