Fitch Rates STAG's $120MM Senior Unsecured Notes 'BBB-'; Outlook Positive
STAG has earmarked the proceeds from the private placement to repay amounts outstanding under its unsecured revolving credit facility and for general corporate purposes, including the funding of future acquisitions. A full list of Fitch's ratings for STAG and its operating partnership STAG Industrial Operating Partnership, L.P. (hereafter STAG or the company) follows at the end of this release.
KEY RATING DRIVERS
The ratings reflect STAG's credit strengths, which include low leverage and strong fixed charge coverage for the rating, excellent liquidity, a sizable unencumbered asset pool and improving access to capital, including unsecured private placements and term loans and common equity via underwritten follow-on common equity offerings and ATM programs.
These credit positives are balanced by the company's portfolio concentration in secondary industrial markets and short operating history as a public company.
The Positive Outlook reflects the upward momentum in STAG's credit profile, including rapid organizational growth, improving fixed-charge coverage and enhanced access to unsecured debt capital - all in the context of leverage sustaining in the low 5.0x range.
STAG has achieved many of the rating sensitivities Fitch has identified as potentially leading to positive ratings momentum. However, the Positive Outlook captures pending additional seasoning in the company's operating portfolio and metrics. Specifically, Fitch will watch closely for evidence of stabilization in the company's same-store net operating income (NOI) growth following a period of unanticipated weakness during most of 2013 and 2014.
Weak Internal Growth
STAG's cash same-store NOI declined by 2.3% during 2014, with the quarterly cadence including year-over-year decreases of 4.9% in the first quarter of 2014 (1Q'14), 1.2% in 2Q'14, 0.6% in 3Q'14 and 1.5% in 4Q'14. The company's annualized same store NOI change has been negative since 2Q'13. Positively, STAG retained 71.7% of its expiring leased square footage in 4Q'14, resulting in an annual tenant retention rate of 69.7%.
During 2013, STAG attributed its same-store NOI declines to unusually low tenant retention due to a period of heightened corporate change and, to a lesser extent, the harsh weather during the late 2013/early 2014 winter. The company has cited the dynamics of its single-tenant acquisition led growth model for its recent same-store NOI declines, whereby the law of large numbers pulls STAG's portfolio occupancy rate closer to market (roughly 95%), despite most properties entering the portfolio 100% leased.
STAG's leverage was 4.9x based on an annualized run rate of STAG's recurring operating EBITDA for the quarter ending Dec. 31, 2014, which is strong for the 'BBB-' rating. This compares with 5.4x on an annualized basis for the quarter ending Dec. 31, 2013 and 6.3x for the quarter ending Dec. 31, 2012. Adjusting 4Q'14 earnings for the impact of partial period acquisitions would reduce STAG's leverage to 4.7x. Fitch's projections anticipate that 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.
Improving Capital Access
STAG's issuances of senior unsecured notes in July 2014, December 2014 and February 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, Fitch continues to view STAG as a relatively less seasoned unsecured bond issuer pending further private placement issuance.
Strong Fixed-Charge Coverage
Fitch expects the company's fixed charge coverage to sustain in the low 3.0x through 2016. The low interest rate environment and higher capitalization rates on class B industrial properties in secondary markets should allow STAG to continue deploying capital on a strong spread investing basis. STAG's fixed charge coverage was 3.4x for the year-ended Dec. 31, 2014 and 3.3x and 2.8x for the years ending Dec. 31, 2013 and 2012, respectively.
STAG completed a \$600 million refinancing of its unsecured bank debt in December 2014. The refinancing reduced the company's 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 replaced its \$200 million unsecured revolving credit facility with a new \$300 million revolver that has a lower cost and extends the maturity by three years to December 2019 through the refinancing.
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 3.0x in 4Q'14, which is strong for the current ratings. 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 traditional ground-up speculative and BTS development undertaken by some of STAG's industrial REIT peers.
Secondary Market Locations
STAG's strategy centers on the acquisition of individual class B, single tenant industrial properties (warehouse/distribution and manufacturing assets) predominantly in secondary markets throughout the United States by sourcing 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 other buyers.
The company has only minimal exposure to what are traditionally considered the '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 given superior liquidity characteristics for industrial assets in 'core' markets - both in terms of financing and transactions.
Limited Public Company Track Record
STAG has a limited track record as a public company, having gone public in 2Q'11. This track record is balanced by 1) the homogeneity of industrial properties, 2) management's prior experience successfully managing STAG's predecessor as a private company that dates back to 2004 and 3) management's extensive real estate and capital markets experience.
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.
The Positive Outlook is based on Fitch's expectation for stabilization and improvement in the company's cash same-store NOI growth over the rating horizon, coupled with Fitch's expectation that STAG will maintain leverage and fixed-charge coverage of approximately 5.0x and 3.0x on a run rate basis, metrics that are consistent with a 'BBB' IDR.
Fitch's base case rating assumptions for STAG include the following:
--Stabilization and improvement in STAG's tenant retention and same-store NOI growth;
--Leverage sustaining in the low 5.0x range over the rating horizon (approximately one to three years);
--Fixed-charge coverage improving to the mid-3.0x range through 2016;
--Industrial property acquisitions of \$400 million in 2015 and \$500 million in 2016;
--STAG funds its near-to-medium term external growth with roughly 60% equity and 40% debt financing; and
--Dividend growth of 5% per annum.
The following factors may have a positive impact on STAG's ratings:
--Stabilization, followed by sustained improvement in STAG's tenant retention and same-store NOI growth is Fitch's primary consideration for positive ratings momentum;
--Continued access to the unsecured bond market;
--Leverage calculated on an annualized basis adjusted for acquisitions sustaining below 5.5x (leverage was 4.7x as of Dec. 31, 2014);
--Fixed charge coverage to sustaining above 3.0x (coverage was 3.4x as of Dec. 31, 2014).
The following factors may have a negative impact on the company's ratings and/or Outlook:
--Fitch's expectation for leverage sustaining above 6.5x;
--Fixed charge coverage sustaining below 2.0x;
--A meaningful increase in the percentage of STAG's encumbered assets relative to gross assets.
In addition to the \$80 million of unsecured notes, Fitch currently rates STAG as follows:
STAG Industrial, Inc.
--Issuer Default Rating (IDR) 'BBB-';
--\$139 million preferred stock 'BB'.
STAG Industrial Operating Partnership, L.P.
--\$300 million senior unsecured revolving credit facility 'BBB-';
--\$180 million senior unsecured notes 'BBB-';
--\$150 million senior unsecured term loans 'BBB-'.