Fitch Rates Prologis' Unsecured Bonds 'BBB'
OREANDA-NEWS. Fitch Ratings has assigned a 'BBB' rating to the $750 million of 3.75% notes due 2025 issued by Prologis, Inc.'s operating partnership Prologis, L.P. (collectively PLD or the company). The company expects to use the net proceeds to repurchase all of its outstanding 4.5% notes due 2017, to fund its $200 million cash tender offer to repay select notes scheduled to mature between 2019 and 2020, as well as for general corporate purposes. The notes were issued at 99.381% of par to yield 3.825%.
The Rating Outlook is Positive. A full list of Fitch's current ratings for PLD follows at the end of this release.
KEY RATING DRIVERS
The Positive Outlook reflects Fitch's expectation that the company's leverage will trend to the 6.0x - 6.5x range over the next 12-to-24 months, which would be consistent with a higher rating. The KTR acquisition in April 2015 added a high quality portfolio largely located near major ports in Southern California, New York-New Jersey, Chicago, San Francisco and Dallas (markets in which Prologis already had a significant presence) and a strong tenant roster with exposure to e-commerce tenants, a growing segment in the industrial real estate market.
High Leverage Expected to Decline
The company's 7.6x pro rata 3Q'15 run rate debt-to-EBITDA ratio is slightly high for the current rating; however, Fitch projects pro rata leverage will trend to the 6.0x - 6.5x range over the next 12-to-24 months. Fitch's 6.5x positive rating sensitivity for Prologis acknowledges the company's strong asset quality and lower market cap rates for its portfolio properties.
Weak Liquidity; No Corporate Debt Maturities Until 2017
Fitch anticipates that the company will continue to match-fund its development expenditures with dispositions and contributions. Maintaining sufficient liquidity before the match-funding reduces the risks to unsecured bondholders during periods of capital markets dislocation.
The company's liquidity coverage ratio is 0.9x for the period Oct. 1, 2015 to Dec. 31, 2017, pro forma for the $750 million unsecured issuance. Fitch defines liquidity coverage as liquidity sources divided by uses. Liquidity sources include the net proceeds from the unsecured issuance, unrestricted cash, availability under revolving credit facilities, and projected retained cash flows from operating activities. 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 moderate as the company's adjusted funds from operations (AFFO) payout ratio was 91.3% in 3Q'15 compared to 88.7% in 2014 and 95.4% in 2013. Based on the current payout ratio, the company would retain approximately $80 million in annual cash flow.
Improving Fundamentals and Fixed-Charge Coverage
Positive net absorption continues to benefit Prologis' portfolio while macro industrial indicators such as manufacturing activity, housing starts and homebuilder confidence indicate that demand may continue to outpace supply.
The company's average net effective rent change on lease rollovers has averaged 11.4% YTD, up from 7.4% on average during 2014 and 4.5% on average in 2013. Occupancy was 96.0% as of September 30, 2015 just below the 96.1% level at Dec. 31, 2014, and up from 95.0% at Dec. 31, 2013 and cash same-store net operating income (NOI) has grown by an average of 3.9% YTD, compared to a 4.5% average in 2014 and 1.8% average in 2013.
Fitch projects that rental rate growth in the high single digits (supported by in-place portfolio rents that are approximately 10% below market) will result in 3% - 4% same store NOI (SSNOI) growth over the next several years. This should result in FCC sustaining in the 2.5x to 3.0x range, which is adequate for the rating. Under the Fitch stress case, FCC would remain around 2.5x.
LTM Sept. 30, 2015 pro rata fixed-charge coverage (FCC) was 2.7x, up from 2.4x in 2014 and 1.8x in 2013. 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 Treatment
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 has and would in the future support or recapitalize unconsolidated entities, its agnostic view toward property management for consolidated and unconsolidated assets, and its focus on pro rata portfolio and debt metrics.
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 Sept. 30, 2015, consolidated run rate leverage was 7.3x; 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 at a weighted average discount of 1.8% to consensus estimated net asset value.
The company also has a $750 million at-the-market (ATM) equity offering program, and in December 2014 received proceeds of $353.9 million through the issuance of equity securities from the exercise of a warrant issued in connection with the formation of Prologis European Logistics Partners and through the ATM program.
Strategic capital is another important source of funding for PLD, as evidenced by the KTR transaction being completed via a partnership with NBIM. 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 (3Q'15 unencumbered NOI divided by a stressed 8% capitalization rate) to net unsecured debt of 1.6x. 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 1.8x.
Increasing 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 costs to complete equal to 3.9% of undepreciated assets at Sept. 30, 2015 (3.2% pro rata) compared with 14.1% at year-end 2007. However, speculative development has increased over the past several years to 75.1% of total development as of Sept. 30, 2015, up from 72.2 and 70.1% as of Dec. 31, 2014 and Dec. 31, 2013, respectively, which implies elevated lease-up risk. The KTR development portfolio increases the likelihood that development will continue in the coming years.
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 for Prologis in Fitch's base case include:
--3% to 4% annual same-store NOI through 2017;
--G&A growth to maintain historical margins relative to total revenues initially but potentially be reduced over the next several years due to geographical overlap of the KTR portfolio;
--$2.0 billion annual development starts through 2017;
--$875 million annual building acquisitions through 2017;
--$1.1 billion annual contributions to co-investment ventures through 2017;
--$1.8 billion annual third-party dispositions through 2017;
--Debt repayment with the issuance of new unsecured bonds;
--AFFO payout ratio in the low 90% range.
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 run rate leverage was 7.6x as of Sept. 30, 2015);
--Fitch's expectation of consolidated leverage sustaining below 6.0x (consolidated run rate leverage was 7.3x as of Sept. 30, 2015. Fitch defines consolidated leverage as net debt to recurring operating EBITDA including Fitch's estimate of recurring cash distributions from unconsolidated entities to Prologis);
--Fitch's expectation of liquidity coverage sustaining above 1.25x (this ratio is 0.9x pro forma for the $750 million unsecured issuance);
--Fitch's expectation of pro rata FCC sustaining above 2x (coverage was 2.7x for the TTM period ended Sept. 30, 2015).
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, which could be the result of the company not funding the KTR transaction on a leverage neutral basis and/or a deterioration in operating fundamentals;
--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 currently rates PLD as follows:
--Issuer Default Rating (IDR) 'BBB';
--Preferred stock 'BB+'.
--Global senior credit facility 'BBB';
--Senior unsecured notes 'BBB';
--Multi-currency senior unsecured term loan 'BBB';
Prologis Tokyo Finance Investment Limited Partnership
--Senior unsecured guaranteed notes 'BBB';
--Senior unsecured revolving credit facility at 'BBB';
--Senior unsecured term loan 'BBB'.
The Rating Outlook is Positive.