Fitch Rates STAG Industrial, Inc.'s $75MM 6.875% Ser C Cumulative Redeemable Preferred Stock 'BB+'

NEW YORK--()--Fitch Ratings has assigned a 'BB+' rating to STAG Industrial, Inc.'s 6.875% Series C Cumulative Redeemable Preferred Stock issued on March 10, 2016. The company plans to use the net proceeds of $72.6 million to finance acquisitions and repay debt outstanding under its unsecured credit facility. A full list of Fitch's ratings for STAG and its operating subsidiary STAG Industrial Operating Partnership, L.P. (hereafter STAG or the company) follows at the end of this release.

The Rating Outlook is Stable.

KEY RATING DRIVERS

Fitch's ratings for STAG reflect the company'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.

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.

That said, STAG's cash SSNOI grew by 1.7% during the fourth quarter of 2015 (4Q'15), helping the company to achieve 0.6% SSNOI growth during 2015. The positive 2015 growth reversed a negative trend that included SSNOI declines of 2.0% and 2.2% in 2014 and 2013, respecitively. STAG retained 49.2% of its expiring leased square footage in 4Q'15. The company's 2015 retention rate was 69.8%, which is generally in-line with its long-term average.

Adequate Leverage

Fitch projects the company will sustain leverage in the 5.0x to 5.5x range 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 5.5x based on an annualized run rate of recurring operating EBITDA for the quarter ending Dec. 31, 2015 and 5.3x after adjusting 4Q'15 earnings for the impact of partial period acquisitions. Fitch recently revised its treatment of REIT cumulative perpetual preferred stock to 50% equity credit from 100%. STAG's annualized leverage adjusted for partial period acquisitions and including 50% of preferred equity credit was 5.7x at Dec. 31, 2015.

Improving Capital Access

STAG's issuances of senior unsecured notes in July 2014, December 2014, February 2015 and December 2015 have been important milestones in the company's transition to a predominantly unsecured borrowing strategy, evidencing broader access to unsecured debt capital. 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 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 3.4x and 3.4x for the years ended Dec. 31, 2015 and 2014, respectively.

Sufficient Liquidity

STAG maintains sufficient liquidity of $12.0 million in cash and $422 million remaining availability under its unsecured credit facility and unsecured term loans. The company has minimal debt maturities over the next several years, until $132 million of secured property level mortages mature during 2018.

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 2.1x in 4Q'15, which is solid 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 (primarily warehouse/distribution and manufacturing assets). Its emphasis on relative value has predominantly led the company to acquire properties 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 institutional buyers.

As of Dec. 31, 2015, the company's portfolio was primarily in secondary markets (64.2% of annualized base revenue), followed by primary markets (23.4%) and tertiary markets (12.4%). 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 only minimal exposure to what market participants general consider '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 - both in terms of financing capacity and transaction volumes.

Differentiated Strategy within Fragmented Market

STAG's current market share of its target markets is less than 1% of the $250 billion single-tenant industrial market in secondary markets, providing growth opportunities in the company's target asset class. The company's management team 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. This differentiated business model is thoughtful in its considerations of 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.

Stable Outlook

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.

KEY ASSUMPTIONS

Fitch's base case rating assumptions for STAG include the following:

--SSNOI declines within a range of 1% - 2% in 2016 and 2017;

--Net acquisition activity of approximately $200 million through 2017;

--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%.

RATING SENSITIVITIES

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 5.7x as of Dec. 31, 2015 after giving effect to partial period acquisitions);

--Further development of STAG's unsecured debt capital access;

--Fixed charge coverage to sustaining above 4.0x (coverage was 3.2x for the year ended Dec. 31, 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 of 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.

--IDR 'BBB';

--Senior unsecured revolving credit facility 'BBB';

--Senior unsecured term loans'BBB';

--Senior unsecured notes 'BBB'.

Date of Relevant Committee: Oct. 7, 2015.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362

Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis (pub. 29 Feb 2016)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=878264

Additional Disclosures

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Contacts

Fitch Ratings
Primary Analyst
Stephen Boyd, CFA
Senior Director
+1-212-908-9153
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Steven Marks
Managing Director
+1-212-908-9161
or
Committee Chairperson
Michael Weaver
Managing Director
+1-312-368-3156
or
Media Relations:
Sandro Scenga, +1 212-908-0278
sandro.scenga@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Stephen Boyd, CFA
Senior Director
+1-212-908-9153
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Steven Marks
Managing Director
+1-212-908-9161
or
Committee Chairperson
Michael Weaver
Managing Director
+1-312-368-3156
or
Media Relations:
Sandro Scenga, +1 212-908-0278
sandro.scenga@fitchratings.com