NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed its ratings of STAG Industrial, Inc. (NYSE: STAG) and its operating partnership STAG Industrial Operating Partnership, L.P. (collectively, the company), including the Long-Term Issuer Default Ratings (IDR), at 'BBB'. Fitch has also assigned a 'BBB' rating to the previously announced $150 million committed term loan STAG plans to draw down during the fourth quarter of 2016 (4Q16). A full list of Fitch's rating actions follows at the end of this release.
KEY RATING DRIVERS
Fitch's ratings for STAG reflect the company's credit strengths, which include appropriate leverage and fixed charge coverage (FCC) metrics for the rating, strong 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 net debt-to-annualized recurring EBITDA (adjusted for partial period investments) sustaining in the low-to-mid-5.0x range and FCC coverage at or above 3.0x.
STAG's policy leverage target is strong relative to similarly rated REITs, which is appropriate given its 75.9% portfolio weighting in company-defined secondary and tertiary markets that generally trade at higher cap rates.
Strategy, Growth Pressuring SSNOI
Fitch expects STAG's same store net operating income (SSNOI) to be flat to slightly positive through our 2018 projection period as occupancy losses offset solidly positive leasing spreads. STAG's SSNOI growth will likely trail its industrial REIT peers due to the company's strategy of acquiring 100% occupied single-tenant industrial buildings. 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%).
STAG is generally compensated for this occupancy loss through higher going-in yields for acquisitions. The company's leasing spreads and tenant retention rates, which Fitch views as alternative measures of portfolio quality and functionality, are generally in-line with its peers.
STAG's cash SSNOI grew by 0.6% during 2Q16 and 2.0% for the first six months of the year. This follows positive 0.6% SSNOI growth during 2015, which reversed a negative trend that included SSNOI declines of 2.0% and 2.2% in 2014 and 2013, respectively. STAG retained 69% of its expiring leased square footage for the TTM ended June 30, 2016 - a level consistent with the company's long-term average.
Appropriate Leverage
Fitch projects the company will have net debt to EBITDA 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 June 30, 2016. The company's leverage was 6.1x including 50% equity credit for its perpetual preferred stock in total debt.
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. However, STAG's unsecured debt capital access remains somewhat less established than similarly rated peers pending an inaugural public unsecured bond offering and further private placement issuance. 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.
Healthy Fixed Charge Coverage
Fitch expects the company's FCC to improve to the mid-3.0x range over the one-to-two-year Outlook horizon. STAG's recent $75 million preferred equity issuance has contributed to FCC declining to 3.0x from 3.4x in 2015. The company plans to redeem its 9% series A preferreds in November 2016, which will improve its FCC, all else equal. Fitch also expects the company to repay its $70 million 6.625% preferred stock when it becomes callable during 2018.
Strong Liquidity Profile
STAG's liquidity position is strong, with $386 million of availability under its committed, unsecured credit facility and $150 million of committed unsecured term loan borrowings that Fitch expects the company to access during 4Q16. STAG has minimal debt maturities until 2018 when $120 million of secured property-level mortgages mature.
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 2Q16, which is solid for the 'BBB' rating.
STAG's substantial unencumbered asset pool is a source of contingent liquidity that enhances its credit profile.
Straightforward Business Model
STAG has not made investments in ground-up development or unconsolidated joint venture partnerships, in contrast to many of its industrial REIT peers. 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.
Secondary Market Locations
STAG's growth strategy centers on the acquisition of single-tenant industrial buildings, including warehouse/distribution properties (87.3% of annualized base rent [ABR]), manufacturing assets (9.2%) and flex/office space (3.5%). The company's emphasis on relative value has led it to acquire mainly properties in secondary markets throughout the United States. Such transactions typically range in price from $5 million to $50 million and have higher going-in yields and less competition from institutional buyers.
At June 30, 2016, secondary markets comprised the majority of STAG's portfolio (64.7% of annualized base revenue), followed by primary markets (24.1%) and tertiary markets (11.2%). The company defines primary markets as markets with approximately 200 million or more in net rentable industrial square footage. Secondary industrial markets have net rentable square footage ranging from approximately 25 million to approximately 200 million, and tertiary markets are those with less than 25 million square feet of net rentable industrial square footage.
The company has only minimal exposure to what market participants generally 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. However, the portfolio's granular geographic diversity should help reduce cash flow volatility.
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, which provides 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 key assumptions within the rating case for STAG include:
--STAG's SSNOI grows by 0%-1% per annum through 2018;
--Acquisitions of approximately $475 million, $550 million, $750 million in 2016, 2017, and 2018, respectively;
--Dispositions of $150 million during 2016 and none thereafter;
--Unsecured debt borrowings of $150 million, $225 million and $325 million during 2016, 2017 and 2018, respectively;
--Equity issuance of $275 million in 2016, $350 million in 2017, and $450 million in 2018;
--STAG repurchases its $69 million 9% Series A preferreds during 4Q16 and its $70 million 6.625% preferred stock when it becomes callable in 2018.
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 5.5x as of June 30, 2016 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 3.0x for the quarter ended June 30, 2016).
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 2.0x (Coverage was 2.1x for the quarter ended June 30, 2016).
FULL LIST OF RATING ACTIONS
Fitch has affirmed STAG's ratings as follows:
STAG Industrial, Inc.
--Issuer Default Rating (IDR) at 'BBB';
--Preferred stock at 'BB+'.
STAG Industrial Operating Partnership, L.P.
--IDR at 'BBB';
--Senior unsecured revolving credit facility at 'BBB';
--Senior unsecured notes at 'BBB';
--Senior unsecured term loans at 'BBB'.
Fitch has also assigned a 'BBB' rating to STAG's $150 million committed term loan that we expect the company to access during 4Q16.
The Rating Outlook is Stable.
Additional information is available on www.fitchratings.com.
Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below:
--Historical and projected recurring operating EBITDA is adjusted to add back non-cash stock-based compensation and include operating income from discontinued operations;
--Fitch has adjusted the historical and projected net debt by assuming the issuer requires $5 million of cash for working capital purposes which is otherwise unavailable to repay debt.
Applicable Criteria
Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)
https://www.fitchratings.com/site/re/885629
Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis (pub. 29 Feb 2016)
https://www.fitchratings.com/site/re/878264
Additional Disclosures
Dodd-Frank Rating Information Disclosure Form
https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1012711
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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1012711
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https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31
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