NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the credit ratings for Prologis, Inc. (NYSE: PLD) and its rated subsidiaries as follows:
--Issuer Default Rating (IDR) at 'BBB';
--$78.2 million preferred stock at 'BB+'.
--IDR at 'BBB';
--$2.5 billion global senior credit facility at 'BBB';
--$5.6 billion senior unsecured notes at 'BBB';
--$460 million senior unsecured exchangeable notes at 'BBB';
--EUR500 million multi-currency senior unsecured term loan at 'BBB'.
Prologis Tokyo Finance Investment Limited Partnership
--JPY45 billion senior unsecured revolving credit facility at 'BBB'.
--JPY40.9 billion senior unsecured term loan at 'BBB'.
The Rating Outlook has been revised to Positive from Stable.
KEY RATING DRIVERS
The Positive Outlook reflects the material improvement in the company's liquidity position, increasing cash flow in excess of fixed charges, reflecting strong property fundamentals and the expectation that leverage will decline to levels commensurate with a 'BBB+' IDR. Prologis reduced leverage over the past year by growing EBITDA and repaying debt with proceeds from asset sales and contributions to co-investment ventures. However, leverage remains high for the 'BBB' rating (pro-rata 7.5x in second quarter 2014 [2Q'14] and 7.8x for the trailing 12 months (TTM) ended June 30, 2014, due in part to the company's land holdings).
Credit strengths include strong asset quality, excellent access to capital, and a global platform with diversification by location and tenant. Prologis has adequate unencumbered asset coverage of unsecured debt. The main credit concerns are the high leverage and the continued increase in the company's speculative development pipeline which results in elevated lease-up risk.
Material Improvement in Liquidity; Change in Strategy
Prologis improved its liquidity position over the past year and Fitch expects PLD will seek to maintain sufficient liquidity before considering proceeds from dispositions and contributions. While Fitch expects PLD 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 improved to 1.2x for the period July 1, 2014 to Dec. 31, 2016 from 0.8x a year prior as a result of multiple bond offerings and increased availability under the bank facility agreements, despite the offsetting effect of using some of the proceeds to tender for longer dated bonds. Fitch defines liquidity coverage as liquidity sources divided by uses for the period July 1, 2014 to Dec. 31, 2016. Liquidity sources include unrestricted cash, availability under revolving credit facilities pro forma for the repurchase of 2017-2018 notes in July 2014, 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. Under a scenario by which the company's 3.25% exchangeable debentures convert to equity in 2015, liquidity coverage would improve to 1.5x.
On a pro forma basis, only 0.4% of pro rata debt matures for the remainder of 2014, followed by 8.5% in 2015 and 8.1% in 2016. Internally generated liquidity is moderate as the company's adjusted funds from operations (AFFO) payout ratio was 83.5% in 2Q'14, down from 95.4% in full year 2013. Based on the current payout ratio, the company would retain approximately $130 million in annual cash flow.
Improving Fundamentals and Fixed-Charge Coverage
Positive net absorption continues to benefit PLD's portfolio while macro industrial indicators such as manufacturing levels, housing starts and homebuilder confidence indicate that demand may continue to outpace supply. The company's average net effective rent change on rollover was 6.4% for the TTM ended June 30, 2014, up from 4.5% on average in 2013. Average occupancy also increased to 94.5% for the TTM ended June 30, 2014 from 94.1% on average for 2013, and cash same-store net operating income (NOI) grew by 3.6% on average for the TTM ended June 30, 2014, up from 1.6% on average in 2013.
Pro rata fixed-charge coverage (FCC) was 2.4x in 2Q'14 (2.1x TTM), up from 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.
Fitch projects that a minor increase in occupancy and rental rate growth in the high single digits (since in-place rents over the next several years remain approximately 10% below market rents) 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 appropriate for a 'BBB+' rating.
High Leverage Expected to Decline
PLD's 7.5x pro rata debt-to-EBITDA ratio as of June 30, 2014 is high for the 'BBB' rating. Fitch projects that pro rata leverage will decline through 2016 to approximately 6.5x due primarily to SSNOI growth. Fitch's leverage threshold of 6.5x for a 'BBB+' rating for Prologis acknowledges the company's strong asset quality and lower portfolio yields.
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. However, this supplementary measure may understate leverage given the inclusion of cash distributions from joint ventures but exclusion of the corresponding non-recourse debt. Fitch does not expect Prologis to take any of the co-investment ventures' assets or debt onto its balance sheet over the next several years.
Excellent Access to Capital
The company issued $9 billion in unsecured bonds since 2009 (using the proceeds to refinance and repurchase bonds) 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 equity offering program, though it has yet to utilize this program. Debt issuance volumes have been particularly strong over the past year as the company has issued EUR1.9 billion and $1.75 billion of bonds since August 2013.
Strategic capital is another important source of funding for PLD. In 2014, PLD formed Prologis U.S. Logistics Venture with Norway's sovereign wealth fund NBIM (the second venture between NBIM and Prologis following the formation of Prologis European Logistics Partners Sarl in 2013). Strategic capital raises also include publicly traded vehicles (FIBRA Prologis and Nippon Prologis REIT). The company rationalized and restructured certain of its investment ventures to increase the permanency of its capital and reduce the inter-dependence over the past several years, which Fitch views favorably.
Prologis had $51.6 billion of assets under management as of June 30, 2014 and the global platform limits the risk of over-exposure to any one region's fundamentals. PLD derived 83.3% of its 2Q'14 NOI from Prologis-defined global markets (56.2% in the Americas, 21.8% in Europe, and 5.3% in Asia), and the remaining 16.7% of 2Q'14 NOI was derived from regional and other markets. The portfolio generally has proximity to ports or intermodal yards, cross-docking capabilities and structural items such as tall clearance heights.
The portfolio has limited tenant concentration, which is a credit strength, as only the top four tenants comprise more than 1% of annual base rent (ABR). PLD's top tenants at March 31, 2014 were DHL (2.1% of ABR), CEVA Logistics (1.4% of ABR), Kuehne & Nagel (1.3% of ABR) and Geodis (1.2% of ABR).
Adequate Unencumbered Asset Coverage
Prologis has adequate contingent liquidity with unencumbered assets (2Q'14 unencumbered NOI divided by a stressed 8% capitalization rate) to unsecured debt of 2.0x. When applying a stressed 50% haircut to the book value of land held and a 25% haircut to construction in progress, unencumbered asset coverage improves to 2.2x.
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.
Fitch views PLD's improved focus on risk management related to its business, including development (i.e. Prologis Integrated Risk Index) favorably. Development is substantially smaller today with total expected investment (TEI) at 9.1% of undepreciated assets at June 30, 2014 versus 31.8% at year-end 2007 (ProLogis and AMB Property Corporation pro forma). Costs to complete are 3.7% of undepreciated assets at June 30, 2014 (2.8% pro rata) compared with 14.1% at year-end 2007. However, speculative development increased post-merger to 82.4% at June 30, 2014 from 58.2% in 2013 and 43.2% in 2012, which illustrates elevated lease-up risk.
Preferred Stock Notching
The two-notch differential between PLD's IDR and its preferred stock rating is consistent with Fitch's 'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis' criteria report dated Dec. 23, 2013, as PLD's preferred securities have cumulative coupon deferral options exercisable by PLD and thus have readily triggered loss-absorption provisions in a going concern.
Prologis Tokyo Finance Investment Limited Partnership
Fitch has assigned a senior unsecured guaranteed notes rating of 'BBB' to Prologis Tokyo Finance Investment Limited Partnership, which is a wholly-owned subsidiary of Prologis, Inc. Prologis, Inc. and Prologis, L.P. guarantee the obligations of Prologis Tokyo Finance Investment Limited Partnership.
The following factors may result in a ratings upgrade to 'BBB+':
--Fitch's expectation of pro rata leverage sustaining below 6.5x is Fitch's primary rating sensitivity (pro rata leverage was 7.5x in 2Q'14 and 7.8x TTM);
--Fitch's expectation of consolidated leverage sustaining below 6x (consolidated leverage was 6.1x in 2Q'14 and 6.5x TTM. 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 1.2x for the period July 1, 2014 to Dec. 31, 2016 but improves to 1.5x under a scenario by which the company's 3.25% exchangeable debentures convert to equity in 2015);
--Fitch's expectation of FCC sustaining above 2x (this ratio was 2.4x in 2Q'14 and 2.1x TTM);
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.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (May 28, 2014);
--'Rating U.S. Equity REITs and REOCs: Sector Credit Factors,' (Feb. 26, 2014);
--'Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis' (Dec.
--'Recovery Ratings and Notching Criteria for Equity REITs' (Nov. 19, 2013).
Applicable Criteria and Related Research:
Recovery Ratings and Notching Criteria for Equity REITs
Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis
Rating U.S. Equity REITs and REOCs (Sector Credit Factors)
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage