Fitch Affirms EastGroup Properties' IDR at 'BBB'; Outlook Stable

NEW YORK--()--Fitch Ratings affirms the following credit ratings of EastGroup Properties Inc. (NYSE: EGP) and its operating subsidiary, EastGroup Properties, LP (collectively EastGroup):

EastGroup Properties, Inc.

--Long-term IDR at 'BBB';

--Unsecured revolving credit facility at 'BBB';

--Unsecured term loans at 'BBB';

--Unsecured notes at 'BBB'.

EastGroup Properties, LP (as co-borrower with EastGroup Properties, Inc.)

--Long-term IDR at 'BBB';

--Unsecured revolving credit facility at 'BBB';

--Unsecured term loans at 'BBB';

--Unsecured notes at 'BBB'.

The Rating Outlook is Stable.

KEY RATING DRIVERS

Fitch's credit ratings reflect EastGroup's granular portfolio of industrial real estate assets across the southern U.S. Additional credit strengths include strong fixed charge coverage for the rating, improved operating fundamentals, appropriate leverage and adequate contingent liquidity provided by unencumbered assets.

EastGroup's modest liquidity shortfall under Fitch's base case projections and its related, growing development pipeline balance the ratings. EastGroup's portfolio is also exposed to markets with high concentrations of energy-related employment, such as Houston. This could lead to pressure from the sharp decline in oil prices during the last six months.

APPROPRIATE LEVERAGE

Fitch anticipates that leverage will approach 6.0x over the next 12-to-24 months, driven by low same-store NOI growth, continued ramp up of recent acquisitions and development completions. EastGroup's leverage was 6.5x at Dec. 30, 2014 on trailing twelve month (TTM) recurring operating EBITDA, which is appropriate for the rating. EastGroup's leverage is down slightly from 6.7x and 6.6x as of Dec. 31, 2013 and Dec. 31, 2012, respectively. Fitch defines leverage as debt, net of readily available cash divided by recurring operating EBITDA.

STRONG FIXED-CHARGE COVERAGE

Fitch expects the ratio to sustain around 3.2x through 2016, due to 1.5% same-store net operating income (NOI) growth and incremental NOI from $50 million in acquisitions and $90MM in developments with a blended yield of 8.2%. For the TTM ended Dec. 31, 2014, fixed-charge coverage (FCC) was 2.8x, which is strong for the rating. Fitch defines FCC as recurring operating EBITDA, less straight-line rent and recurring capital expenditures, divided by total cash interest incurred.

STRONG PORTFOLIO FUNDAMENTALS

Fitch expects fundamentals to generally remain strong in EastGroup's markets, but expects that the rate of growth will moderate over the rating horizon (typically one to two years), primarily due to weakness in Houston. Fitch expects same-store NOI for Houston properties to decline 2.5% for 2015. EastGroup's cash same-store NOI grew by 3.4% during 2014, following increases of 1.5% and 1.8% in 2013 and 2012, respectively.

GROWING DEVELOPMENT PIPELINE

EastGroup has expanded its development activities over the past few years with $132.5 million in projected total costs (including projects in lease-up and under construction) as of Dec. 31, 2014. The unfunded development costs to complete represented 1.8% of undepreciated cost basis of assets as of Dec. 31, 2014, which is still below the pre-crisis level of 3.7% as of Dec. 31, 2006.

MODEST ENERGY RELATED EXPOSURE

Fitch is concerned that the slowing economy in Houston and the potential for weakened demand and tenant credit issues, which have already affected the pace of leasing activity in Houston, may put additional pressure on EastGroup. Fitch sees the most risk in EGP's development pipeline where the lease-up of speculative development has slowed. Houston accounted for roughly 24% of committed development capital as of Dec. 31, 2014. While Houston represents approximately 20% of EastGroup's annualized base rent (ABR), EastGroup's direct exposure to energy-related tenants in its operating portfolio is relatively modest at 5% of ABR. Fitch views EastGroup's actual exposure as somewhere in between, given the importance of the energy sector to the Houston economy.

SLIGHT LIQUIDITY SHORTFALL

Fitch's liquidity projection for EGP shows a $46 million shortfall through 2016 due primarily to $195 million of mortgage debt maturing during the period. Liquidity coverage improves to 1.8x from 0.8x under an alternative scenario in which EastGroup refinances 80% maturing mortgage debt through Dec. 31, 2016.

This alternative scenario is unlikely given EastGroup's strategy of unencumbering assets by refinancing mortgage maturities with new unsecured debt. However, strong in-place debt yields of more than 14% would support refinancing in a more challenging capital markets environment. Fitch calculates liquidity coverage as sources of capital divided by uses of capital.

SOLID UNENCUMBERED ASSET COVERAGE

Contingent liquidity from EastGroup's growing unencumbered portfolio helps moderate Fitch's modest base case liquidity shortfall expectation. Based on a stressed 9% cap rate applied to fourth-quarter 2014 unencumbered NOI, the pool covers net unsecured debt by 2.2x and provides credit support for unsecured bondholders appropriate for the 'BBB' rating.

TRANSITION TO UNSECURED BORROWER

EastGroup continues to transition to an unsecured borrowing strategy and Fitch expects EGP to continue to refinance maturing mortgage debt with new unsecured debt, primarily via unsecured term loans and/or private placement senior unsecured notes. Fitch views this transition positively, as it diversifies sources of capital and increases financial flexibility by broadening EastGroup's unencumbered asset pool. However, EastGroup has yet to evidence full access to unsecured debt capital by accessing the public unsecured bond market. EastGroup's secured debt/total debt declined to 55% at Dec. 31, 2014 from 75% at Dec. 31, 2012.

ELEVATED LEASE EXPIRATIONS

EastGroup's leases generally average four-to-five years, which leads to an elevated level of leases expiring annually. 53% of the company's annualized base rent expires through 2017. This exposes EastGroup's cash flow to re-leasing risk. That said, Fitch notes that EastGroup's strong retention rates, combined with positive rent growth and proactive leasing, should help EGP preserve its cash flows. EGP renewed 72% of its leases during the year, equating to 79% of expiring square feet. Leasing spreads have also continued to recover - GAAP leasing spreads on renewals were positive for the third consecutive year during 2014 and cash spreads continued to improve in 2014 to 1.5% from (2.4%) in 2013 and (4.2%) in 2012.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:

--1.5% same store NOI growth, $90 million in developments and $50 million in annual acquisitions with a blended yield of 7.8%;

--External growth is funded with roughly 65% equity and 35% debt financing;

--CapEx and G&A growth consistent with historical levels relative to recurring operating EBITDA;

--Secured debt repayment with the issuance of new unsecured debt;

--AFFO payout ratio of approximately 80%.

RATING SENSITIVITIES

Fitch does not expect near-term positive rating momentum. However, the following factors may have a positive impact on EGP's ratings and/or Rating Outlook:

--Fitch's expectation of net debt to recurring operating EBITDA sustaining below 5.5x (TTM leverage was 6.5x as of Dec. 31, 2014);

--Fitch's expectation of fixed-charge coverage sustaining above 2.8x (coverage was 2.8x for the 12 months ended Dec. 31, 2014);

Conversely, the following factors may have a negative effect on EastGroup's ratings and/or Rating Outlook:

--Fitch's expectation of leverage sustaining above 6.5x;

--Fitch's expectation of fixed-charge coverage sustaining below 2.0x;

--Fitch's expectation of unencumbered asset to unsecured debt ratio sustaining below 2.0x.

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

Applicable Criteria and Related Research:

--'EastGroup Properties, Inc. - Ratings Navigator' (Feb. 26, 2015);

--'Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage' (May 28, 2014).

Applicable Criteria and Related Research:

EastGroup Properties, Inc. - Ratings Navigator

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=862014

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=981140

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Contacts

Fitch Ratings
Primary Analyst
Boris Alishayev, +1-212-612-7880
Associate Director
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Stephen Boyd, CFA, +1-212-908-9153
Director
or
Committee Chairperson
Steven Marks, +1-212-908-9161
Managing Director
or
Media Relations
Sandro Scenga, New York, +1 212-908-0278
sandro.scenga@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Boris Alishayev, +1-212-612-7880
Associate Director
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Stephen Boyd, CFA, +1-212-908-9153
Director
or
Committee Chairperson
Steven Marks, +1-212-908-9161
Managing Director
or
Media Relations
Sandro Scenga, New York, +1 212-908-0278
sandro.scenga@fitchratings.com