Credit Opinion: Citycon OYJ

Transcription

1 Credit Opinion: Citycon OYJ Global Credit Research - 25 Aug 2015 Helsinki, Finland Ratings Category Outlook Issuer Rating Senior Unsecured -Dom Curr Citycon Treasury B.V. Outlook Bkd Senior Unsecured -Dom Curr Moody's Rating Stable Baa2 Baa2 Stable Baa2 Contacts Analyst Phone Roberto Pozzi/London Maria Maslovsky/London Patrick Mispagel/London Key Indicators [1]Citycon OYJ 6/30/2015(L) 12/31/ /31/ /31/ /31/2011 FFO Payout 70.3% 64.0% 52.7% 81.5% 60.5% Amount of Unencumbered Assets 99.8% 99.9% 99.4% 98.5% 98.6% Debt / Gross Assets [2] 40.8% 39.0% 49.3% 54.5% 57.9% Net Debt / EBITDA 8.5x 7.6x 9.6x 11.1x 12.7x Secured Debt / Gross Assets 0.1% 1.0% 1.0% Gross Assets (USD Million) $3,507.5 $3,678.4 $4,106.5 $3,723.0 $3,479.5 Development Pipeline 8.0% 7.2% 1.1% 0.8% EBITDA Margin (YTD) 61.0% 62.0% 59.9% 55.9% 53.1% EBITDA Margin Volatility 3.7% 7.2% 5.3% 3.9% 4.5% EBITDA / Fixed Charges (YTD) [3] 4.0x 2.7x 2.3x 2.0x 1.9x Joint Venture Exposure (YTD) 16.1% 15.8% 17.5% 1.6% 1.4% [1] All ratios are based on 'Adjusted' financial data and incorporate Moody's Global Standard Adjustments for Non- Financial Corporations. Source: Moody's Financial Metrics [2] Debt includes a portion of hybrid securities considered to have debt like features as explained in Moody's Approach to Global Standard Adjustments in the Analysis of Financial Statements for Non-Financial Corporations revised December 2010 [3] Fixed Charges includes capitalized interests explained in Moody's Approach to Global Standard Adjustments in the Analysis of Financial Statements for Non-Financial Corporations revised December Note: For definitions of Moody's most common ratio terms please see the accompanying User's Guide. Opinion Rating Drivers

2 - Solid cash flow generation supported by high occupancy rates - Inflation-indexed leases underpin rental growth - Modest exposure to development risk - Moderate leverage and healthy fixed charge coverage - Commitment to a conservative financial policy, demonstrated by rights issue to support recent acquisition of Sektor Corporate Profile Citycon OYJ is a real estate company that invests in and manages community shopping centres in urban locations close to public transportation, primarily in Finland, Sweden and Estonia, with a foothold in Denmark. The company is headquartered in Finland and has been listed since 1988 on the Helsinki Stock Exchange. The company's market cap was EUR2.9 billion as of 7 August Citycon's three largest shareholders are Gazit Globe, an Israeli investment company with a 42.8% stake, Canada Pension Plan Investment Board European Holdings (CPPIBEH) with 15%, and Finnish pension fund, Ilmarinen Mutual, with 7.13%. Citycon reported last-12- months consolidated net rental income of EUR million and total assets of EUR3.1 billion as of 30 June In July 2015, Citycon acquired Sektor Gruppen AS (unrated), Norway's second largest retail property investment company, for a purchase price of EUR 541 million, or EUR 1,493 million enterprise value. Sektor reported revenues equivalent to EUR127 million and EUR1.5 billion of gross assets at year-end SUMMARY RATING RATIONALE Citycon's Baa2 rating primarily reflects its stable and recurring rental income, which benefits from inflation-indexed leases. The company has pursued a successful strategy to invest in and manage shopping centres offering grocery- and necessity-driven retail that are based in growing urban locations, dominant in their catchment area, close to public transportation and located primarily in Finland, Sweden, Estonia and now also Norway. The company's solid cash flow is supported by high average occupancy rates, reported at 96% as of 30 June 2015, compared 95.7% per June We expect that Citycon will maintain high occupancy levels, particularly because the cost of occupation for its tenants is at affordable levels. This expectation is supported by the weaker but positive consumer sentiment indices in the Nordic countries, despite our forecast of sluggish GDP growth for Finland and Norway in 2015 and 2016 (between 0.3% and 1.6%). Citycon has more flexibility over the disposition of its cash resources than many industry peers because it is not a real estate investment trust (REIT); cash can be used to manage leverage and capital expenditure rather than pay obligatory dividends as required by REIT tax rules. Between 2009 and 2014, the company has deleveraged, with growth being supported by its shareholders. Citycon executed two equity raisings in the first half of 2014, totalling EUR400 million, of which around EUR300 million of the proceeds have reduced indebtedness, thereby improving its financial flexibility Citycon's rating has been constrained by the company's size and diversification with some income concentration risk to its anchor tenants. However, the acquisition of Sektor will add scale, increasing Citycon's size by around 45%, from EUR 3.4 billion to EUR 4.9 billion gross assets, including Kista Galleria. The acquisition will also reduce the company's exposure to the weak Finnish economy to around 35% of assets compared to 50% previously. DETAILED RATING CONSIDERATIONS FOCUS ON ACQUIRING AND MAINTAINING GOOD QUALITY ASSETS Citycon's strategy is focused on investing in high quality retail centres located in growing, urban locations with good demographics in Nordic and Baltic countries. Urbanisation came late to Sweden, Norway and Finland, with the result that Stockholm, Oslo and Helsinki are among the faster growing cities in Western Europe by population, according to Eurostat. Citycon invests in retail centres that offer convenience and (1) are typically anchored by grocery stores and tenanted by other retailers of essential services and day-to-day necessities; (2) benefit from strong potential footfall by being located close to public transport; and (3) are dominant in their catchment area. The company also invests in larger malls in Sweden and Estonia, shaping its strategy around their different demand patterns. Its larger malls also offer a leisure experience and therefore provide a strong alternative to competing online sales.

3 Sektor will be a valuable strategic fit with limited integration risk because its investment focus is comparable to that of Citycon's. Both companies invest in shopping centres that are located in urban areas with a focus on necessitybased shopping and benefit from high occupancy rates. Sektor's shopping centres are located in the top three urban areas in Norway with around 82% in the Oslo region and around 15% in Stavangar and Bergen. Synergies will also arise as Sektor will have access to Citycon's international tenants: Citycon intends to generate annual like-for-like net rental income growth of +100 basis points above CPI for the Sektor portfolio. The company is recycling its capital with the divestment of non-core properties and has signed divestments of approximately EUR190 million not yet included in reported figures as of 30 June 2015, thus almost reaching the assets sales target of EUR million planned for Citycon's non-core properties are those that are not shopping centres, not urban and not growing. For example, the company owns many single supermarkets, acquired as part of a sale and leaseback transaction with Kesko years ago, that do not qualify as core assets. SLOWING RENTAL GROWTH BUT SEKTOR ACQUISITION IMPROVES GEOGRAPHIC DIVERSIFICATION, ENHANCING STABILITY We expect Citycon's net rental income to remain stable to slightly improve organically over the next months reflecting positive but slowing net rental growth and continued focus on cost control. Through the acquisition of Sektor, Citycon will be more balanced geographically, with around a third of the value of its asset portfolio in each of the three main economies but will hardly escape the fairly weak macroeconomic environment, particularly in Finland and Norway. Like-for-like net rental growth slowed down in H to 1.6% compared to 3.6% in 2014, 4.8.% in 2013 and 4.9% in The picture was mixed in the first half of the year: net rental income in Finnish like-for-like properties decreased slightly by 0.5% compared to the previous year compared to growth of 5.1% in Sweden (excluding currency effects). The company has been reducing its operating expenses by using the scale of its operations to reduce its cost of procuring services, such as cleaning, maintenance and security. We note that nearly all leases are linked to the Consumer Price Index (CPI) with upward revisions only, so management's objective is to grow rents at a rate that exceeds inflation (0.5% in Finland and -0.3 % in Sweden in 2014). Based on the value of the assets at 30 June 2015, 50% of Citycon's portfolio is located in Finland, 39% in Sweden, 10% in EStoni and Denmark. The acquisition of Sektor will rebalance the company's portfolio exposure by asset value: 35% Finland, 31% Norway, 27% Sweden, and 7% in Estonia and Denmark. From a macro perspective, our economists expect solid real GDP growth in Sweden (2.6% and 2.7% in 2015 and 2016, respectively) and modest but improving growth in Norway (1% and 1.6%) and Finland (0.3% and 1.0%). Whilst still in positive territory, consumer confidence has recently deteriorated in both Sweden and Norway whilst improving in Finland, pointing at a mixed outlook for retail spending and, by extension, Citycon's performance in Also, household indebtedness and house prices are fairly high in the region, which could also pressure consumer spending. DIVERSIFICATION ASSISTED BY JOINT VENTURE OWNERSHIP OF LARGER ASSETS We view Citycon's asset base as high quality and well diversified, both geographically, by industry as well as in terms of tenant base. The acquisition of Sektor will further enhance the quality of Citycon's asset portfolio, in our view. Citycon is a sizeable property investment company with adjusted gross assets of EUR4.6 billion (USD5.0 billion) as of 30 June 2015 including Sektor but excluding Kista Galleria. Following the acquisition, Citycon will own 55 shopping centres in the Nordic countries and Estonia and increase its total annual footfall from approximately 150 million to over 200 million. Finland will represent 35% of group asset value (compared to 51% before the acquisition), Norway 31% (from 0%), Sweden 27% (from 39%) and Baltics & Denmark 7% (from 10%). The company will be the largest listed property company in the Nordics and the 5th largest in Europe based on gross asset value, although only half the size of the 4th largest (Hammerson) in terms of gross asset value. The retailers operating from the company's shopping centres represent a variety of different retail segments, but Citycon's shopping centres are typically anchored by grocery stores and the company derives around 20% of its rental income from grocers. The risk of grocer default is low because there is an oligopoly of three grocers in Sweden, which between them hold a market share of approximately 70%. Similarly, Finland's two main grocers have a combined market share of around 75%. Excluding Sektor, Citycon's portfolio consists of 60 property assets, of which 35 are shopping centres, including Kista Galleria, a large shopping centre in Stockholm (GLA: 92,000 sqm) that was acquired in January 2013 in a

4 50:50 joint venture with CPPIBEH. The company also owns 33 shops that are leased to Kesko OYJ and has some income concentration exposure because Kesko contributed around 15.4% of total rental income in 2014 (2013: 16.1%). Following the completion of Citycon's planned sale of several non-core assets, and after the acquisition of Sektor, this proportion should decrease to under 9%. The next highest tenant exposure that the company reports is only 6% in 2014, to S Group, a Finnish retailing cooperative that also sells groceries. Citycon's strategy is to acquire larger shopping centres with a joint venture (JV) partner, which limits concentration risk on any one property asset. Citycon's JV partners are prominent investors, such as its shareholders Ilmarinen and CPPIBEH. CASH FLOW IS UNDERPINNED BY STEADY OCCUPANCY RATES AND TENANT AFFORDABILITY Citycon's rental income and cash flow are underpinned by steady occupancy rates that have remained fairly stable over time and between 95% and 96% in the last three years (96.0% in H1 2015), which will slightly improve after the integration of Sektor, which had an occupancy rate of 96.5% last year. In addition, the occupancy cost ratio (rent + related outgoings)/sales for Citycon's tenants is at affordable levels; the overall average was a moderate 8.9% in H LEVERAGE HAS BEEN MANAGED DOWN AND THERE IS NO SECURED DEBT OUTSIDE THE KISTA GALLERIA JOINT VENTURE (EXCLUDING SEKTOR) We anticipate the effective leverage to rise to around 45% once Sektor is fully consolidated and to be maintained within a range of 40% to 45% thereafter, in line with Citycon's own financial targets. Citycon has pursued a deleveraging path since The company raised approximately EUR400 million in new equity in Q2 2014, of which EUR300 million wasused to repay debt. In addition, Citycon completed a EUR604 million rights issue to partly finance the acquisition of Sektor. Effective leverage, as measured by adjusted total debt/gross assets, as of 30 June 2015 had fallen to 41% from 49% at year-end Lower debt levels and lower average interest rates have decreased interest expense while EBITDA has grown with the improvement in margins owing to the growth of the portfolio and the company's cost efficiency programme. Therefore, Citycon's fixed charge coverage for year-to-date H rose to 4.0x from 2.7x for financial year All of Citycon's consolidated on-balance sheet property assets are unencumbered whilst Sektor's debt is largely secured, and Citycon plan to refinance most of it with unsecured debt. Also, the group's large Swedish shopping centre, Kista Galleria, was part-financed with secured debt by Citycon and CPPIBEH, its JV partner (unrated). The secured debt is not recorded on Citycon's balance sheet because its 50% investment in the jointly owned company that owns Kista Galleria is accounted for using the equity method, in accordance with IFRS accounting standards. GOOD ACCESS TO CAPITAL Citycon has raised more than EUR1.83 billion since 2005 in a series of rights issues and direct share issues. The company's rights issues are typically covered at around 99% by primary subscription rights and are oversubscribed overall, including the secondary method. In addition, Citycon has developed relationships with financially strong JV partners. LIMITED EXPOSURE TO DEVELOPMENT ACTIVITY Citycon has moderate exposure to committed redevelopment activities, with committed investment capital expenditure of approximately 8.0% of total assets as of 31 December 2014 (this percentage is even lower including Kista and Sektor). However, all of the company's current development activities are based on low-risk redevelopments and extensions of successful, existing properties that meet its internal investment criteria rather than involving the construction and development of new sites. This reduces significantly the company's exposure to development risk and removes the necessity to acquire and/or maintain expensive land banks. Liquidity Profile CASH RESOURCES EXCEED CASH OUTFLOWS OVER THE NEXT MONTHS Citycon exhibits an adequate liquidity profile, underpinned by the steady generation of recurring cash flow and ample availability under its sizeable and long-dated revolving credit facilities (RCFs).

5 Cash reported on the balance sheet as of 30 June 2015 was only EUR14 million; however, at the same date, the company had total liquidity available of EUR343.6 million, including undrawn committed RCFs. We expect these resources to more than cover cash outflows anticipated over the next months. The final maturities of its revolving credit facilities range from 2016 to 2019 and are subject to financial covenant compliance. We consider the current headroom under the company's financial covenants to be comfortable, at 37.5% for the equity ratio and 122% for the interest coverage ratio in the covenant test as at 30 June Nevertheless, because all facilities contain repeating material adverse change language (MAC clauses), we regard the reliability of external liquidity sources with caution. Citycon's near-term debt amortisation profile is amply covered by its cash resources, with only EUR115.6 million due for repayment in the next 18 months. The average debt maturity of 5.3 years is in line with other European real estate peers. The company manages its currency risk by using natural hedges where possible and its interest rate hedging policy is to fix 70%-90% of its interest rate exposure. As at 30 June 2015, 81.5% of its interest rates were fixed. In addition, all of Citycon's on-balance sheet property assets were unencumbered as of 30 June 2015 providing a potential source of alternative liquidity. As part of the financing of the acquisition of Sektor, the company has recently raised EUR 222 million in bridge loans with a one-year maturity and received waivers regarding the change of control in Sektor's existing bank debt for an amount of EUR 671 million. We expect these credit facilities to be refinanced via longer term debt within the next 6-9 months or to be extended. Rating Outlook The stable outlook reflects our expectation that the company's credit metrics will remain in line with the current rating level. We note that Citycon has financed the acquisition of Sektor in accordance with its own target to maintain its loan to value ratio in the range of 40% to 45%. As part of the financing of the transaction, the company successfully completed a rights issue worth EUR604 million on 14 July to partly fund the acquisition whilst at the same time raising EUR893 million in bridge loans with a one-year maturity. The stable outlook on the rating also reflects our view that (1) the countries in which Citycon operates will experience modest economic growth in 2015, which will support tenant demand for retailing space; and (2) Citycon will maintain high occupancy rates and its inflation-indexed leases will contribute towards growing operating profits; and that (3) the company will maintain and adequate liquidity profile at all times. Execution risk in relation to the integration of Sektor should be limited given the similar investment focus of the two companies, in our view. What Could Change the Rating - Up Positive pressure on the ratings is unlikely in the near term. The rating is currently constrained by some income concentration risk in relation to its anchor tenants, although this risk will be meaningfully reduced with the integration of Sektor. However, upward rating pressure could start building as the company continues its careful expansion and as a result of an improvement in credit metrics, with reduced leverage maintained in the mid-30s (percent) or lower and fixed charge coverage rising sustainably above 3.0x (the ratio climbed to 4.0x for in the 12 months to June 2015). What Could Change the Rating - Down Downward pressure could result from an adverse deviation in operating performance or other factors that result in a worsening in fixed charge coverage or leverage metrics, specifically fixed charge coverage trending towards 2.2x or effective leverage rising above 45%. Negative rating pressure could also result if a deteriorating trend in the company's covenant headroom or liquidity develops. Other Considerations GRID INDICATED RATING The principal methodology used in rating Citycon was Moody's Global Methodology for REITs and Other Commercial Property Firms, published July The Baa2 final rating is now at the same level as the grid outcome largely because leverage and fixed charge coverage have improved substantially. Previously the final rating was one notch lower than the grid.

6 Rating Factors Citycon OYJ REITs and Other Commercial Property Firms Industry Grid [1][2] Factor 1: Liquidity and Funding Current LTM 6/30/2015 [3]Moody's Month Forward ViewAs of 8/10/2015 Measure Score Measure Score (24.5%) a) Liquidity Coverage Ba Ba Ba Ba b) Debt Maturities Ba Ba Ba Ba c) FFO Payout 70.3% Baa 65% - 70% Baa d) Amount of Unencumbered 99.8% Aa 97% - 100% Aa Assets Factor 2: Leverage and Capital Structure (30.5%) a) Debt / Gross Assets [4] 40.8% Baa 41% - 45% Baa Net Debt b) Net Debt / EBITDA 8.5x B 10x - 12x Caa Positive c) Secured Debt / Gross Assets 0.0% Aa 0% Aa d) Access to Capital Baa Baa Baa Baa Factor 3: Market Position and Asset Quality (22%) a) Franchise / Brand Name Baa Baa Baa Baa b) Gross Assets(USD Million) $3,507.5 Baa $ $5900 Baa c) Diversity: Location / Tenant / Industry / Economic Baa Baa Baa Baa d) Development Pipeline 8.0% Baa 8% Baa e) Asset Quality Baa Baa Baa Baa Factor 4: Cash Flows and Earnings (23%) a) EBITDA Margin (YTD) 61.0% Baa 60% - 63% Baa b) EBITDA Margin Volatility 3.7% Baa 5% Baa c) EBITDA / Fixed Charges 4.0x A 3.6x - 4.2x A (YTD) [4] d) Joint Venture Exposure (YTD) 16.1% Ba 10% - 12% Baa Rating: a) Indicated Rating from Grid Baa2 Baa2 b) Actual Rating Assigned Baa2 [1] All ratios are based on 'Adjusted' financial data and incorporate Moody's Global Standard Adjustments for Non- Financial Corporations. [2] As of 6/30/2015(L); Source: Moody's Financial Metrics [3] This represents Moody's forward view; not the view of the issuer; and unless noted in the text, does not incorporate significant acquisitions and divestitures. [4] Fixed Charges includes capitalized interests explained in Moody's Approach to Global Standard Adjustments in the Analysis of Financial Statements for Non-Financial Corporations revised December This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on for the most updated credit rating action information and rating history.

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