Fitch Ratings has affirmed at 'BBB' the ratings for Prologis, Inc.
(NYSE:PLD) and certain rated subsidiaries (collectively, Prologis or the
company) following the announcement that the company's 55-45
consolidated joint venture with Norges Bank Investment Management
(NBIM), Prologis U.S. Logistics Venture, has agreed to acquire the real
estate assets and operating platform of KTR Capital Partners (KTR) and
its affiliates for a total purchase price of $5.9 billion including the
assumption of debt.
The Rating Outlook is Positive. A full list of ratings follows at the
bottom of this release.
KEY RATING DRIVERS
The Positive Outlook reflects Fitch's expectation that the company's pro
rata leverage will remain around 7.0x, initially pro forma for the KTR
transaction. Fitch also expects leverage to trend in the 6.0x - 6.5x
range over the next 12-to-24 months, which would be consistent with a
'BBB+' rating. Favorable credit elements of the KTR transaction include
the acquisition of a high quality portfolio largely located near major
ports in Southern California, New York-New Jersey, Chicago, San
Francisco and Dallas (markets in which Prologis already has a
significant presence) and a strong tenant roster with exposure to
e-commerce tenants, a growing segment in the industrial real estate
market.
Prologis has indicated that it intends to fund the KTR transaction on a
leverage-neutral basis; however, there are uncertainties surrounding the
levels of proceeds from asset sales, equity, and corporate level debt
that will ultimately be used to fund the transaction. Under the agency's
base case, Fitch expects that $630 million of term loan borrowings, the
issuance of $230 million of operating partnership units, the assumption
of $385 million of pro rata mortgage debt, $500 million of asset sales
and hedge settlement proceeds, and $1.5 billion of equity proceeds will
comprise the consideration for Prologis' $3.2 billion share of the KTR
transaction. A deviation from funding the transaction on a leverage
neutral basis would slow the trajectory of the company's de-leveraging
and could place pressure on the Positive Outlook. In addition, it is
likely that Prologis' development pipeline on a pro rata basis will
continue in the coming years since the KTR development portfolio
includes 3.6 million square feet of properties under development and
land holdings. PLD's pro rata cost to complete development compared to
total asset value remains low when compared with the company's levels
during the previous upcycle.
High Leverage Expected to Decline
The company's 6.9x pro rata debt-to-EBITDA ratio as of March 31, 2015
was appropriate for the 'BBB' rating. Fitch projects that pro rata
leverage will be 6.9x initially pro forma for KTR, and trend in the 6.0x
- 6.5x range over the next 12-to-24 months. Fitch's leverage threshold
of 6.5x for a 'BBB+' rating for Prologis acknowledges the company's
strong asset quality and lower portfolio yields. In a stress case
whereby the company does not issue any equity and thus the only equity
component of the transaction is the $230 million of operating
partnership units, leverage would be 7.5x, which would be weak for the
'BBB' rating.
Adequate Liquidity; No Corporate Debt Maturities Until 2017
Fitch expects the company will continue to maintain sufficient liquidity
before considering proceeds from dispositions and contributions. While
Fitch anticipates that the company 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 is 1.4x for the period April 1,
2015 to Dec. 31, 2016 pro forma for the KTR transaction. Fitch defines
liquidity coverage as liquidity sources divided by uses. Liquidity
sources include unrestricted cash, availability under revolving credit
facilities pro forma, 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. Moreover, the
company has no corporate maturities until 2017.
Internally generated liquidity is moderate as the company's adjusted
funds from operations (AFFO) payout ratio was 88.8% in 1Q'15 compared to
88.7% in 2014 and 95.4% in 2013. Based on the current payout ratio, the
company would retain approximately $95 million in annual cash flow.
Improving Fundamentals and Fixed-Charge Coverage
Positive net absorption continues to benefit Prologis' 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
9.7% in 1Q'15, up from 7.4% on average during 2014 and 4.5% on average
in 2013. Occupancy was 95.9% as of March 31, 2015 compared to 96.1% as
of Dec. 31, 2014, up from 95.0% as of Dec. 31, 2013 and cash same-store
net operating income (NOI) grew by 3.9% in 1Q'15, 4.5% on average in
2014 and 1.8% on average in 2013.
Pro rata fixed-charge coverage (FCC) is 2.8x in 1Q'15 pro forma for the
KTR transaction, up from 2.7x in 1Q'15, 2.4x in 2014 and 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 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 strong for a 'BBB'
rating. Under the Fitch stress case, FCC would remain around 2.5x, which
is also strong for the rating.
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.
Excellent Access to Capital
The company issued $7.1 billion and EUR2.5 billion in unsecured bonds
since 2009 (using the proceeds to refinance and repurchase bonds and for
general corporate purposes) 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 (ATM) equity
offering program, and in December received proceeds of $353.9 million
through the issuance of equity securities from the exercise of a warrant
issued in connection with the formation of Prologis European Logistics
Partners and through the ATM program.
Strategic capital is another important source of funding for PLD, as
evidenced by the KTR transaction being completed via a partnership with
NBIM. The company rationalized and restructured certain of its
investment ventures to increase the permanency of its capital (e.g.,
FIBRA Prologis and Nippon Prologis REIT) and reduce the inter-dependence
over the past several years, which Fitch views favorably.
Global Platform; KTR Transaction Improves Portfolio Quality
Prologis had $52.6 billion of assets under management as of March 31,
2015 and the global platform limits the risk of over-exposure to any one
region's fundamentals.
PLD derived 83.2% of its 1Q'15 NOI from Prologis-defined global markets
(59.3% in the Americas, 20.4% in Europe, and 3.5% in Asia), and the
remaining 16.8% of 1Q'15 NOI was derived from regional and other
markets. The KTR transaction will increase the company's exposure to
major U.S. markets, including Southern California (21.9% of pro forma
U.S. NOI), New York-New Jersey (10.1%), Chicago (9.8%), San Francisco
Bay Area (7.0%) and Dallas (6.0%).
The KTR transaction will also increase the company's exposure to
e-commerce, a growing segment in the industrial real estate market, as
evidenced by the increase in annualized base rent from Amazon.com to
2.4% pro forma, compared to 1.0% as of March 31, 2015. Other top tenants
pro forma include DHL (1.8%), Kuehne & Nagel (1.3%), CEVA Logistics
(1.3%), and Geodis (1.0%).
Adequate Unencumbered Asset Coverage
Prologis has adequate contingent liquidity with a stressed value of
unencumbered assets (1Q'15 unencumbered NOI divided by a stressed 8%
capitalization rate) to net unsecured debt of 2.2x. When applying a 50%
haircut to the book value of land held and a 25% haircut to construction
in progress, unencumbered asset coverage improves to 2.4x.
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.
Development is substantially smaller today than in the previous upcycle
with costs to complete equal to 4.0% of undepreciated assets at March
31, 2015 (3.2% pro rata) compared with 14.1% at year-end 2007. However,
speculative development increased over the past several years to 83.5%
as of March 31, 2015 from 72.2% at Dec. 31, 2014 and 58.2% as of Dec.
31, 2013, which illustrates elevated lease-up risk. However, the company
estimates that approximately 75% of its future development is comprised
of speculative projects. The KTR development portfolio increases the
likelihood that development will continue in the coming years.
Preferred Stock Notching
The two-notch differential between PLD's IDR and preferred stock rating
is consistent with Fitch's criteria for corporate entities with an IDR
of 'BBB'. Based on Fitch research titled 'Treatment and Notching of
Hybrids in Nonfinancial Corporate and REIT Credit Analysis', 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.
Exchangeable Senior Notes Ratings Withdrawal
Fitch has withdrawn the 'BBB' rating on Prologis, L.P.'s $460 million
senior unsecured exchangeable notes. On March 16, 2015, the company
announced the exchange of the exchangeable notes for a total of 11.9
million shares of the company's common stock. The ratings on the senior
unsecured exchangeable notes are no longer relevant to the agency's
coverage.
KEY ASSUMPTIONS
Fitch's key assumptions for Prologis in Fitch's base case include:
--The KTR transaction closes in 2Q'15 and is funded with the $630
million of term loan borrowings, the issuance of $230 million of
operating partnership units, the assumption of $385 million of mortgage
debt, $500 million of asset sales and hedge settlement proceeds, and
$1.5 billion of common equity;
--3% to 4% annual same-store NOI through 2017;
--G&A growth to maintain historical margins relative to total revenues
initially but potentially be reduced over the next several years due to
geographical overlap of the KTR portfolio;
--$2.0 billion annual development starts through 2017;
--$875 million annual building acquisitions through 2017;
--$1.1 billion annual contributions to co-investment ventures through
2017;
--$1.8 billion annual third-party dispositions through 2017;
--Debt repayment with the issuance of new unsecured bonds;
--AFFO payout ratio in the low 90% range.
RATING SENSITIVITIES
The following factors may result in an upgrade to 'BBB+':
--Fitch's expectation of pro rata leverage sustaining below 6.5x is
Fitch's primary rating sensitivity (pro rata leverage was 6.9x as of
March 31, 2015 and is also 6.9x pro forma under Fitch's base case);
--Fitch's expectation of consolidated leverage sustaining below 6.0x
(consolidated leverage was 6.2x as of March 31, 2015 and is 5.9x pro
forma under Fitch's base case. 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 1.4x pro forma);
--Fitch's expectation of pro rata FCC sustaining above 2x (this ratio
was 2.5x for the TTM ended March 31, 2015 and is 2.8x pro forma under
Fitch's base case).
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, which
could be the result of the company not funding the KTR transaction on a
leverage neutral basis and/or a deterioration in operating fundamentals;
--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.
Fitch has affirmed the following ratings:
Prologis, Inc.
--Issuer Default Rating (IDR) at 'BBB';
--$78.2 million preferred stock at 'BB+'.
Prologis, L.P.
--IDR at 'BBB';
--$2.5 billion global senior credit facility at 'BBB';
--$5.7 billion senior unsecured notes at 'BBB';
--EUR500 million multi-currency senior unsecured term loan at 'BBB'.
Prologis Tokyo Finance Investment Limited Partnership
--Senior unsecured guaranteed notes at 'BBB';
--JPY45 billion senior unsecured revolving credit facility at 'BBB';
--JPY40.9 billion senior unsecured term loan at 'BBB'.
The Rating Outlook is Positive.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Prologis, Inc. Ratings Navigator' (Feb. 26, 2015);
--'U.S. Equity REITs and REOCs Ratings Navigator Companion' (Feb. 5,
2015);
--'Treatment and Notching of Hybrids in Non-Financial Corporate and REIT
Credit Analysis' (Nov. 25, 2014);
--'Recovery Ratings and Notching Criteria for Equity REITs' (Nov. 18,
2014);
--'Corporate Rating Methodology' (May 28, 2014).
Applicable Criteria and Related Research:
U.S. Equity REITs and REOCs: Ratings Navigator Companion
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=861519
Treatment and Notching of Hybrids in Non-Financial Corporate and REIT
Credit Analysis
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=821568
Recovery Ratings and Notching Criteria for Equity REITs
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=813628
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=983352
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