NEW YORK--()--Fitch Ratings has upgraded the credit ratings of Prologis, Inc. (NYSE: PLD), its operating partnership, Prologis, L.P. and its subsidiary Prologis Tokyo Finance Investment Limited Partnership (collectively, Prologis or the company) as follows:
--Issuer Default Rating (IDR) to 'BBB' from 'BBB-';
--$582 million preferred stock to 'BB+' from 'BB'.
--IDR to 'BBB' from 'BBB-';
--$1.7 billion global senior credit facility to 'BBB' from
--$5.0 billion senior unsecured notes to 'BBB' from 'BBB-';
--$944.0 million senior unsecured convertible notes to 'BBB' from 'BBB-';
--EUR487.5 million senior unsecured term loan to 'BBB' from 'BBB-'.
Prologis Tokyo Finance Investment Limited Partnership
--JPY36.5 billion senior unsecured revolving credit facility to 'BBB' from 'BBB-';
--JPY10 billion senior unsecured term loan to 'BBB' from 'BBB-'.
The Rating Outlook has been revised to Stable from Positive.
Key Rating Drivers
The upgrade of Prologis' IDR to 'BBB' centers on the company's material reduction in leverage, principally via the announced European joint venture (European JV) with Norges Bank Investment Management (NBIM) and the successful recent initial public offering of Nippon Prologis REIT, Inc., a Japanese REIT (J-REIT). Credit strengths include the company's global industrial real estate platform including the private capital franchise, a granular tenant roster, and strong access to capital. Credit concerns include fixed charge coverage that is low for the rating but projected to improve, as well as increasing development (including speculative projects) and significant 2014 debt maturities that weaken liquidity.
Material Leverage Reduction
PLD's leverage was 7.1x as of Dec. 31, 2012 pro forma for dispositions and fund contributions, down from 8.2x in FY2012 and 7.8x in 4Q'2011 and meaningfully below the 8.0x leverage threshold Fitch previously established as a key ratings driver for positive ratings momentum. Fitch expects leverage will improve modestly to the high 6x range over the next 12-to-24 months assuming low-single digit same-store NOI growth and additional debt repayment via contributions and dispositions. PLD's pro forma and forecasted leverage are strong for the 'BBB' rating for a large global industrial REIT. In a stress case not anticipated by Fitch in which same-store NOI declines are similar to those experienced in 2009-2010, leverage would approach 8.0x, which would be weak for a 'BBB' rating.
Upon completion of the June 2011 ProLogis-AMB merger, PLD announced a 10-quarter strategic plan that would re-align the portfolio with greater exposure to global markets, strengthen the company's financial position, streamline the private capital business, and improve asset utilization. Debt repayment via proceeds from asset dispositions and contributions (most notably the European JV and J-REIT listing) has been the primary mechanism through which PLD has achieved its goal to strengthen its financial position.
On Dec. 20, 2012, PLD announced a joint venture with NBIM to which PLD would contribute 195 stabilized European properties. The JV is structured as a 50-50 venture with an equity commitment of EUR2.4 billion ($3.1 billion) including a EUR1.2 billion ($1.55 billion) co-investment by both NBIM and Prologis. The venture has an initial term of 15 years. Prologis will have the ability to reduce its ownership to 20% following the second anniversary of closing, which is expected in March 2013.
On Feb. 14, 2013, Nippon Prologis REIT, Inc. (NPR), a J-REIT externally managed by PLD, priced its initial public offering. Prologis contributed 12 Japan properties to NPR for initial consideration of approximately JPY 173 billion ($1.9 billion) and received cash proceeds of JPY 153 billion ($1.7 billion). PLD expects to sell additional Japanese properties to NPR going forward.
The company's large platform limits exposure to regional fundamentals, with 49.6% of 4Q'2012 NOI derived from Prologis-defined global markets in the Americas, 21.1% in Europe, 12.4% in Asia, and the remainder in regional and other markets. The private capital platform provides an additional layer of fee income and recurring cash distributions to cover PLD's fixed charges. In addition, Prologis has a granular tenant roster, including top three tenants DHL (2.0% of annual base rent), CEVA Logistics (1.4% of annual base rent) and Kuehne & Nagel (1.3% of annual base rent), with no other tenant exceeding 1.0% of annual base rent.
Historically Strong Access to Capital
Legacy ProLogis and AMB Property Corporation both had strong access to capital, and since the merger, Prologis has raised proceeds via a multicurrency unsecured term loan and private capital financings and recast its multicurrency unsecured revolving credit facility. The company has not raised meaningful proceeds in the unsecured bond or equity markets due to a lack of need since the merger. The company will likely fund a significant portion of near-term corporate uses of liquidity with asset sales and contributions proceeds and will fund longer-term liquidity needs via unsecured bond and equity offerings.
Increasing Development Activity
Prologis' development activities entail moderate lease-up risk, as build-to-suit assets represented approximately 57% of the development pipeline as of Dec. 31, 2012, with the remainder being speculative projects. The pipeline is increasing but remains somewhat small, as cost to complete development represented 3.2% of gross assets as of Dec. 31, 2012 compared with 1.4% as of Dec. 31, 2011. The pipeline should remain active in the coming years due to industrial real estate supply-demand dynamics.
Adequate Liquidity Despite 2014 Maturities
Liquidity coverage, defined as liquidity sources divided by uses, is 1.3x for the period Jan. 1, 2013 through Dec. 31, 2014. Liquidity sources include unrestricted cash, availability under revolving credit facilities pro forma for Prologis' share of projected contributions to the Norges JV and J-REIT and projected retained cash flows from operating activities. Liquidity uses include pro rata debt maturities after extension options at PLD's option and pro forma debt transfer related to the Norges JV, and projected recurring capital expenditures. When including Prologis' share of projected development starts as a liquidity use, liquidity coverage weakens to 1.0x. 2014 debt maturities represented 25.2% of pro rata debt maturities as of Dec. 31, 2012, which adversely impact liquidity coverage, however a portion of these maturities are extendable at the company's option.
Prologis has strong contingent liquidity with unencumbered assets (4Q'2012 estimated unencumbered NOI divided by a 7.0% capitalization rate pro forma for the Norges JV, J-REIT, and other contributions and dispositions) to unsecured debt of 2.4x. When applying a stressed 50% haircut to the book value of land held, unencumbered asset coverage improves to 2.6x. In addition, the covenants in the company's debt agreements do not restrict financial flexibility, and the company's AFFO payout ratio was 92.9% in 2012 indicating some liquidity generated from operating cash flow.
Fixed-Charge Coverage to Improve
The company's fixed charge coverage ratio is low for the 'BBB' rating at 1.7x in 4Q'2012 pro forma. Fixed-charge coverage was 1.6x in 4Q'2012 due to higher merger-related G&A expense and higher pro rata capital expenditures stemming from heavy leasing volume. This compares with the 1.8x for FY2012 and 1.8x for 4Q'2011. Fitch defines fixed-charge coverage as recurring operating EBITDA including Fitch's estimate of recurring cash distributions from unconsolidated entities less recurring capital expenditures less straight-line rent adjustments divided by total interest incurred and preferred stock dividends.
Fitch's base case anticipates that coverage will approach 2.5x over the next 12-to-24 months due to low single-digit same-store NOI growth as occupancy continues to rise and rental rate rollover declines moderate. Same-store cash NOI increased by 0.8% in 4Q'2012 after growth of 3.0%, 2.3% and 3.1% in 3Q'2012, 2Q'2012 and 1Q'2012, respectively. Total occupancy was 94.0% as of Dec. 31, 2012 compared with 92.2% as of Dec. 31, 2011, and rental rates declined by 2.3% on average during 2012 compared with a 7.0% average decline during 2011. Coverage sustaining between 2.0x and 2.5x would be appropriate for a 'BBB+' rating.
In a stress case not anticipated by Fitch in which same-store NOI declines by levels experienced in 2009 - 2010 and development leasing is limited, coverage would remain around 2.0x, which would remain adequate for the 'BBB' rating.
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', available on Fitch's web site at 'www.fitchratings.com', 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.
The following factors may result in positive momentum on the rating and/or Outlook:
--Liquidity coverage including development sustaining above 1.25x (base case liquidity coverage is 1.3x, but 1.0x including development);
--Fitch's expectation of leverage sustaining below 6.5x (pro forma leverage is 7.1x);
--Fitch's expectation of fixed-charge coverage sustaining above 2.0x (pro forma coverage is 1.7x).
The following factors may result in negative momentum on the rating and/or Outlook:
--Liquidity coverage including development sustaining below 1.0x;
--Fitch's expectation of leverage sustaining above 8.0x;
--Fitch's expectation of fixed charge coverage ratio sustaining below 1.5x.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis (Dec. 13, 2012);
--Recovery Ratings and Notching Criteria for Equity REITs (Nov. 12, 2012);
--Corporate Rating Methodology (Aug. 8, 2012);
--Parent and Subsidiary Rating Linkage (Aug. 8, 2012);
--Criteria for Rating U.S. Equity REITs and REOCs (Feb. 27, 2012).
Applicable Criteria and Related Research:
Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis
Recovery Ratings and Notching Criteria for Equity REITs
Corporate Rating Methodology
Parent and Subsidiary Rating Linkage
Criteria for Rating U.S. Equity REITs and REOCs