DBRS Limited (DBRS Morningstar) changed the trends on the Issuer Rating and Senior Unsecured Debentures rating of SmartCentres Real Estate Investment Trust (SmartCentres or the Trust) to Negative from Stable. In addition, DBRS Morningstar confirmed both ratings at BBB (high).
The trend change to Negative follows (1) SmartCentres’ completed acquisition of a two-thirds interest in 53 acres of land in Vaughan, Ontario, for approximately $513 million (the Acquired Lands) to be funded with $200 million in equity (issued by way of limited partnership units exchangeable into Trust units) and approximately $313 million in debt (including draws on its existing credit facilities) (the Transaction) and (2) DBRS Morningstar’s December 1, 2021, press release wherein it outlined certain credit negative aspects of the Transaction, principally deterioration in SmartCentres’ key financial risk metrics and possible incremental execution risks related to the Trust’s growing development pipeline. The Acquired Lands are primarily vacant land for development, with the exception of a Lowe’s store and several quick service restaurants.
Indeed, DBRS Morningstar forecasts SmartCentres’ total debt-to-EBITDA and EBITDA interest coverage to deteriorate in the near term (from 9.2 times (x) and 3.17x, respectively, for the last 12 months ended September 30, 2021) and fluctuate around the 10.0x range and 3.0x range, respectively, through YE2023. DBRS Morningstar’s updated outlook takes into consideration modest deleveraging initiatives. This updated outlook contrasts with DBRS Morningstar’s December 10, 2020, forecast for SmartCentres’ total debt-to-EBITDA and EBITDA interest coverage to fluctuate around the 9.0x range and 3.3x range, respectively.
The rating confirmations consider the various levers SmartCentres can pull to improve key financial risk metrics relative to DBRS Morningstar’s expectations, including capital recycling initiatives whereby the Trust sells passive partial interests in various properties, as well as better-than-expected operational performance. The ratings continue to be supported by SmartCentres’ (1) strong tenant profile with Walmart Inc. (Walmart; rated AA with a Stable trend by DBRS Morningstar) representing 25.3% of annualized rental revenue at September 30, 2021 (remaining average lease term of 5.5 years); (2) large retail property portfolio with newer, large, and open-format Walmart-anchored shopping centres generating stable cash flow; and (3) predominately unsecured debt capital stack (secured debt-to-total debt ratio of 29.9% at September 30, 2021) and sizable unencumbered asset pool ($6.0 billion), which together warrant a one-notch uplift to SmartCentres' stand-alone credit assessment.
The ratings continue to be constrained by (1) elevated leverage as measured by the total debt-to-EBITDA ratio; (2) concentration risks, such as asset-type concentration in retail, tenant concentration (most significantly, Walmart), and geographic concentration in the Greater Toronto Area; and (3) potentially increasing development execution risks, such as construction risks affecting timelines and budgets, leasing, sales, counterparties in joint arrangements, and funding risks, among others, that together may increase volatility of cash flows and metrics. As a result of potentially increasing development execution risks, DBRS Morningstar would expect SmartCentres’ to operate with an increased buffer relative to threshold metrics for a given rating level.
Ratings downgrades are likely within the next 12 months should SmartCentres fail to lower leverage such that its total debt-to-EBITDA is likely to remain above 9.3x and EBITDA interest coverage to remain below 3.0x on a sustained basis, all else being equal. Conversely, the trends may change to Stable should SmartCentres demonstrate total debt-to-EBITDA comfortably below 9.3x and EBITDA interest coverage above 3.0x.
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.
All figures are in Canadian dollars unless otherwise noted.
The principal methodologies are Rating Entities in the Real Estate Industry (April 23, 2021; https://www.dbrsmorningstar.com/research/377358) and DBRS Morningstar Criteria: Guarantees and Other Forms of Support (May 31, 2021; https://www.dbrsmorningstar.com/research/379424), which can be found on dbrsmorningstar.com under Methodologies & Criteria. Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021; https://www.dbrsmorningstar.com/research/373262).
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The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.
Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar trends and ratings are under regular surveillance.
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