Fitch Assigns First-Time 'A' Rating to Scentre; Outlook Stable

(The following statement was released by the rating agency) Fitch Ratings-Sydney-February 20: Fitch Ratings has assigned Scentre Group Limited a Long-Term Foreign-Currency Issuer Default Rating (IDR) of 'A'. The Outlook is Stable. Fitch has also assigned senior unsecured ratings of 'A' to Scentre Management Limited, RE1 Limited and RE2 Limited. The senior unsecured ratings are at the same level as the IDR, as the debt is guaranteed jointly and severally by Scentre, Scentre Management in its capacity as responsible entity and trustee of Scentre Group Trust 1, RE1 in its capacity as responsible entity and trustee of Scentre Group Trust 2 and RE2 in its capacity as responsible entity and trustee of Scentre Group Trust 3. Scentre's rating is driven by the strength of its business profile, in particular its uniquely positioned portfolio in a global context. Scentre's portfolio of premier Westfield shopping centres across Australia is accessible to around 65% of the country's population, generating over 535 million customer visitations per year. The quality of the portfolio is reflected in consistently high occupancy levels of above 99% and, therefore, high visibility over the company's rental stream. Scentre's financial profile is reflective of an 'A' rated company on a global basis. Its net debt/operating EBITDA (leverage) was 7.1x and net debt/investment properties (LTV) was around 35% at end-2018, while its debt servicing ability, as measured by operating EBITDA/interest paid, was 3.7x. The company's profile also benefits from its conservative liquidity policy, which saw it report total liquidity of AUD2.1 billion at end-2018. KEY RATING DRIVERS Australia's Largest Retail REIT: Scentre owns a portfolio of Australian premier shopping centres, valued at around AUD54 billion - of which Scentre's share was around AUD39 billion - at end-2018. Scentre's portfolio is concentrated in the retail sector and contains 16 of the country's top-25 retail malls. In addition, over 80% of capital was invested in centres that generated retailer in-store sales in excess of AUD500 million in 2018. Furthermore, over 80% of invested capital is located in Sydney, Melbourne and Brisbane - cities that drive economic growth - and around 65% of Australia's population lives within a 30 minute drive from the malls. This saw around 7% of total retail sales in Australia being made at a Scentre mall and over 535 million customer visits a year across the portfolio. The company is strategically re-weighting its portfolio towards more resilient and experiential stores, such as food and beverage, health and beauty, and entertainment as it seeks to address the changing retail landscape and consumer preferences, particularly the effect of e-commerce. This, combined with the prime locations of its retail malls, respected brand and the diversity of the centres, limits Scentre's exposure to challenges faced by smaller retailers and lower-grade malls. Stable Rental Income: Scentre has strong visibility over rental cash inflow, driven by high occupancy levels - which have historically exceeded 99% - lease tenure of around 15 to 20 years for anchor tenants and five years for specialty tenants, weighted-average lease expiries of around six years, around 10% of leases expiring annually and 99% of rental income being derived from minimum base rents, with less than 1% linked to turnover. We believe these factors demonstrate the high demand for space in Scentre's shopping centres and offset risks around the company's renewal rate of around 70%, which is lower than the average in Fitch's rated universe for the company's rating level, particularly as around half of non-renewals occur when Scentre strategically positions its portfolio. The company has reported comparable net operating income growth of between 2%-3% since 2014, with around 75% of rental growth driven by contractual annual rent escalation - typically CPI + 2% - lending itself to high rental income visibility. Scentre reported negative low-single-digit percentage leasing spreads in 2017 and 2018, due to structural challenges in the retail sector as well as the company offering shorter-term leases at lower rentals as part of its planning for upcoming developments. Nevertheless, with the contracted rent escalations, the negative leasing spreads are typically caught up within one year, limiting any impairment to Scentre's rental stability and visibility. Diverse Portfolio Exposure: Scentre's portfolio includes around 11,500 stores representing more than 3,500 brands, which reduces tenant concentration despite exposure to anchor tenants that typically lease larger areas for longer. Tenant quality is high, demonstrated by negligible delinquent debtors. However, around 11% of total square metres of Scentre's portfolio - or 23 stores - is leased to Australian department store, Myer, which continues to be affected by structural changes in the retail sector and management issues. Nevertheless, Scentre's exposure is mainly to key Myer locations, such as Sydney's central business district, which limits risk around tenant longevity. Prudent Development Exposure: Scentre has limited development exposure, with the company's new five-year plan focusing on optimising its current portfolio to meet changing consumer preferences, particularly updating its food and beverage and lifestyle offerings. Scentre had active development projects worth AUD0.8 billion (both past and future cash flow) in 2018, of which its share was AUD0.4 billion, or around 1% of the value of its investment properties; the company typically invests around AUD600 million on development each year. Scentre's business profile may weaken if its development exposure were to become more speculative, which could result in a change in its rating. Market Leading Access to Capital: Fitch views Scentre as having sector-leading and durable access to capital, along with relative and absolute access to debt capital. Substantiating this view is the diversity of Scentre's capital sources. The company has demonstrated access to debt capital in multiple currencies, including the US dollar, European euro, British pound and Australian dollar, and across a wide range of tenors. DERIVATION SUMMARY Scentre's rating is well positioned compared with US peer, Simon Property Group (NYSE:SPG), Inc. (A/Stable). The ratings of both REITs reflect their high-quality retail real-estate portfolios - being among the world's largest REITs and market leaders - cycle-tested management team, market-leading access to capital, conservative financial policies and significant scale, which influences efficiencies. Simon is more conservatively levered than Scentre, but Scentre's level is consistent with its rating. The quality of Scentre's portfolio is also comparable with that of European peer, Unibail-Rodamco (AS:URW) SE (A-/Stable). The one notch difference reflects Unibail's elevated leverage following its acquisition of Westfield's international operations. The one-notch difference between Scentre and Australian peer, Mirvac Group (A-/Stable), reflects Scentre's larger scale and limited development exposure as well as Mirvac having a homebuilding business. These factors offset Mirvac's more conservative financial profile as it looks to manage risk from its development exposure. KEY ASSUMPTIONS Fitch's Key Assumptions Within Our Rating Case for the Issuer - Leasing spread of between -2.5% and -4.5% (2018: -3.5%), with average contracted annual rent escalations of CPI + 2% - Rent per square metre to increase by 4% to 6% from 2018 to 2021 (2018: -3.3%) - Capital expenditure of AUD500 million per year in 2019 to 2021 (2018: AUD962 million) - Dividend payout ratio of 85% of FFO - Share buyback of AUD700 million to only be enacted on asset sales or other events, resulting in an offsetting cash inflow and not affecting balance sheet strength RATING SENSITIVITIES Developments that May, Individually or Collectively, Lead to Positive Rating Action - Net debt/operating EBITDA improving to below 6.0x on a sustained basis. - Operating EBITDA/interest paid improving to above 4.0x on a sustained basis. Developments that May, Individually or Collectively, Lead to Negative Rating Action - Net debt/operating EBITDA deteriorating to above 7.5x for a sustained period. - Operating EBITDA/interest paid deteriorating to below 3.0x for a sustained period. - Large and sustained decline in occupancy. LIQUIDITY Adequate Liquidity and Asset-Liability Management: Scentre had AUD2.1 billion in liquidity as at end-2018; its average debt maturity was 4.4 years against weighted-average lease expiries of 5.9 years. The company's funding comprises bonds and bank facilities and it has access to global markets with outstanding bonds denominated in US dollars, euros, pound sterling and Australian dollars. Scentre swaps all its foreign-exchange debt into floating Australian dollars to minimise foreign exchange and interest rate risk, then manages interest rate risk with the remainder of its portfolio - where typically more than 75% of its interest rate is fixed (2018: 69%). Contact: Primary Analyst Kelly Amato, CFA Director +61 2 8256 0348 Fitch Australia Pty Ltd Level 15, 77 King Street, Sydney, NSW, 2000, Australia Secondary Analyst Leo Park Associate Director +61 2 8256 0323 Committee Chairperson Vicky Melbourne Senior Director +61 2 8256 0325 Summary of Financial Statement Adjustments: Fitch has treated Scentre's property-linked notes as an effective sale of the underlying assets, based on the note holders having no recourse to returns on other assets held by Scentre, annual returns being determined by the notes' proportionate interest in the underlying asset and the noteholders being unable to elect to have the property-linked notes redeemed for cash. Media Relations: Leslie Tan, Singapore, Tel: +65 6796 7234, Email: leslie.tan@thefitchgroup.com. 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