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Fitch Affirms STORE Capital Corp.'s IDR at 'BBB-'; Outlook Revised to Positive
April 19, 2017 / 9:47 PM / 3 months ago

Fitch Affirms STORE Capital Corp.'s IDR at 'BBB-'; Outlook Revised to Positive

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(The following statement was released by the rating agency) NEW YORK, April 19 (Fitch) Fitch Ratings has affirmed the Issuer Default Rating (IDR) for STORE Capital Corporation (NYSE: STOR). Fitch has revised the Rating Outlook to Positive from Stable. A full list of rating actions follows at the end of the release. The Positive Outlook primarily reflects STOR's public commitment to targeting stronger financial metrics, including sustaining leverage between 5.75x - 6.25x and the company reducing leverage on a run-rate basis to 6.1x as of Dec. 31, 2016. KEY RATING DRIVERS STOR's ratings reflect the issuer's strong management team, differentiated investment strategy, diversified portfolio and solid credit metrics. The company's portfolio of 1,660 leased and financed retail properties located in 48 states was 99.5% occupied as of Dec. 31, 2016. Since the divestiture of a majority equity interest by Oaktree Capital Management, the company has committed to a more conservative capital structure and a reduction in leverage. These strengths are offset in part by the cross-collateralization features and reputational risk associated with the Master Funding conduit which may restrict STOR's financial flexibility and provide material economic incentives for the issuer to prioritize the encumbered asset pool. The conduit acts as a credit positive during favorable markets, providing STOR with an incremental and flexible source of capital. However, in more stressed markets, the conduit may limit financial flexibility as compared to REITs with more traditional debt structures. DIFFERENTIATED STRATEGY STOR is a triple-net lease REIT that focuses on originating sale-leasebacks with non-rated middle market and larger companies on the real estate where they conduct their business (e.g. retail or service but not office headquarters). The portfolio is well-diversified by store size, location and tenant, with lease maturities that are long-dated given the strategy and young age of the portfolio. STOR's asset class focus enables it to acquire net lease assets at yields 50 basis points (bps) - 300bps wider than marketed portfolios leased predominantly to investment-grade tenants. However, the middle-market and larger tenants, few of which are rated by Fitch, limit the agency's ability to assess tenant credit quality, though median EBITDAR coverage ratios are in excess of 2.0x at Dec. 31, 2016. While STOR is a relatively new company and thus the performance to-date of its underwriting is not a meaningful indicator of its sufficiency, its senior management previously founded and ran two public companies (Franchise Finance Corporation of America - NYSE: FFA and Spirit Finance - NYSE: SFC). Fitch views management favorably but notes the FFA and SFC track records are mixed. Fitch estimates FFA's conduit trusts incurred realized losses of more than 7% of original loan balance while SFC's losses were more than 3%. Fitch attributes the improving collateral performance to better underwriting and 'lessons learned' (e.g. reduced sector concentration and lower LTVs) and would expect STOR's performance to be closer to that of Spirit than FFCA. Further, many of the losses were incurred after FFCA and Spirit were sold. DIVERSIFIED PORTFOLIO STOR's portfolio has little tenant concentration with no tenant representing more than 2.8% or concept representing more than 3.1% of 2016 ABR. The company's top lines of trade as of Dec. 31, 2016 were full service restaurants (13.8%), limited service restaurants (8.4%) and early childhood education centers (7.4%), movie theaters (6.9%) and health clubs (6.2%). Industry-wide in-store retail sales growth is expected to be modestly positive at 1% in 2017 according to Fitch's 2017 Outlook: U.S. Retail and Restaurants. Fitch expects restaurant profitability will improve for most of the industry except for casual dining chains which typically provide full service. Thus, weaker chains such as Applebee's (2.2% of tenant revenues) could see reduced store counts or operating pressure. STOR faces potential challenges related to Gander Mountain Company's recent bankruptcy filing and Fitch's recent downgrade of AMC Multi-Cinema, Inc.'s parent to 'B'. Lease expirations are light over the next three years with less than 2% coming due. Further, STOR's weighted average remaining lease term is approximately 14 years, signaling stability in cash flows, absent tenant bankruptcies. INVESTMENT-GRADE METRICS Fitch projects STOR will operate with leverage between 6.0x - 6.5x EBITDA through 2020 (and below 6.0x when calculating EBITDA on a quarterly pro forma or run rate basis). Reported metrics may be weaker due to the timing and size of acquisitions. STOR's tenant diversification, contractual rental increases and long-dated lease maturities improve the durability and predictability of operating cash flows and provide a cushion for the issuer to maintain its metrics in the event of tenant credit issues. Whether STOR's metrics deviate from its targets will be conditioned by the amount and timing of equity issuances relative to acquisitions. Similarly, Fitch expects STOR will operate with fixed-charge coverage (FCC) in the 3.5x-4.0x range through 2017 as compared to 3.5x for 2015 and 2016. Contractual rental increases could be offset by higher interest expense should interest rates increase. MASTER FUNDING INTEGRAL TO STRATEGY, IMPACTS FINANCIAL FLEXIBILITY The majority of STOR's debt financing comes through the STORE Master Funding debt program, a conduit through which STOR issues ABS debt. Upon the contribution of new properties and the issuance of a new series of debt under this program, the entire collateral pool (including the newly added real estate) is pledged to secure all of the notes (i.e. the existing and new series) on a pro rata basis. The Master Funding program has mixed implications for STOR's credit profile. As the buyers are typically ABS-focused and not traditional commercial real estate lenders, STOR has access to an incremental source of capital as compared to its peers, a credit positive. Moreover, as the structure is more flexible than CMBS in regards to asset sales and substitutions it allows STOR to re-tenant or dispose of underperforming assets with greater ease than if held in a CMBS structure, thus better matching the investment strategy of focusing on non-rated entities. Further, Master Funding demonstrates leveragability and contingent liquidity for the company's portfolio, and Fitch believes there is no adverse selection between assets financed with Master Funding as compared to the unencumbered pool. While integral to STOR's strategy, the Master Funding program effectively cross-collateralizes a significant portion of STOR's assets which has two potential implications. The first is that should there be losses such that the cash trap provision is exercised, STOR would lose access to a significant percentage of cash flow to address corporate obligations and pay dividends. While cash trap provisions exist in CMBS and thus is not a risk unique to STOR, it wouldn't impact as large of a percentage of a REIT's assets if funding via single-asset mortgages or CMBS. Secondly, the cross-collateralization and reputational risk make the Master Funding program 'recourse-like' providing material economic incentives for STOR to support Master Funding potentially at the expense of the unencumbered pool. ABOVE-AVERAGE LIQUIDITY & CONTINGENT LIQUIDITY STOR has strong liquidity due to very little in debt maturities over the next two years; further, the company completed a $230 million equity offering and issued $235 million in term debt in March 2017. Fitch estimates STOR's sources of liquidity (unrestricted cash, availability under the $500 million revolving credit facility and retained cash flow from operations after dividends) cover uses (debt maturities and committed acquisitions) by more than 9.8x for the period Jan. 1, 2017 - Dec. 31, 2018. Fitch expects STOR will operate with above average liquidity as its limited operating history naturally results in few near-term debt maturities. Fitch expects STOR's liquidity will moderate towards the REIT average as it seasons and the initial debt issuances come into the rating horizon. STOR's first meaningful year of debt maturities is 2019 when $214 million (or approximately 10% of total debt) of ABS and CMBS debt matures. While STOR funds itself principally through secured debt, it nonetheless maintains a sizable pool of unencumbered assets providing contingent liquidity to unsecured creditors. Fitch estimates the current pool has a stressed value of $1.7 billion assuming a 10% capitalization rate which would provide 2.9x coverage of unsecured debt. While the unencumbered pool is sizable, Fitch notes that the unencumbered pool could be used by management as a warehouse for acquisitions before contributing to subsequent Master Funding issuances and be subject to adverse selection. KEY ASSUMPTIONS Fitch's key assumptions within the rating case for STOR include: --Same store revenue growth of approximately 1%, consistent with long-term historical levels and reflective of contractual rent bumps on the portfolio. Consolidated operating EBITDA margins remain just above 90%; --Approximately $1.1 billion in net acquisitions in 2017 and 2018 with cap rates approximately 8%; --Fitch assumes a $400 million in unsecured debt issued in 2017 and $450 million in 2018; --Fitch's forecast reflects $600 million equity offerings in 2017 and $600 million in 2018; --STOR will continue to maintain its pool of unencumbered assets and will not demonstrate any adverse selection or utilize the pool as a warehouse facility / back-up liquidity for Master Funding. RATING SENSITIVITIES The following factors may result in Fitch upgrading STOR's IDR to 'BBB': --Fitch's expectation of leverage sustaining approximately 6.0x on a pro forma basis (run-rate leverage was 6.1x at Dec. 31, 2016); --Fitch's expectation of FCC sustaining above 3.0x (FCC was 3.7x for the quarter ended Dec. 31, 2016). The following factors could result in Fitch revising the Outlook to Stable with the IDR at 'BBB-': --Fitch's expectation of leverage sustaining above 6.25x on a run-rate basis. The following factors could result in negative momentum on the ratings and/or Outlook: --Deterioration in the quality, value and/or ability to finance the unencumbered pool. Examples could include tenant credit issues, adverse selection between the encumbered and unencumbered assets and/or the recycling of unencumbered assets into Master Funding in exchange for challenged assets; --Fitch's expectation of leverage sustaining above 7.0x on a pro forma basis; --Fitch's expectation of a liquidity shortfall. FULL LIST OF RATING ACTIONS Fitch has affirmed the following ratings: STORE Capital Corporation: --Long-term IDR at 'BBB-'; --Senior unsecured revolving credit facility at 'BBB-'; --Senior unsecured notes at 'BBB- '. Fitch has assigned the following ratings: STORE Capital Corporation: --Senior unsecured term loans at 'BBB-'. The Rating Outlook is revised to Positive from Stable. Contact: Primary Analyst Steven Marks Managing Director +1-212-908-9161 Fitch Ratings, Inc. 33 Whitehall St. New York, NY 10004 Secondary Analyst Ronald Nirenberg Director +1-212-612-7747 Committee Chairperson Mark Sadeghian Senior Director +1-312-368-2090 Media Relations: Sandro Scenga, New York, Tel: +1 212-908-0278, Email: sandro.scenga@fitchratings.com. Summary of Financial Statement Adjustments: Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below: --Historical and projected operating EBITDA is adjusted to add back non-cash stock based compensation; --Fitch has adjusted the historical and projected net debt by assuming the issuer requires $25 million of cash for working capital purposes that is otherwise unavailable to repay debt. 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