Mercialys’ business risk profile is underpinned by its strategy of holding retail property assets over the long term, and renovating and renting them, with limited exposure to development activities. We view positively the company’s good competitive position in France’s retail property market, which we consider to be generally stable, given its high barriers to entry and low retail sales volatility. We factor in Mercialys’ close business relationship with French retail group Casino Guichard - Perrachon & Cie S.A. (Casino; BBB-/Stable/A-3), which is the company’s largest shareholder and its main tenant.
We also note Mercialys’ stable rental income track record, stemming from the “Droit au Bail” lease structure, which is a cashable right to leases granted to tenants by landlords, and a low occupancy cost ratio of 9.4%. These factors support the company’s high and resilient occupancy rate, which was 98% on Dec. 31, 2011. Mercialys’ management is experienced, in our view, as demonstrated by the company’s ability to sign about 400 leases in 2011.
Mercialys’ portfolio of assets is large at EUR2.6 billion on Dec. 31, 2011, comprising 121 sites, 84 of which are food anchored shopping centers in large and midsize French cities. We believe the company’s focus on its largest shopping centers, which fits best with its strategy, should improve the overall quality of the asset portfolio, with a limited impact on the total value.
The ratings are constrained by Mercialys’ lower geographic and asset diversity than peers we rate. We also note that the company’s portfolio is smaller than those of most rated retail real estate investment trusts in Europe. This is emphasized by Mercialys’ disposal target, under which we understand it intends to halve the number of properties it owns to approximately 60 to 70 in the next one to two years. We understand Mercialys aims to focus the asset portfolio on the fastest growing locations and larger developments, where there are better opportunities for extending and reconfiguring retail floorspace to tap into growing consumer demand. The company’s main tenant, Casino, accounted for 19% of total rental income in 2011. This concentration is partly offset by Mercialys’ very low tenant concentration outside the Casino tenancies. Lastly, we think that decreasing inflation and tight consumer spending in France could limit growth in Mercialys’ rental revenues, although they have historically demonstrated relatively low sensitivity to retail performance. This is because Mercialys tends to maintain its rents below market level and the ratio of rental cost to tenants’ revenues at a competitive level.
Our assessment of Mercialys’ financial risk profile as intermediate reflects our view of the company’s moderate financial policy. This incorporates our projected maximum loan-to-value (LTV) target ratio for Mercialys of around 40%, which we see as conservative. We also acknowledge the company’s recent implementation of a new capital structure and distribution of two exceptional dividends to shareholders. We believe that Mercialys’ debt structure should remain well diversified, with consistent access to debt capital markets.
The ratings also reflect the strength of Mercialys’ debt coverage metrics relative to peers, which remains a key ratings driver given the capital-intensive characteristics of the sector. We project EBITDA interest coverage of close to or higher than 3x over the next two years, assuming a scenario where growth in rental income would be more moderate than in 2011 owing to large disposals. We understand that the exceptional dividend distributions in 2012 are one-off transactions. We believe that Mercialys is likely to maintain a stable dividend policy going forward. We expect the company to maintain a close relationship with its banks and generate a track record of good access to funding sources, given its satisfactory business profile and commitment to stable debt leverage. In assessing Mercialys’ corporate governance, we note that it has a close relationship with its 40.21% shareholder Casino, which has a weaker credit profile, in our view (see “Casino Guichard - Perrachon & Cie S.A.,” published May 30, 2012, on RatingsDirect on the Global Credit Portal). We do not align our ratings on Mercialys with those of Casino, nor do we cap them at the same level. This is owing to Casino’s strategy to reduce its shareholding in Mercialys. Casino sold a 9.8% stake in Mercialys in May 2012, which will later lead to the deconsolidation of the company’s results from Casino’s accounts. We acknowledge that Mercialys has established a track record of operating as an independent listed company and is likely to maintain its arm’s length commercial relationship with Casino.
S&P base-case operating scenario
In the next two years, we anticipate that Mercialys’ reported EBITDA will decrease to a range between EUR130 million and EUR140 million in the year to Dec. 31, 2013, from EUR142 million on Dec. 31, 2011, mainly as a result of rent loss from net selling positions, as per the company’s stated disposal plan. We have factored into our analysis lower Like-for-Like increase of rents to reflect our anticipation of downward pressures on retailers’ sales and sluggish consumption in France for 2012.
S&P base-case cash flow and capital-structure scenario
We forecast that Mercialys should post a Standard & Poor‘s-adjusted ratio of FFO to debt between 9% and 10% in 2012 and 2013. In our view, its credit metrics will likely weaken owing to the leveraging up of the capital structure over this year and rent losses linked to asset disposals. Assuming that rental income stabilizes in a EUR140 million-EUR150 million range by Dec. 31, 2013, matching 2010’s level, we forecast that Mercialys’ debt service should also stabilize, with adjusted EBITDA interest coverage of about 3x by the same date. We believe this level is consistent with our assessment of the company’s financial risk profile as intermediate.
Our projection of Mercialys’ adjusted LTV ratio is steady in the low 40% area over the next two years, which remains well within our guidelines for the current ratings. We have not factored into our analysis any appreciation in the asset portfolio’s value, other than invested capital expenditures (capex), to reflect the downward pressure that a prolonged slowdown in real estate activity would exert on the appraisal values.
We classify Mercialys’ liquidity as adequate under our criteria. We expect liquidity sources to meet funding needs by more than 1.2x in the next 12 months.
As of June 30, 2012, we estimate that liquidity needs over the next 12 months mainly consisted of:
-- EUR15 million of debt amortization on asset disposals, as per the contractual 40% LTV mandatory repayment;
-- EUR110 million to EUR130 million of investment capex;
-- EUR72 million representing a standard dividend distribution
-- EUR40 million of committed acquisitions.
Supporting liquidity as of June 30, 2012, are the following:
-- EUR110 million to EUR130 million of funds from operations (FFO) estimated over the next 12 months that will almost fully fund capex;
-- EUR38 million of proceeds from committed sales, part of which covers the 40% LTV mandatory debt amortization; and
-- The EUR200 million available back-up loan from the revolving credit facility maturing in February 2015.
The EUR1 billion exceptional dividend distribution in April 2012 is fully covered by debt of EUR1 billion comprising a EUR350 million term loan maturing in February 2015 and a EUR650 million bond maturing in March 2019.
We understand that an additional EUR250 million exceptional dividend could be distributed at the end of 2012, if Mercialys meets its EUR500 million asset disposal target, which would more than cover the potential payout.
Additional supporting liquidity factors are, in our view, Mercialys’ significant headroom under its covenants and its ability to raise additional liquidity from its large pool of unencumbered assets.
The stable outlook reflects our view of Mercialys’ resilient retail property portfolio and high occupancy rate, which will likely enable it to continue generating stable and predictable income. Our stable outlook also takes into account the company’s maintenance of a moderate financial policy after the change in capital structure.
Our base case scenario anticipates that Mercialys should be able to maintain an EBITDA interest coverage ratio of more than 2.5x and a maximum LTV ratio of about 45%. We also believe Mercialys will likely maintain adequate hedging and back-up credit lines to limit any interest rate or refinancing related risks over the next two years.
We might consider raising the ratings if the company develops a strong track record of organic growth once its portfolio has been reshaped after the current disposal program and if its LTV ratio stays comfortably below 40%.
We might take a negative rating action if the company shifts toward a more aggressive financial profile, with an LTV above 45% over a prolonged period, because of a deteriorating income stream or increased shareholder distributions. Although our base-case macroeconomic scenario for France supports stable operating prospects for Mercialys’ portfolio, we consider consumer confidence in the country to be a principal operating risk for the company.
Related Criteria And Research
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
-- Key Credit Factors: Global Criteria For Rating Real Estate Companies, June 21, 2011
-- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011