Fitch Ratings has assigned Castellana Properties SOCIMI, S.A a first-time Long-Term Issuer Default Rating (IDR) of 'BBB-'.
The Outlook on the IDR is Stable.
The rating reflects Castellana's fairly small EUR1 billion portfolio of 16 retail assets in Spain with some concentrations. The top eight assets constitute 80% of its directly-held investment property portfolio while its 10-largest tenants represent 40% of rents. However, the (some grocery-anchored) portfolio has been resilient over the past two years as space has been re-let with net flat-to-positive increases in rent. Pandemic-related rent waivers are now diminished, footfall is recovering and occupancy high.
Asset values have been stable (net initial yield (NIY): 6%), with rising e-commerce less of an immediate threat to these regionally-placed, frequent-visited and, particularly in retail parks (RPs), omnichannel-conducive properties. We expect Castellana to expand in its domestic market. Castellana's rating includes the benefit of the recent 21.7% equity investment in Lar Espana.
Key Rating Drivers
Concentrated Portfolio: The eight largest of Castellana's 16 assets totalled EUR831 million (80%) of the group's end-September 2021 (1HFY22) investment property portfolio. The largest assets focus on six shopping centres (SCs), and Granaita RP, which are geographically spread around Spain with a weighting to the south west (bordering Portugal) and south (Andalucia region). As with sector peers', these retail assets have recovered to around 80%-90% of pre-pandemic footfall (1HFY22: 96.4%), and tenants' sales are above previous levels due to 'mission shopping' and higher average basket size.
Stable Portfolio Profile: The portfolio's rents have been largely stable with pandemic-related case-by-case rent waivers much smaller in FY22. Despite the portfolio's short weighted average lease term (WALT) of 2.7 years to earliest break, re-leasing of expired leases (3% of group rents) was flat in FY21 and up 2.5% in 1HFY22. Since December 2018, occupancy remained stable at around 98% (1HFY22: 97%). Virtually all lease contracts' rents are indexed to inflation. These operational metrics indicate the underlying stability of this non-prime retail-focussed portfolio.
Regionally Dominant and Relevant: Castellana's retail assets are regionally dominant, rather than competing within a multi-participant city centre. Some SCs or RPs are anchored by essential retail stores (Carrefour, Mercadona) complemented by other names such as Inditex (various facias including Zara), MediaMarkt, Leroy Merlin, Tendam and Primark.
Less Affected by E-Commerce: Although the fashion and accessories retail segment constitutes 34% of the portfolio by rent, Fitch believes that Spain is less adversely affected by rising e-commerce penetration. Castellana is further aided by its RPs and SCs having critical mass (average SC size: 33,000 sqm) in its local catchment area and having a variety of stores, food & beverage and leisure activities (including cinemas), which lengthen dwell times. RPs are also conducive to today's retailers' omnichannel positioning.
Near-Term Rent Increase: Castellana has re-positioned some of its SC assets and signed new leases that will increase rental income. For example, it purchased an adjacent El Corte Ingles store to expand retailer diversity for the 35,333 sqm SC Bahia Sur (Cadiz-Andalusia), and repositioned an El Corte Ingles hypermarket store to Mercadona to enhance its 26,680 sqm SC Los Arcos (Seville-Andalusia). The capital outlay for this repositioning is reflected in higher FYE21 and FYE22 debt but the expected positive effect from this active asset management on the location's nearby units' full-year rents has yet to materialise.
Acquisition of Lar Espana Interest: We acknowledge the financial rationale behind Castellana's Lar Espana equity purchase by buying assets that share similar characteristics to its own at a 50% discount to net asset value, plus a resultant high dividend yield. However, it is difficult to see the operational strategy as a seat on Lar Espana's board would raise conflict-of-interest issues, and the Grupo Lar family are unlikely to relinquish their shareholding or asset management function. Castellana has reiterated that its EUR97 million investment in Lar Espana is friendly. It would yield a normalised EUR9 million-EUR10 million dividend. Fitch includes this regular dividend in Castellana's EBITDA, comparable with its rental-derived portfolio's EBITDA as this is a, subordinated, post-interest expense, income flow from a stable and complementary 'BBB' rated entity.
Improving Cash Flow Leverage: Fitch forecasts Castellana's net debt/EBITDA to improve to 9.0x-9.5x in FY22 and FY23 when its reconfigured core SCs benefit from full-year rent contributions. Including the EUR97 million cash investment for its Lar Espana stake (of which parent Vukile Property Fund's EUR75 million shareholder loan has been approved for conversion into equity) and a EUR9 million-EUR10 million recurring dividend, the ratio will improve to around 7.8x-8.4x in FY23 and FY24. This compares with a higher normalised leverage of around 10x in FY20 and FY21 (reversing pandemic-related rent reductions), which includes debt incurred for the reconfiguration. EBITDA interest cover ratio is forecast at around 3.8x for the next two years.
Target LTV Below 40%: Fitch estimates the loan-to-value ratio (LTV, net debt to directly-held investment property) at around 45%-50% in the next two years. Castellana's announced financial policy is LTV below 40% although the company calculates this ratio using the equity investment (at an undiscounted value).
PSL Porous Legal Ring-Fencing: Vukile owns 89.6% of Castellana. Under Fitch's Parent and Subsidiary Linkage (PSL) Criteria, we assess Castellena under the stronger subsidiary path. We view legal ring-fencing as 'porous', reflecting existing and planned LTV covenant protection, fiduciary responsibilities of, and oversight by, Castellana directors to stakeholders including its debtholders when considering potential adverse upstreaming of asset disposals and dividends to a distressed parent.
Under the PSL Criteria, access and control is assessed as 'open', blending the dominant shareholder control with Castellana's autonomous debt funding and cash management. To date, Vukile has injected equity into Castellana to aid its expansion. These factors enable Castellana's rating to be a maximum one notch above the criteria's synthetic consolidated profile of Vukile and Castellana.
Derivation Summary
Castellana's closest Fitch-rated peer is Lar Espana Real Estate SOCIMI, S.A. (IDR: BBB/Stable). Both entities characterise their SC and RP assets (Castellana: six and 10, respectively, in numbers; Lar Espana: nine and five) as dominant in their local catchment. Lar Espana is more grocery-anchored but both have food & beverage, and leisure operators (including cinema) to attract footfall from the local catchment. Castellana's assets are generally smaller, and have much smaller RPs than Lar Espana's. Each company's NIY is similar at 6%.
Both companies have repositioned some of their assets through expansion and reconfiguration, and both entities have yet to see the full rental effect due to pandemic operating restrictions. Both entities' rent/sqm for SCs and RPs are broadly similar, and Lar Espana's end-December 2021 WALT is the same as Castellana's 2.7 years. A period of downward pressure on rental values could expose asset weaknesses and prompt tenants to negotiate lower rents, although this did not happen over the past two years for either company. The European framework for retail rents, with annual increases indexed to CPI has led to more stable rental profiles compared with the boom-and-bust approach of some UK rent-setting in retail, which has exposed excess retail space. Lar Espana's March 2022 occupancy was 96.1% versus Castellana's end-September 2021 at 97%.
Wider comparisons can be made with NewRiver REIT plc (IDR: BBB/Stable, EUR1.1 billion portfolio) in the UK, which also has non-prime convenience-led, community-based SCs and RPs that suffered less during the past years of reduced rents and values in response to an over-supply of retail space as further exposed by the pandemic. NewRiver fared better than peers, due to its avoidance of department stores and mid-market fashion retailers and, like the abovementioned Spanish peers, has maintained its affordable rents.
IGD SIIQ S.p.A. (IDR: BBB-/Stable) has a larger EUR2.2 billion Italian portfolio that includes the local COOP grocer operator (anchor stores and IGD shareholder) and is more leveraged. Citycon Oyj (IDR: BBB-/Stable) has a EUR4.3 billion Nordic SC-biased portfolio, also urban-focussed, whose rental growth potential is less visible, and has higher leverage than Castellana.
All these retail asset-owning companies have positioned their portfolios to differentiate themselves from their countries' rising e-commerce penetration, using their local dominance and types of retail mix, to encourage frequency-of-visit (including grocery anchors) over less frequent destination shopping. Fitch also believes that the RPs, where these retailers' units have the store space and conditions (ease of parking and click-and-collect) for omnichannel services, provide some resilience against rising e-commerce compared with destination, fashion-orientated, shopping centres.
Although Lar Espana and Castellana have similar leverage at 8x net debt/EBITDA for portfolios with similar 6% NIY (Castellana's metrics are enhanced by recurring subordinated dividends from its recent investment in Lar Espana), Castellana's overall quality, greater concentrations resulting from size and short WALT, lead to a 'BBB-' IDR.
Key Assumptions
Fitch's Key Assumptions Within Our Rating Case for the Issuer
Year-on-year increases in rent include the benefits from repositioning of some SCs (see Key Rating Drivers above), partly from acquiring an adjacent El Corte Ingles department store and hypermarket, re-letting this reconfigured space, and/or letting to new tenants (17 new retail units in the department store example). This also benefits rental levels across the adjacent SC. Management reports that much of FY22 rental income is already achieved, and full-year rent effects for some assets spill over to FY23, and FY23's into FY24
CPI increase of 1% per year
Refurbishment capex of EUR29.5 million in FY22 and EUR17.7 million in FY23
EUR26 million office disposals in FY22
FY22 includes the January 2022-acquired Lar Espana equity stake. Castellana's share of EUR9 million recurring dividend is received in FY23
Dividends average 50% of IFRS-based funds from operations (FFO) whereas SOCIMI dividend payout rules are based on Spanish GAAP
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Larger directly-held investment property portfolio providing increased asset diversity
Net debt/EBITDA below 8.0x
Net interest coverage above 3x
Weighted average lease length (earliest break basis) of more than three years, with continued like-for-like rental income growth
Under Fitch's PSL Criteria, a strengthening of the consolidated profile or greater ring-fencing of Castellana
Factors that could, individually or collectively, lead to negative rating action/downgrade:
Net debt/EBITDA above 9.0x
Net interest coverage below 2x
Inability to refinance debt well in advance of scheduled maturities, leading to a liquidity score below 1.0x
Under Fitch's PSL Criteria, a weakening of the consolidated profile or less ring-fencing of Castellana
Best/Worst Case Rating Scenario
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
Liquidity and Debt Structure
Adequate Liquidity: Castellana had EUR52.8 million cash at end-1HFY22 but does not intend to have an undrawn revolving credit facility (RCF) available for future financing needs. Castellana plans to issue unsecured debt and use proceeds to prepay some existing secured debt funding to create an unencumbered property portfolio. A EUR10 million shareholder loan from Vukile is also expected to be repaid in FY23 (concerning the other EUR75 million used to fund the Lar Espana investment, Castellana's board of directors has approved its conversion into equity, which will take place by end-March 2022).
Following Castellana's refinancing in early 2022, the main existing secured debt is a EUR290.8 million SC facility whose bullet maturity is September 2025 and a EUR184.8 million RP facility with small near-term amortisations, maturing in February 2029.
CASTELLANA PROPERTIES SOCIMI, S.A. 
