Fitch Ratings has revised the Outlook on Arabian Centres Company's (ACC) Long-Term Foreign-Currency Issuer Default Rating (IDR) to Stable from Negative and affirmed its IDR at 'BB+'.

Fitch has also affirmed ACC's 'BB+' senior unsecured rating, and the 'BB+' ratings of the sukuk trust certificates issued through Arabian Centres Sukuk Limited and Arabian Centres Sukuk II Limited. A full list of ratings is provided below.

The Outlook revision reflects the stabilisation and improvement of ACC's operations, which are benefiting from Saudi Arabia's (KSA; A/Positive) positive economic developments, with the country's GDP forecast to grow by more than 8% in 2022, driven by high oil prices and production. This, combined with the end of Covid-19 restrictions and higher vaccination rates, falling unemployment and increasing wage subsidies, is boosting consumer confidence and ACC's operational metrics.

The ratings reflect ACC's position as the largest retail real estate company in KSA with a portfolio of 21 shopping centres in the country's biggest cities. ACC maintains conservative financial metrics, with net debt to EBITDA of 6.7x (FY21: 6.6x) at the end of the financial year that ends 31 March 2022 (FYE22).

Key Rating Drivers

Positive Operating Environment: Fitch expects KSA's real GDP growth to exceed 8% in 2022 (2021: 3.2%). The economic recovery, which coincides with the end of pandemic-related restrictions and higher vaccinations (more than 70% of the population has received a second booster), helped to reduce unemployment to 11% in 4Q21 (2Q20: 15.4%) and to boost consumer confidence.

The positive sovereign environment has helped ACC to start to recover from pandemic-related restrictions, which included government enforced shuts of shopping malls for six weeks. KSA's retail market, while still relatively underdeveloped, has positive dynamics, such as low mall penetration (about one-third of Dubai's), and a young and growing population.

Operational Recovery Is Progressing: Total footfall, which fell by more than 40% in FYE21, increased to 81 million at FYE22 from 72 million at FYE21. It is still below pre-pandemic levels largely because of restrictions remaining in 1HFY22. Like-for-like (LFL) occupancy was 94.1% at FYE22 (FYE21: 92.9%, FYE20: 93.1%). The occupancy of U-Walk and Nakheel Mall Dammam, both of which opened in FY19, reached 97% at FYE22 (FYE21: 85%) and 98% (92%), respectively. These improvements, along with reduced discounts, led to a 4.5% growth in LFL net rental revenue in FY22 (FY21: -20%).

Strong Competitive Position: ACC operates a portfolio of 21 malls (20 owned) in the largest cities of KSA. The gross lettable area (GLA) is 1.3 million square metres (sqm) with a reported value of SAR15.5 billion (EUR4 billion) at FYE22. Market value, which ACC will begin using in 3QFY23, is about SAR23 billion. Assets are concentrated on four super-regional malls, which generated 44% of revenue in FYE22. ACC has a large development pipeline, which, if fully delivered, will increase GLA by about 28%, but concentration will remain.

Covid-19 Discounts Amortising: The company waived rents during the six-week government-imposed lockdown in FY21 and provided case-by-case tenant support thereafter. Total Covid-19-related discounts are estimated at SAR579 million, which are being recognised over the term of the lease contracts. Of the discounts, SAR436 million have already been recognised and the cash impact was accounted for in FY21. While non-recurring Covid-19-related discounts have ceased, discounts provided to new tenants continue. These fell to 1.3% in FY21 (FY19: 6.8%), but may grow as new malls open.

Front-Ended Lease Expiries: The company renewed more than 90% of leases expiring in FY22, but the lease maturities remain short with 34% expiring in FY23 and 35% in FY24. Rental rates remain under pressure. Renewal rates were largely flat in class 'A' and 'B' malls, which comprised 85% of lease expiries in FY22, while rates in class 'C' malls were slightly down. The short lease expiry schedule (about three years), allows ACC to manage GLA and tenants, but also reduces cash flow visibility and can increase volatility.

Related Parties; Rental Forbearance Risks: Related-party transactions are material, particularly with parent company Fawaz Abdulaziz Alhokair Co., one of the largest retail companies in the Gulf Cooperation Council (GCC). Amounts due from related parties were SAR325 million at FYE22 (FYE21: SAR379.4 million), largely comprising rental receivables. In FY22, ACC received SAR350 million from sister company FAS Hotels. Related parties generate about one-quarter of rents.

Lynx, a parent-owned developer, has built almost all of the company's shopping malls. ACC's policy requires related-party transactions to remain at arm's length, but rental forbearance risks remain.

Active Development Pipeline: In FY22, ACC completed the 120,000sqm Jeddah Park and the 56,000sqm The View. Jeddah Park, originally under a head-lease, is operated through a management agreement and has an option to revert to the initial lease contract after three years. This is part of ACC's growing asset-light strategy. The View, ACC's seventh mall in Riyadh, is on freehold land. ACC's medium-term capex pipeline is a significant SAR3.8 billion, including seven malls.

Although largely uncommitted and can be adjusted depending on conditions, high development spending will likely pressure financial metrics.

New Funds Established: In June 2022, ACC, along with Riyad Capital, established two closed-end real estate funds to develop two projects - Jawharat Riyadh and Jawharat Jeddah. The funds, valued at SAR6.2 billion, acquired the land from ACC. ACC retains full ownership rights to the funds' units and will operate the assets after completion. Riyad Capital will manage the funds, whose debt is non-recourse to the company. The funds will allow ACC to limit balance-sheet debt and is part of the company's asset-light strategy.

Financial Metrics Pressured: Financial metrics remain under some pressure, despite the rental income improving. Funds from operation (FFO) lease-adjusted net debt leverage was 6.9x at FYE22 (FY21: 6.2x). The income yields of the investment portfolio are relatively high at more than 8.0%, owing to the nascent stage of the KSA retail market. We forecast leverage to remain at 6.8x, thereafter, owing to high development outlays and cash dividends.

Derivation Summary

Fitch-rated EMEA peers to ACC are limited, owing to the less developed stage of the retail market in KSA and the substantial dependence of the economy on oil, both of which can create volatility, as well as the high level of related-party transactions.

AKROPOLIS GROUP, UAB (BB+/Stable) owns a small EUR0.8 billion portfolio of four prime shopping centres in Lithuania (A/Stable) and Latvia (A-/Stable). NEPI Rockcastle S.A. (BBB/Positive) owns and operates a larger EUR5.6 billion portfolio, but with a low asset concentration and a presence in nine countries predominantly rated 'BBB' or below (61% of NEPI's market value). In the GCC, Majid Al Futtaim Holding LLC (BBB/Stable) and Emaar Properties PJSC (BBB-/Stable), each have retail portfolios of more than EUR5 billion that are concentrated in Dubai, but with assets in other countries. The retail portfolios of both, however, are part of a large conglomerate structure, which brings significant revenue diversity.

A number of factors, however, set ACC apart from other EMEA peers. About two-thirds of its revenue is generated from assets on long-term leaseholds, which lowers EBITDA margins by about 10% compared with peers. The leases also carry renewal risk, as they do not automatically renew. If ACC is unable to renew the lease, the ownership of buildings on the site would transfer to the landowner with no compensation to ACC, although assets are depreciated over the life of the lease. The average remaining leasehold maturity is about 12 years, which implies a long-term risk.

The next expiry is for the Mall of Dharan, the company's largest shopping centre. Negotiations have already begun. Fitch views the likelihood of a failure to renew as remote, owing to the mutual benefit of extending the lease for both parties, but the lease expense is likely to increase. ACC's leasehold cost is typically about 10% of total revenue. ACC previously renewed the lease for Aziz Mall for 30 years, but the lease cost more than doubled to 16% of the mall's rent. The effect of increases diminishes over time as revenue from the mall grows.

In 2022, ACC did not renew the head leases over two malls, which were viewed as non-core. The first, Salma Mall, was a small community shopping centre, which had an occupancy of only 68% in 2021. The second, Khurais Mall, was a larger, but old, regional mall in Riyadh, where ACC already has seven shopping malls making it superfluous to the portfolio. Both assets were fully depreciated.

ACC also has materially higher related-party activities than peers, particularly with Alhokair companies (mainly in rental receivables). ACC is reducing these, but they are still likely to remain high. Lynx, a group-company developer, built most of ACC's malls, and the largest single tenant is parent-company Alhokair Fashion Retail.

Compared with most other EMEA countries, the KSA retail market is less developed with low mall penetration, but also with the largest, and one of the youngest, populations in the GCC. This provides competitive opportunities for ACC, but also means the domestic market can be volatile. Government policies can also substantially affect the retail market.

Key Assumptions

Fitch's Key Assumptions within our Rating Case for the Issuer

Revenue growth at low single digits for 2023-24

Average occupancy ratio above 90%

Stable EBITDA margin at 60%

Capex ratio of 13%-14% for the forecast period and significant near-and-medium-term developments

Dividend payment in line with 2022 figures

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Occupancy rates consistently above 95%

FFO adjusted leverage consistently below 4.5x

Improvement of the operating environment on a sustained basis

A material reduction in asset concentration

A smoother lease maturity profile

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Deterioration in the operating environment

FFO adjusted leverage exceeding 7.0x on a sustained basis

Fitch-adjusted EBITDA interest cover of 1.75x

Occupancy rates below 90%

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

Comfortable Liquidity: At FYE22, there was SAR556 million of available cash on the balance sheet, along with SAR575 million of the company's SAR750 million revolving facility (RCF). This adequately covers amortisations of about SAR278 million and expected FFO of negative SAR146 million, and yields a liquidity cover ratio of about 4x. The undrawn revolver matures in November 2022, but we expect this to be renewed shortly.

In April 2021, ACC issued a USD650 million sukuk, followed by a USD225 million tap in July 2021. ACC used the proceeds to repay its fully drawn RCF, pay down more than USD472 million of secured debt and increase cash. The issuance was neutral to net debt, but improved the position of senior unsecured debt holders by reducing secured debt and extending the debt maturity schedule. The unencumbered assets/unsecured debt ratio exceeds 3x. Secured debt is now 34% of total debt, down from 74% in FY21.

Issuer Profile

ACC is the largest real-estate company in KSA and owns and operates a portfolio of 21 malls. The assets are located in KSA's largest cities with a GLA of about 1.3 million sqm with a market share of 14%.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

ACC has an ESG Relevance Score of '4' for Group Structure, reflecting a high degree of related-party transactions that generate more than 25% of group rental income. This has a negative impact on the credit profile, and is relevant to the ratings in conjunction with other factors.

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg

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