Fitch Ratings has upgraded NEPI Rockcastle N.V.'s (NEPI) Long-Term Issuer Default Rating (IDR) to 'BBB+' from 'BBB'.

The Outlook is Stable. Fitch also upgraded NEPI's unsecured debt rating and the senior unsecured ratings on NE Property B.V.'s bonds to 'BBB+' from 'BBB'. The bonds are guaranteed by NEPI.

The upgrades reflect the improvements in recent years in NEPI's operational metrics, with increasing occupancy, footfall and tenants' sales exceeding pre-pandemic levels. NEPI's EUR5.7 billion income-producing properties portfolio benefits from diversification across central eastern European (CEE) countries, assets and tenants. The portfolio's quality and moderate occupancy costs positions it to withstand lower consumption as the rising cost of living puts pressure on consumers' disposable incomes.

The upgrades also reflect NEPI's long record of a prudent financial profile and Fitch's expectation that this will continue. With end-2021 net debt/EBITDA leverage at 5.7x, NEPI has maintained a significant buffer from our previous 7.0x upgrade to 'BBB+' rating sensitivity. Its interest coverage was 5.7x at end-2021 and is forecast to remain strong despite rising interest rates.

Key Rating Drivers

Improved Operating Performance: In 1H22 tenants' sales in NEPI's portfolio were 8% higher than the equivalent period in 2019. This was due to an increase in average shopping basket value, which was 27% higher in 1H22 compared with 1H19, while footfall still lagged pre-pandemic levels. The pattern of lower footfall but higher tenants' sales in retail is evident across several European markets. The sales of all tenants' segments in NEPI's portfolio in 1H22 exceeded pre-pandemic levels except for entertainment (2% of the portfolio's total tenants' sales) where sales were around 17% lower and fashion (45% of total), which was broadly in line with 1H19.

The vacancy rate for NEPI's retail portfolio decreased to 3.2% at end-1H22 (1H21: 4.4%). Of the leases expiring during 2022, 80% were renewed by mid-August.

Uncertain Rental Growth Prospects: Inflation, which has so far aided growth of the shopping basket, may erode households' disposable income, affecting retailers' performance. Inflation also feeds into higher rents through inflation-linked rent indexation clauses included in most of NEPI's leases. These leases are usually euro-denominated and use EU27 CPI as a reference. Fitch expects that eurozone CPI will be lower than inflation in countries where NEPI operates.

Combined with a moderate occupancy cost ratio (1H22: 13.3%, excluding hypermarkets), this will help tenants absorb rent increases to some extent. However, if lower disposable incomes lead to lower tenants' sales, rent increases may prove to be unsustainable. To maintain the portfolio's high occupancy rate like other retail landlords, NEPI may choose not to maximise CPI-linked rent increases. The affordable rent profile may also be affected by a sharp depreciation of the domestic currencies, in which retailers' revenues are earned, versus the euro.

Stable Cash Flow Leverage: NEPI's end-2021 net debt/EBITDA remained low at 5.7x despite pandemic-related rent discounts provided to some tenants. Fitch forecasts net leverage to increase moderately to 6.1x during 2023-2025 as the capex programme continues, after falling to 5.4x in 2022 as expiring rent discounts are partially offset by increased cash dividend and capex. We expect interest cover to remain comfortable (2022: 6.6x; 2023: 6.9x) as NEPI benefits from strong cash flows, low leverage and long-dated interest rate fixing.

Accelerated Development Activity: As at 1H22, NEPI had four projects under construction with total capex to complete at around EUR300 million. The projects include the mixed-use extension of Promenada Mall (around 60,000 sqm of new space) in Bucharest; refurbishment and extension of Bonarka City Center in Krakow (4,500 sqm); and development of a new shopping centre (64,000 sqm) in Craiova, Romania. The fourth is a residential complex adjacent to an existing NEPI-owned retail park in Bucharest. Projects under permitting and pre-leasing with EUR230 million of total capex expected include construction of new retail assets in Bulgaria and Romania and an investment in photovoltaic panels.

CEE Retailers: NEPI's tenants include well-known international and regional brands. Compared with their western European peers, regional retailers have been less exposed to flat retail sales growth, other geographies' higher and increasing e-commerce share and their oversupply of retail space. This provides some buffer against the risk of a decline in consumer demand, increasing staff salaries or inventories prices in CEE retail markets. NEPI's tenant diversification (top 10 generating 24% of total rental income) helps mitigate the risk of specific tenant default.

Property Management Internalisation: NEPI decided to unify its property management operations and systems. This means that in Poland, Lithuania, Czech Republic and Hungary, NEPI will take over property management functions from third-party managers. It will allow for more active management, better information flow and some cost savings. The process is scheduled for completion by mid-2024. Fitch considers nimble property management an important success factor in a fast-changing retail environment.

New Management Team: In June 2022, interim CEO Rudiger Dany and CFO Eliza Predoiu were appointed at their positions on a permanent basis. Marek Noetzel was appointed COO. The new CFO and COO have many years' experience with the company. Rudiger Dany joined NEPI in July 2021 having extensive experience in the retail real estate sector. Fitch understands that management is committed to NEPI's prudent financial profile.

Derivation Summary

NEPI's peers include Globe Trade Centre S.A. (GTC, BBB-/Stable) with its EUR2.1 billion portfolio, which benefits from diversification across asset classes with offices (65% of market value) and retail (35%) and Globalworth Real Estate Investments Limited (BBB-/Stable) whose office-focused portfolio was valued at EUR2.8 billion. GTC's country risk exposure is the most similar to NEPI's with a presence in six countries predominantly rated 'BBB' or below (60% of GTC's assets' market value). Globalworth's portfolio is almost equally split between Poland (A-/Stable) and Romania (BBB-/Negative). The smaller (EUR1.0 billion), all-retail portfolio of AKROPOLIS GROUP, UAB (BB+/Stable) is in 60% in Lithuania (A/Stable), the rest in Latvia (A-/Stable).

NEPI's end-2021 net debt/EBITDA, at 5.7x, is lower than GTC's leverage of around 10x and Globalworth's of about 8.5x.

NEPI has a net initial yield (NIY, this measures annualised net rents to investment property asset values) of 6.7%. The remaining CEE peers do not disclose directly comparable NIY data. Fitch believes the quality of Globalworth and GTC's portfolios is broadly similar to that of NEPI.

Akropolis has the lowest leveraged financial profile, with 2022 net debt/EBITDA at 4.9x ahead of a planned construction project, which will increase its leverage. Akropolis's portfolio has a NIY estimated at around 7% and LTV of below 40%. However, its rating is constrained by its concentration on a limited number of assets, restricting asset and geographical diversification.

Key Assumptions

Fitch's Key Assumptions Within Our Rating Case for the Issuer

Rent changes arising from acquisitions, disposals or developments coming on stream annualised rather than accounted on a part-year basis.

Like-for-like rent increase of 3% in 2022 and 2% increase in 2023, reflecting partial forfeiture of inflation-linked rent indexation and a mix of rental levels upon lease renewals. Rent increases of 1% per year in 2024 and 2025.

Around EUR50 million of net acquisitions spending in 2022.

Over EUR820 million of capex between 2022 and 2025, including EUR40 million a year spent on non-income-yielding reinvestments.

EUR241 million cash dividend in 2022 and 90% of FFO in a given year thereafter.

RATING SENSITIVITIES

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

Given the retail-focused portfolio and mix of CEE countries, Fitch does not expect an upgrade of NEPI to the 'A' rating category in the near future.

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

Material expansion in new or existing non-investment-grade countries, either through expansion or through downgrades.

Significant deterioration of operating metrics on a sustained basis, such as higher vacancies.

Increase in leverage with such metrics as loan-to-value (adjusted net debt/investment properties) consistently exceeding 40% or net debt/EBITDA surpassing 7.0x on a sustained basis.

A liquidity score below 1.25x on a sustained basis.

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

Strong Liquidity: At end-1H22, NEPI had EUR428 million of readily available cash (excluding EUR22 million held on the secured loans' related reserve accounts) and access to EUR620 million of available revolving credit facilities maturing not earlier than December 2024. Proceeds from EUR500 million eight-year bonds issued in January 2022 were used to repay a bond due in May 2023. The refinancing extended the group's average debt maturity to 4.7 years at end-1H22 from 3.7 years at end-2021. The next meaningful debt repayment is scheduled for November 2024, when EUR499 million of bonds fall due. In 2022 and 2023 only around EUR4 million and EUR66 million, respectively, of secured loans mature.

NEPI's debt is predominantly unsecured. At end-June 2022 its unencumbered investment property pool was valued at EUR5.3 billion (91% of total income-producing assets, by value) pro-forma for full consolidation of Ploiesti Shopping City. NEPI acquired the remaining stake in Ploiesti SC in September 2022. The group's pro forma unencumbered income producing investment properties/unsecured debt ratio was 2.6x.

Issuer Profile

NEPI is a retail-focused property company with an income-producing portfolio of regionally dominant shopping centres spread over nine CEE countries, valued at EUR5.7 billion at end-June 2022.

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

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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