Fitch Affirms Prologis, Inc.'s IDR at 'BBB' on KTR Announcement; Outlook Positive

NEW YORK--(BUSINESS WIRE)-- Fitch Ratings has affirmed at 'BBB' the ratings for Prologis, Inc. (NYSE: PLD) and certain rated subsidiaries (collectively, Prologis or the company) following the announcement that the company's 55-45 consolidated joint venture with Norges Bank Investment Management (NBIM), Prologis U.S. Logistics Venture, has agreed to acquire the real estate assets and operating platform of KTR Capital Partners (KTR) and its affiliates for a total purchase price of $5.9 billion including the assumption of debt.

The Rating Outlook is Positive. A full list of ratings follows at the bottom of this release.

KEY RATING DRIVERS

The Positive Outlook reflects Fitch's expectation that the company's pro rata leverage will remain around 7.0x, initially pro forma for the KTR transaction. Fitch also expects leverage to trend in the 6.0x - 6.5x range over the next 12-to-24 months, which would be consistent with a 'BBB+' rating. Favorable credit elements of the KTR transaction include the acquisition of a high quality portfolio largely located near major ports in Southern California, New York-New Jersey, Chicago, San Francisco and Dallas (markets in which Prologis already has a significant presence) and a strong tenant roster with exposure to e-commerce tenants, a growing segment in the industrial real estate market.

Prologis has indicated that it intends to fund the KTR transaction on a leverage-neutral basis; however, there are uncertainties surrounding the levels of proceeds from asset sales, equity, and corporate level debt that will ultimately be used to fund the transaction. Under the agency's base case, Fitch expects that $630 million of term loan borrowings, the issuance of $230 million of operating partnership units, the assumption of $385 million of pro rata mortgage debt, $500 million of asset sales and hedge settlement proceeds, and $1.5 billion of equity proceeds will comprise the consideration for Prologis' $3.2 billion share of the KTR transaction. A deviation from funding the transaction on a leverage neutral basis would slow the trajectory of the company's de-leveraging and could place pressure on the Positive Outlook. In addition, it is likely that Prologis' development pipeline on a pro rata basis will continue in the coming years since the KTR development portfolio includes 3.6 million square feet of properties under development and land holdings. PLD's pro rata cost to complete development compared to total asset value remains low when compared with the company's levels during the previous upcycle.

High Leverage Expected to Decline

The company's 6.9x pro rata debt-to-EBITDA ratio as of March 31, 2015 was appropriate for the 'BBB' rating. Fitch projects that pro rata leverage will be 6.9x initially pro forma for KTR, and trend in the 6.0x - 6.5x range over the next 12-to-24 months. Fitch's leverage threshold of 6.5x for a 'BBB+' rating for Prologis acknowledges the company's strong asset quality and lower portfolio yields. In a stress case whereby the company does not issue any equity and thus the only equity component of the transaction is the $230 million of operating partnership units, leverage would be 7.5x, which would be weak for the 'BBB' rating.

Adequate Liquidity; No Corporate Debt Maturities Until 2017

Fitch expects the company will continue to maintain sufficient liquidity before considering proceeds from dispositions and contributions. While Fitch anticipates that the company will continue to match-fund its development expenditures with dispositions and contributions, maintaining sufficient liquidity before the match-funding reduces the risks to unsecured bondholders during periods of capital markets dislocation.

The company's liquidity coverage ratio is 1.4x for the period April 1, 2015 to Dec. 31, 2016 pro forma for the KTR transaction. Fitch defines liquidity coverage as liquidity sources divided by uses. Liquidity sources include unrestricted cash, availability under revolving credit facilities pro forma, and projected retained cash flows from operating activities. Liquidity uses include pro rata debt maturities after extension options at PLD's option, projected recurring capital expenditures, and pro rata cost to complete development. Moreover, the company has no corporate maturities until 2017.

Internally generated liquidity is moderate as the company's adjusted funds from operations (AFFO) payout ratio was 88.8% in 1Q'15 compared to 88.7% in 2014 and 95.4% in 2013. Based on the current payout ratio, the company would retain approximately $95 million in annual cash flow.

Improving Fundamentals and Fixed-Charge Coverage

Positive net absorption continues to benefit Prologis' portfolio while macro industrial indicators such as manufacturing levels, housing starts and homebuilder confidence indicate that demand may continue to outpace supply. The company's average net effective rent change on rollover was 9.7% in 1Q'15, up from 7.4% on average during 2014 and 4.5% on average in 2013. Occupancy was 95.9% as of March 31, 2015 compared to 96.1% as of Dec. 31, 2014, up from 95.0% as of Dec. 31, 2013 and cash same-store net operating income (NOI) grew by 3.9% in 1Q'15, 4.5% on average in 2014 and 1.8% on average in 2013.

Pro rata fixed-charge coverage (FCC) is 2.8x in 1Q'15 pro forma for the KTR transaction, up from 2.7x in 1Q'15, 2.4x in 2014 and 1.8x in 2013. Fitch defines pro rata FCC as pro rata recurring operating EBITDA less pro rata recurring capital expenditures less straight-line rent adjustments divided by pro rata interest incurred and preferred stock dividends. Fitch projects that rental rate growth in the high single digits (since in-place rents over the next several years remain approximately 10% below market rents) will result in 3% - 4% same store NOI (SSNOI) growth over the next several years. This should result in FCC sustaining in the 2.5x to 3.0x range, which is strong for a 'BBB' rating. Under the Fitch stress case, FCC would remain around 2.5x, which is also strong for the rating.

Pro Rata Treatment

Fitch looks primarily at pro rata leverage (pro rata net debt-to-pro rata recurring operating EBITDA) rather than consolidated metrics given Fitch's expectation that PLD has and would in the future support or recapitalize unconsolidated entities, its agnostic view toward property management for consolidated and unconsolidated assets, and its focus on pro rata portfolio and debt metrics.

As a supplementary measure, Fitch calculates consolidated leverage as consolidated net debt-to consolidated recurring operating EBITDA plus Fitch's estimate of recurring cash distributions from unconsolidated co-investment ventures, since these cash distributions benefit unsecured bondholders. However, this supplementary measure may understate leverage given the inclusion of cash distributions from joint ventures but exclusion of the corresponding non-recourse debt.

Excellent Access to Capital

The company issued $7.1 billion and EUR2.5 billion in unsecured bonds since 2009 (using the proceeds to refinance and repurchase bonds and for general corporate purposes) and $3.7 billion of follow-on common equity at a weighted average discount of 1.8% to consensus estimated net asset value. The company also has a $750 million at-the-market (ATM) equity offering program, and in December received proceeds of $353.9 million through the issuance of equity securities from the exercise of a warrant issued in connection with the formation of Prologis European Logistics Partners and through the ATM program.

Strategic capital is another important source of funding for PLD, as evidenced by the KTR transaction being completed via a partnership with NBIM. The company rationalized and restructured certain of its investment ventures to increase the permanency of its capital (e.g., FIBRA Prologis and Nippon Prologis REIT) and reduce the inter-dependence over the past several years, which Fitch views favorably.

Global Platform; KTR Transaction Improves Portfolio Quality

Prologis had $52.6 billion of assets under management as of March 31, 2015 and the global platform limits the risk of over-exposure to any one region's fundamentals.

PLD derived 83.2% of its 1Q'15 NOI from Prologis-defined global markets (59.3% in the Americas, 20.4% in Europe, and 3.5% in Asia), and the remaining 16.8% of 1Q'15 NOI was derived from regional and other markets. The KTR transaction will increase the company's exposure to major U.S. markets, including Southern California (21.9% of pro forma U.S. NOI), New York-New Jersey (10.1%), Chicago (9.8%), San Francisco Bay Area (7.0%) and Dallas (6.0%).

The KTR transaction will also increase the company's exposure to e-commerce, a growing segment in the industrial real estate market, as evidenced by the increase in annualized base rent from Amazon.com to 2.4% pro forma, compared to 1.0% as of March 31, 2015. Other top tenants pro forma include DHL (1.8%), Kuehne & Nagel (1.3%), CEVA Logistics (1.3%), and Geodis (1.0%).

Adequate Unencumbered Asset Coverage

Prologis has adequate contingent liquidity with a stressed value of unencumbered assets (1Q'15 unencumbered NOI divided by a stressed 8% capitalization rate) to net unsecured debt of 2.2x. When applying a 50% haircut to the book value of land held and a 25% haircut to construction in progress, unencumbered asset coverage improves to 2.4x.

Increasing Speculative Development

PLD's strategy of developing industrial properties centers on value creation and complements the company's core business of collecting rent from owned assets. After construction and stabilization, the company either holds such assets on its balance sheet or contributes them to managed co-investment ventures. PLD endeavors to match-fund development expenditures and acquisitions with cash from dispositions or contributions of assets to the ventures. If the company does not anticipate disposition or contribution volumes, PLD management has stated that the company would scale back development starts and acquisitions accordingly, though the sector has a mixed track record of forecasting market cycles.

Development is substantially smaller today than in the previous upcycle with costs to complete equal to 4.0% of undepreciated assets at March 31, 2015 (3.2% pro rata) compared with 14.1% at year-end 2007. However, speculative development increased over the past several years to 83.5% as of March 31, 2015 from 72.2% at Dec. 31, 2014 and 58.2% as of Dec. 31, 2013, which illustrates elevated lease-up risk. However, the company estimates that approximately 75% of its future development is comprised of speculative projects. The KTR development portfolio increases the likelihood that development will continue in the coming years.

Preferred Stock Notching

The two-notch differential between PLD's IDR and preferred stock rating is consistent with Fitch's criteria for corporate entities with an IDR of 'BBB'. Based on Fitch research titled 'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis', these preferred securities are deeply subordinated and have loss absorption elements that would likely result in poor recoveries in the event of a corporate default.

Exchangeable Senior Notes Ratings Withdrawal

Fitch has withdrawn the 'BBB' rating on Prologis, L.P.'s $460 million senior unsecured exchangeable notes. On March 16, 2015, the company announced the exchange of the exchangeable notes for a total of 11.9 million shares of the company's common stock. The ratings on the senior unsecured exchangeable notes are no longer relevant to the agency's coverage.

KEY ASSUMPTIONS

Fitch's key assumptions for Prologis in Fitch's base case include:

--The KTR transaction closes in 2Q'15 and is funded with the $630 million of term loan borrowings, the issuance of $230 million of operating partnership units, the assumption of $385 million of mortgage debt, $500 million of asset sales and hedge settlement proceeds, and $1.5 billion of common equity;

--3% to 4% annual same-store NOI through 2017;

--G&A growth to maintain historical margins relative to total revenues initially but potentially be reduced over the next several years due to geographical overlap of the KTR portfolio;

--$2.0 billion annual development starts through 2017;

--$875 million annual building acquisitions through 2017;

--$1.1 billion annual contributions to co-investment ventures through 2017;

--$1.8 billion annual third-party dispositions through 2017;

--Debt repayment with the issuance of new unsecured bonds;

--AFFO payout ratio in the low 90% range.

RATING SENSITIVITIES

The following factors may result in an upgrade to 'BBB+':

--Fitch's expectation of pro rata leverage sustaining below 6.5x is Fitch's primary rating sensitivity (pro rata leverage was 6.9x as of March 31, 2015 and is also 6.9x pro forma under Fitch's base case);

--Fitch's expectation of consolidated leverage sustaining below 6.0x (consolidated leverage was 6.2x as of March 31, 2015 and is 5.9x pro forma under Fitch's base case. Fitch defines consolidated leverage as net debt to recurring operating EBITDA including recurring cash distributions from unconsolidated entities to Prologis);

--Fitch's expectation of liquidity coverage sustaining above 1.25x (this ratio is 1.4x pro forma);

--Fitch's expectation of pro rata FCC sustaining above 2x (this ratio was 2.5x for the TTM ended March 31, 2015 and is 2.8x pro forma under Fitch's base case).

The following factors may result in negative action on the ratings and/or Rating Outlook:

--Fitch's expectation of pro rata leverage sustaining above 7.5x, which could be the result of the company not funding the KTR transaction on a leverage neutral basis and/or a deterioration in operating fundamentals;

--Fitch's expectation of consolidated leverage sustaining above 7.0x;

--Fitch's expectation of liquidity coverage sustaining below 1.0x;

--Fitch's expectation of FCC sustaining below 1.5x.

Fitch has affirmed the following ratings:

Prologis, Inc.

--Issuer Default Rating (IDR) at 'BBB';

--$78.2 million preferred stock at 'BB+'.

Prologis, L.P.

--IDR at 'BBB';

--$2.5 billion global senior credit facility at 'BBB';

--$5.7 billion senior unsecured notes at 'BBB';

--EUR500 million multi-currency senior unsecured term loan at 'BBB'.

Prologis Tokyo Finance Investment Limited Partnership

--Senior unsecured guaranteed notes at 'BBB';

--JPY45 billion senior unsecured revolving credit facility at 'BBB';

--JPY40.9 billion senior unsecured term loan at 'BBB'.

The Rating Outlook is Positive.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Prologis, Inc. Ratings Navigator' (Feb. 26, 2015);

--'U.S. Equity REITs and REOCs Ratings Navigator Companion' (Feb. 5, 2015);

--'Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis' (Nov. 25, 2014);

--'Recovery Ratings and Notching Criteria for Equity REITs' (Nov. 18, 2014);

--'Corporate Rating Methodology' (May 28, 2014).

Applicable Criteria and Related Research:

U.S. Equity REITs and REOCs: Ratings Navigator Companion

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=861519

Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=821568

Recovery Ratings and Notching Criteria for Equity REITs

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=813628

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=983352

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Fitch Ratings
Primary Analyst
Sean Pattap
Senior Director
+1-212-908-0642
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Britton Costa, CFA
Director
+1-212-908-0524
or
Committee Chairperson
Steven Marks
Managing Director
+1-212-908-9161
or
Media Relations
Sandro Scenga
+1-212-908-0278
New York
[email protected]

Source: Fitch Ratings

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