Fitch Ratings has assigned a 'BBB-' rating to STAG Industrial Operating Partnership, L.P.'s $80 million unsecured notes issued through a private placement on Dec. 30, 2014. The notes have a 12-year term and bear interest at a fixed rate of 4.42%. A full list of Fitch's ratings for STAG and its operating partnership STAG Industrial Operating Partnership, L.P. (hereafter STAG or the company) follows at the end of this release.
The Rating Outlook is Positive.
These notes are the first issuance under a $200 million note purchase agreement that STAG announced on Nov. 24, 2014. The company expects to issue the remaining notes under this purchase agreement on or around Feb. 20, 2015. The remaining notes are $20 million of additional 12-year notes bearing interest at 4.42% and $100 million of 10-year notes bearing interest at 4.32%.
KEY RATING DRIVERS
The ratings reflect STAG's credit strengths, which include low leverage and strong fixed charge coverage for the rating, excellent liquidity, a sizable unencumbered asset pool and improving access to capital, including unsecured private placements and term loans and common equity via underwritten follow-on common equity offerings and ATM programs.
These credit positives are balanced by the company's portfolio concentration in secondary industrial markets and short operating history as a public company.
The Positive Outlook reflects the upward momentum in STAG's credit profile, including rapid organizational growth, improving fixed-charge coverage and enhanced access to unsecured debt capital - all in the context of leverage sustaining in the low 5.0x range.
STAG has achieved many of the rating sensitivities Fitch has identified as potentially leading to positive ratings momentum. However, the Positive Outlook captures pending additional seasoning in the company's operating portfolio and metrics. Specifically, Fitch will watch closely for evidence of stabilization in the company's same-store net operating income (NOI) growth following a period of unanticipated weakness during most of 2013.
Internal Growth to Stabilize and Improve
STAG's cash same-store NOI declined for the TTM ended Sept. 30, 2014 including year-over-year decreases of 0.7% in fourth quarter 2013 (4Q'13), 4.9% in 1Q'14, 1.2% in 2Q'14 and 0.6% in 3Q'14. The same-store weakness can be attributed to unusually low tenant retention due to a period of heightened corporate change and, to a lesser extent, the harsh weather during the 2013-2014 winter season.
The company has replaced some of the larger tenant vacancies, including the loss of Brown Shoe at its Sun Prairie, WI, asset that was backfilled with minimal downtime. However, free rent granted under selected replacement tenant leases has been a near-term drag on cash same store NOI growth that should abate as these concessions burn off.
Fitch projects same store NOI growth of 2.9% in 2015 and 3.3% in 2016, based on improved occupancy and positive GAAP rent spreads for new and renewal leases. The agency's projections assume stabilization and improvement in the company's tenant retention ratios during 2015 through 2016, towards a more normalized level of between 70% and 80%. On Jan. 5, 2015, STAG announced that it retained 71.7% of its expiring leased square footage in 4Q'14, resulting in an annual tenant retention rate of 69.7%.
Low Leverage
STAG's leverage was 5.8x based on an annualized run rate of STAG's recurring operating EBITDA for the quarter ending Sept. 30, 2014, which is strong for the 'BBB-' rating. This compares with 5.4x on an annualized basis for the quarter ending Dec. 31, 2013 and 4.9x for the quarter ending Sept. 30, 2013. Adjusting 3Q'14 earnings for the impact of partial period acquisitions would reduce STAG's leverage to 5.3x. Fitch's projections anticipate that the company will sustain leverage of approximately 5.0x during the next three years on an annualized basis that includes a full-year's impact of earnings from projected acquisitions.
Small Size But Improving Access to Capital
STAG's sale of $300 million of private placement unsecured notes (including an additional $120 million of notes under delayed draw agreements) is an important milestone in the company's transition to a predominantly unsecured borrowing strategy that evidences broader access to unsecured debt capital. Prior to the company's inaugural private unsecured notes placement, STAG's unsecured borrowings were limited to three bank term loans, as well as drawdowns under the company's unsecured revolver. However, Fitch continues to view STAG as a relatively less seasoned unsecured bond issuer pending further private placement issuance.
Strong Fixed-Charge Coverage
Fitch expects the company's fixed charge coverage to sustain in the low 3.0x through 2016. The low interest rate environment and higher capitalization rates on class B industrial properties in secondary markets should allow STAG to continue deploying capital on a strong spread investing basis. STAG's fixed charge coverage was 3.3x for the TTM ended Sept. 30, 2014 and 3.2x and 2.5x for the years ending Dec. 31, 2013 and 2012, respectively.
Excellent Liquidity
STAG completed a $600 million refinancing of its unsecured bank debt in Dec. 2014. The refinancing reduced the company's cost of fully committed unsecured bank debt to Libor + 1.41% from Libor + 1.66% and increased the weighted average term to 5.9 years from 3.8 years.
STAG also replaced its $200 million unsecured revolving credit facility with a new $300 million revolver that has a lower cost and extends the maturity by three years to December 2019 through the refinancing.
STAG's unencumbered assets, defined as unencumbered net operating income (NOI) (as calculated in accordance with the company's unsecured loan agreements) divided by a stressed capitalization rate of 10%, covered its unsecured debt by 3.5x in 3Q'14, which is strong for the current ratings. The company's substantial unencumbered asset pool is a source of contingent liquidity that enhances STAG's credit profile.
Straightforward Business Model
STAG has not made investments in ground-up development or unconsolidated joint venture partnerships. The absence of these items helps simplify the company's business model, improve financial reporting transparency and reduce potential contingent liquidity claims, which Fitch views positively.
While the company may selectively pursue the acquisition of completed build-to-suit (BTS) development projects in the future, Fitch anticipates only a moderate amount of such activity by STAG on an ongoing basis. Fitch views the acquisition of completed BTS projects developed by third parties as less risky than the traditional ground-up speculative and BTS development undertaken by some of STAG's industrial REIT peers.
Strong Management
Fitch views management favorably due to its successful track record in executing its single-tenant industrial portfolio acquisition strategy, as well as its extensive real estate capital markets experience. Fitch does not expect the company's appointment of Geoff Jervis as Chief Financial officer to result in a change in financial policies. Fitch anticipates that Mr. Jervis will continue to broaden STAG's unsecured debt base beyond bank debt and that the company will remain committed to its low-leverage strategy.
Secondary Market Locations
STAG's strategy centers on the acquisition of individual Class B, single tenant industrial properties (warehouse/distribution and manufacturing assets) predominantly in secondary markets throughout the United States by sourcing third party purchases and structured sale-leasebacks. Such transactions typically range in price from $5 million to $50 million and have higher going-in yields, stronger internal rates of return, and less competition from other buyers.
The company has only minimal exposure to what are traditionally considered the 'core' U.S. industrial and logistics markets, which include Chicago, Los Angeles/Inland Empire, Dallas - Fort Worth, Atlanta and New York/Northern New Jersey. Fitch views this as a credit negative given superior liquidity characteristics for industrial assets in 'core' markets - both in terms of financing and transactions.
Limited Public Company Track Record
STAG has a limited track record as a public company, having gone public in 2Q'11. This track record is balanced by 1) the homogeneity of industrial properties, 2) management's prior experience successfully managing STAG's predecessor as a private company that dates back to 2004 and 3) management's extensive real estate and capital markets experience.
Preferred Stock Notching
The two-notch differential between STAG's IDR and preferred stock rating is consistent with Fitch's criteria for a U.S. REIT with an IDR of 'BBB-'. 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.
Positive Outlook
The Positive Outlook is based on Fitch's expectation for stabilization and improvement in the company's cash same-store NOI growth over the rating horizon, coupled with Fitch's expectation that STAG will maintain leverage and fixed-charge coverage of approximately 5.0x and 3.0x on a run rate basis, metrics that are consistent with a 'BBB' IDR.
RATING SENSITIVITIES
The following factors may have a positive impact on STAG's ratings:
--Stabilization, followed by sustained improvement in STAG's tenant retention and same-store NOI growth is Fitch's primary consideration for positive ratings momentum;
--Continued access to the unsecured bond market;
--Leverage calculated on an annualized basis adjusted for acquisitions sustaining below 5.5x (leverage was 5.3x as of Sept. 30, 2014);
--Fixed charge coverage to sustaining above 3.0x (coverage was 3.3x as of Sept. 30, 2014).
The following factors may have a negative impact on the company's ratings and/or Outlook:
--Fitch's expectation for leverage sustaining above 6.5x;
--Fixed charge coverage sustaining below 2.0x;
--A meaningful increase in the percentage of STAG's encumbered assets relative to gross assets.
In addition to the $80 million of unsecured notes, Fitch currently rates STAG as follows:
STAG Industrial, Inc.
--Issuer Default Rating (IDR) 'BBB-';
--$139 million preferred stock 'BB'.
STAG Industrial Operating Partnership, L.P.
--IDR 'BBB-';
--$300 million senior unsecured revolving credit facility
'BBB-';
--$100 million senior unsecured notes 'BBB-';
--$300 million senior unsecured term loans 'BBB-'.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis' (Nov. 25, 2014);
--'Recovery Rating and Notching Criteria for Equity REITs' (Nov. 18, 2013).
--'Corporate Rating Methodology' (May 28, 2014);
--'Rating U.S. Equity REITs and REOCs: Sector Credit Factors' (Feb. 26, 2014).
Applicable Criteria and Related Research:
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 Rating and Notching Criteria for Equity REITs' Effective May 12, 2011 to May 3, 2012
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=628490
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393
Rating U.S. Equity REITs and REOCs (Sector Credit Factors)
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=737957
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=964075
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