S&P: Goodman Australia Industrial Partnership Rating Raised To 'BBB+' On Lower Leverage Range; Outlook Stable
"We raised the rating because we consider GAIP's more-conservative leverage targets support cash flow protection metrics at the higher end of our expectations for its current financial profile. In addition, its stronger asset portfolio has improved the quality of its earnings," said S&P Global Ratings credit analyst Brenda Wardlaw.
GAIP's more-conservative leverage targets include: a preferred net debt-to-net assets ratio of below 30% amid the current environment of strong asset-price growth, and below 35% if market conditions were to weaken and caused significant asset-price declines. The latter target retains a 5% buffer to the top-end of the partnership's 40% leverage limit for potential acquisitions. Should GAIP reach this limit, we expect the partnership would develop a clear funding strategy to return its leverage below 35% within a short period of time.
GAIP has strengthened its asset mix, which has improved the quality of its earnings. The partnership has recently completed a number of development projects, entrenching its market position in supply-constrained locations near Sydney Airport and Port Botany in the State of New South Wales. Proceeds from the sale of noncore properties located mainly in weaker markets outside New South Wales have partly funded the development pipeline.
The partnership's development exposure in nominal terms remains conservative, at below 5% of its total asset base. As a result, we expect the quality of GAIP's earnings to enable the partnership to operate at the top-end of our expectations for its financial profile. We expect the partnership to sustain an adjusted funds from operations (FFO) to debt above 12% and EBITDA interest coverage of about 3x.
Supporting GAIP's business risk profile are its relatively stable cash flows generated from a high-quality portfolio of industrial - and office-park assets compared with the industry average. In addition, GAIP's portfolio has a good lease-maturity profile, high occupancy levels, and solid market position. Partly tempering these strengths are the partnership's susceptibility to cyclicality in the real estate market, and the potential for increased exposure to property development.
We expect about 4% of GAIP's asset base will be under development in nominal terms over the next 12 months given the partnership's measured amount of speculative development. We consider this development load to be manageable. The partnership largely undertakes developments with substantial precommitment by tenants. This high tenant take-up reflects the fact that GAIP constructs distribution centers and logistics facilities that are generally customized to meet its tenants' needs.
We expect GAIP to operate within its target net debt-to-net assets ratio of up to 35%, with flexibility to temporarily spike at 40%. Over the next 12 months, we expect GAIP to operate at below 30%. As at June 30, 2016, its leverage was 29.4%, down significantly from 36.4% at June 30, 2015. The lower leverage ratio benefited from the partnership's sizable asset-sale proceeds that more than offset expenditure on developments.
GAIP's improved earnings quality should enable it to maintain sufficient debt headroom relative to its financial policy. We expect the partnership's adjusted FFO-to-total debt ratio to track at between 12% and 14%. Development activity, lease renewals, acquisitions, and disposal amounts will influence this ratio. Likewise, we expect the partnership's EBITDA interest coverage to track about 3x, above the mid-2x level over the past two years.
When GAIP is operating at its peak leverage level, we believe the partnership will operate at the stronger end of the intermediate cash flow/leverage descriptor. These stronger credit metrics are supportive of the one-notch uplift and consistent with other real estate peers. GAIP's more-conservative leverage policy, higher-quality income stream following portfolio realignment, and reinvestment of recent sizable asset-sale proceeds into property developments, support our opinion.
Ms. Wardlaw added: "The stable outlook reflects our expectation that GAIP would prudently manage the timing and execution of its asset sales or equity issuance to fund its committed development pipeline. As a result, we expect GAIP to maintain an adjusted EBITDA interest coverage of about 3.0x and FFO-to-debt consistently above 12% at the top of its leverage range."
Downward pressure on the rating could occur if GAIP adopted a more-aggressive growth strategy, or introduced more speculative development as a proportion of its development book. Downward momentum could also occur if GAIP entered into asset types or geographic markets outside of its core business areas, causing deterioration in the company's business risk profile. In addition, downward rating pressure could arise if GAIP's financial metrics were to materially worsen, such that its interest coverage was below 3.0x and FFO-to-debt below 12%.
We consider upward rating to be unlikely over the medium term. However, an upgrade could eventuate if GAIP adopted more-conservative financial policies that are supported by a significant and sustainable improvement in financial metrics.