OREANDA-NEWS. Fitch Ratings has affirmed UK real estate company SEGRO plc's (Segro) Long-Term Issuer Default Rating (IDR) at 'BBB+', senior unsecured rating at 'A-', and Short-Term IDR at 'F2'. The Outlook is Stable.

The ratings reflect SEGRO's high-quality logistics property portfolio, improved leverage and stable rental income. The refocused portfolio towards high-quality logistics assets in prime locations continues to perform well and benefits from low vacancy rates and moderate rental growth.

Last Friday's equity placement will help the company finance its large development programme and Fitch expects Segro to remain well within the agency's rating guidelines over the coming years following this transaction.

KEY RATING DRIVERS

Capital Increase De-risks Development. Segro successfully raised GBP325m through an equity placement and intends to use the proceeds to finance its large development programme. Adjusted for the equity placement Fitch-calculated loan-to-value would fall to 33%, from 39% in 1H16. Leverage may slightly increase as the company deploys the proceeds but should stabilise over the next two years well below our rating sensitivities.

Appetite for Development. Segro's low vacancies illustrate the limited availability of modern well-located warehouse buildings, which the company sees as an opportunity to develop more assets. Segro has detailed up to GBP456m of development; GBP199m for its current pipeline (whereof GBP150m was indicated for 2H16) and up to GBP257m of additional development that could start over the next six to 12 months. Fitch views positively that most of the properties in the current pipeline are pre-let.

The short-development cycle of logistics assets limits the amount of committed capex and Segro can quickly adjust its development appetite while land options (as the ones acquired in its deal with Roxhill) help the company keep a light balance sheet. However, a short development cycle also means that the need for logistics space could potentially be quickly met. Fitch has not seen any such evidence yet, particularly as quality lands remains scarce and believes Brexit may also reduce the appetite for speculative development in the short term.

Strong Operating Performance. Segro posted strong 2015 results, with solid like-for-like net rental income growth, especially in the UK (up 5.2%) and a further decline in vacancies (to below 5%). Both 1H16 results and Segro's trading statements for July and August, which to some extent captures the initial impact of Brexit, confirmed the positive trend.

Structural Growth. E-commerce grew from less than 3% of total UK retail sales in 2007 to close to 14% in 2016 and is still growing much faster (low double digits) than overall retail sales (low single digits). This, together with urbanisation, means that more logistics space is needed to deliver in bulk to large stores and to make individual deliveries. A large part of Segro's portfolio is located on the edge of major cities and addresses those needs. In 2015, 21% of new rents came from parcel deliveries and third-party logistics companies while Segro also added online fashion retailers.

Less Impacted by Brexit. Fitch expects the prime UK logistics sector to show more resilience to Brexit than most other UK property segments (especially London offices and high-end residential). Our expectations were confirmed by the latest RICS survey and in its recent trading statement Segro indicated that industrial assets outperformed most of the other property sectors in the IPD-index. Secular drivers such as e-commerce and urbanisation should be supportive in the longer run, although as for other sectors Brexit uncertainty could still weigh on performance in the short term.

Manageable FX Impact. Segro currently holds a significantly higher proportion of its debt in euro than the share of its investment properties on the continent. As a result any weakness of the pound against the euro will lead to an increase of LTV. We estimate that a 10% depreciation of the pound translates into a 1.5% increase in LTV. The pound has dropped 20% since the beginning of the year, with potentially more weakness according to our sovereign team.

Lower LTV Target. Segro has a 40% mid-cycle LTV target but its management acknowledges that it should be somewhat lower in the current part of the cycle. Yields for prime London logistics and their spread over other prime asset classes have compressed significantly over the past few years. Looking only at published valuation gains from 2010 would be misleading as non-core assets subsequently disposed of significantly underperformed Segro's core assets.

Repositioned Portfolio. The Bath Road disposal (offices in Slough, proceeds received in 1H16) was the last meaningful disposal of non-core assets. We expect no major disposals as Segro has successfully repositioned its portfolio to comprise mostly big-box, smaller and light industrial warehouses.

KEY ASSUMPTIONS

- High occupancies

- Moderate rental income growth

RATING SENSITIVITIES

Positive: Future developments that may, individually or collectively, lead to positive rating action include:

-Material improvement in SEGRO's sector or geographical diversification

-Increase in Fitch-adjusted EBITDA net interest cover above 2.5x

-Fitch-adjusted LTV (net debt/investment properties, excluding development property and including proportionally consolidated investment property and net debt in JV) sustainably below 30%

Negative: Future developments that may, individually or collectively, lead to negative rating action include:

-Deterioration in EBITDA NIC to below 1.75x on a sustained basis

-Fitch-adjusted LTV (net debt/investment properties, excluding development property and including proportionally consolidated investment property and net debt in JV) above 45% over the cycle on a sustained basis

-Liquidity score below 1.25x (committed undrawn facilities plus cash divided by debt maturities and committed capex) over 18-24 months

-Deterioration in unencumbered asset cover to significantly below 2.0x on a sustained basis, which may affect the IDR and the senior unsecured rating uplift

LIQUIDITY

Improved financing. Segro extended the maturity of its committed credit facilities to 2021 and increased their size by GBP92m to GBP650m with most of it undrawn (GBP429m) at end-1H16. Segro's liquidity is comfortable as it does not have any debt maturing before 2018.