DBRS Limited (DBRS Morningstar) upgraded Granite REIT Holdings Limited Partnership’s (GRHLP) Issuer Rating and Senior Unsecured Debentures rating to BBB (high) from BBB, both with Stable trends. DBRS Morningstar notes that the ratings are based on the credit risk profile of the combined entity, including GRHLP and its subsidiaries, as well as Granite Real Estate Investment Trust (Granite REIT) and Granite REIT Inc. (collectively, Granite or the Trust).
The upgrades reflect Granite successfully managing its operations through the ongoing Coronavirus Disease (COVID-19) pandemic and consequent economic slowdown with minimal impact, as well as Granite's continued execution of its long-term strategy to grow and diversify its asset base. As a result, DBRS Morningstar revised its business risk assessment of Granite and, consequently, considers the rating uplift now to be warranted for Granite's low proportion of secured debt-to-total debt (0% at December 31, 2020).
DBRS Morningstar has revised upward its assessment of Granite's asset quality and market position. These revisions are supported by Granite completing approximately $2.0 billion in acquisitions over the last two years, with such acquisitions consisting of modern distribution assets located in key distribution markets in Canada, the Netherlands, and the U.S., while continuing to dispose of noncore special-purpose properties. Furthermore, the Trust collected 100% of its rent during the pandemic while improving occupancy and generating robust same property net operating income growth, therefore demonstrating the resilience of Granite's assets, tenants, and cash flows.
As a result of Granite's materially improved asset quality and market position, DBRS Morningstar now views that the rating uplift is warranted in consideration of Granite's fully unsecured debt stack and a portfolio of assets qualitatively assessed to be solidly investment grade, among other reasons further elaborated upon. In assessing the merits of applying uplift to the rating for a low proportion of secured debt in Granite's debt stack, DBRS Morningstar also considered the following expectations: (1) Granite's secured debt-to-total debt ratio will remain comfortably below 40%, (2) DBRS Morningstar expects all senior unsecured debt will remain pari passu and the Senior Unsecured Debentures will not become structurally subordinated, (3) Granite's financial risk assessment will remain consistent with an investment-grade rating, and (4) the composition of the unencumbered asset pool will continue to be generally consistent with the overall portfolio and will continue to provide ample coverage over the unsecured debt (unencumbered assets-to-unsecured debt, including undrawn capacity on credit facilities, was 2.2 times (x) at December 31, 2020).
The ratings are supported by (1) Granite's institutional-quality industrial real estate portfolio underpinning cash flow stability; (2) financial flexibility provided by a sound balance sheet and low cost of debt; (3) Granite’s strong lease profile with high-quality tenants including Amazon, notwithstanding concentrated exposure to a Tier 1 global automotive supplier in Magna International Inc. (rated A (low) with a Negative trend by DBRS Morningstar) and its operating subsidiaries; and (4) an unsecured debt capital stack and sizable unencumbered asset pool valued at $5.9 billion at December 31, 2020 (including $3.8 billion modern warehouse exposure), which combined with additional considerations noted above, warrant a one-notch uplift to Granite's stand-alone credit assessment. The ratings continue to be constrained by (1) Granite’s lack of scale in its trade areas with a relatively small and geographically dispersed portfolio, notwithstanding the Trust's improving market position; (2) tenant and lease maturity concentration with 58% of annualized revenue derived from the Trust’s top 10 tenants (as at December 31, 2020) and heightened lease renewal risk in 2023 and 2024; and (3) asset-type concentration with a portfolio solely focused on the industrial segment, notwithstanding some diversification across different industrial uses.
The Stable trends consider DBRS Morningstar's expectations that industrial real estate fundamentals will remain supportive in the near to medium term and that Granite will continue to execute its long-term strategy of growing and diversifying its asset base through acquisitions and developments as well as funding such growth initiatives with cash on hand, incremental debt, and equity, similar to recent years. DBRS Morningstar anticipates that in the near term the impact of annualized EBITDA from recent transactions and use of cash on hand as a source of funds ($250 million Series 2 Senior Unsecured Debentures were redeemed subsequent to year end) will result in total debt-to-EBITDA to decline toward the mid-7.0x range in 2021 from 8.5x at December 31, 2020 (7.5x pro forma repayment of the Series 2 Senior Unsecured Debentures), and remain relatively stable through 2022.
DBRS Morningstar views Granite's ratings as strongly positioned within the BBB (high) rating category following these upgrades. However, DBRS Morningstar would need to assess further improvement in either Granite's business risk assessment profile or a material sustained improvement in leverage relative to DBRS Morningstar's expectations before considering further positive rating actions, which DBRS Morningstar views as unlikely in the near to medium term. DBRS Morningstar would consider a negative rating action should DBRS Morningstar's outlook for Granite's total debt-to-EBITDA increase above 9.3x on a sustained basis.
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.
All figures are in Canadian dollars unless otherwise noted.
The principal methodologies are Rating Entities in the Real Estate Industry (June 4, 2020, https://www.dbrsmorningstar.com/research/362015) and DBRS Morningstar Criteria: Guarantees and Other Forms of Support (January 14, 2021, https://www.dbrsmorningstar.com/research/372344), which can be found on dbrsmorningstar.com under Methodologies & Criteria. Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021, https://www.dbrsmorningstar.com/research/373262).
For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.
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The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.
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