DBRS Morningstar Confirms SmartCentres Real Estate Investment Trust’s Ratings at BBB with Stable Trends

DBRS Limited (DBRS Morningstar) confirmed the Issuer Rating and Senior Unsecured Debentures credit rating on SmartCentres Real Estate Investment Trust (SmartCentres or the Trust) at BBB with Stable trends.

Despite DBRS Morningstar’s expectation for weaker financial risk metrics than previously anticipated (i.e., total debt to EBITDA at 9.8 times (x)), SmartCentres does have some financial flexibility in the current credit rating category. As such, the trends remain Stable. SmartCentres' solid operational performance over the last 12 months reflects continued strong demand for the Trust's value-oriented retail assets, as demonstrated by occupancy and same-property net operating income growth. However, DBRS Morningstar's downward assessment of the Trust's Financial Risk Assessment (FRA) factors, namely its total debt-to-EBITDA and EBITDA-to-interest coverage ratios, offset the marginal improvement in the Trust’s operational performance. Following the last credit rating action on May 12, 2023, DBRS Morningstar now expects SmartCentres' leverage (as measured by total debt to EBITDA) to weaken modestly from the previous expectation of 9.8x to 10.1x by YE2023 and then increase to the mid-to high-10.0x range through YE2025 as the Trust should continue executing its upcoming development projects with incremental debt in the near to medium term. DBRS Morningstar notes, however, that historically, some of these development projects of a similar nature (for example ArtWalk Condominium Phase 1 and Laird drive- Canadian Tire retail project) benefitted from substantial pre-sales and pre-lease activity. Similarly, DBRS Morningstar expects SmartCentres’ coverage (as calculated by EBITDA interest coverage) to decrease to 2.6x and then to the mid-2.0x range by YE2025 from the high 2.0x range at the last review. DBRS Morningstar’s downward assessment of the FRAs also reflects lower expectations surrounding the Trust's capital-recycling initiatives in the near term, owing to a persistently deteriorating macroeconomic environment that remains consistent with DBRS Morningstar’s previous review.

Nevertheless, the BBB credit ratings continue to be supported by SmartCentres’ (1) strong tenant profile with Walmart Inc. (Walmart; rated AA with a Stable trend by DBRS Morningstar), representing 24.1% of annualized rental revenue at September 30, 2023; (2) large retail property portfolio with new, large, and open-format Walmart-anchored shopping centres generating stable cash flow; and (3) predominately unsecured debt capital stack with a secured debt-to-total debt ratio of 19.3% at September 30, 2023, and sizable unencumbered asset pool ($9.1 billion), which together warrant a one-notch uplift to SmartCentres' stand-alone credit assessment.

However, the credit ratings continue to be constrained by (1) elevated leverage as measured by the Trust's total debt-to-EBITDA ratio, which is expected to escalate further; (2) concentration risks, such as asset-type concentration in retail, tenant concentration (most significantly Walmart), and geographic concentration in the Greater Toronto Area; and (3) potentially increasing development execution risks, which may increase volatility of cash flows and metrics. As a result of potentially increasing development execution risks, DBRS Morningstar would expect SmartCentres to operate with an increased buffer relative to threshold metrics for the current credit rating level.

DBRS Morningstar would consider taking a negative credit rating action if SmartCentres’ total debt-to-EBITDA ratio deteriorates above 10.8x and EBITDA-interest coverage deteriorates below 2.3x on a sustained basis. At the same time, DBRS Morningstar does not anticipate any positive credit rating action for SmartCentres over the medium term.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factors that had a significant or relevant effect on the credit analysis.

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/416784 (July 4, 2023).

Notes:
All figures are in Canadian dollars unless otherwise noted.

DBRS Morningstar applied the following principal methodologies:
-- Global Methodology for Rating Entities in the Real Estate Industry (April 11, 2023; https://www.dbrsmorningstar.com/research/412477)
-- DBRS Morningstar Global Criteria: Guarantees and Other Forms of Support (March 28, 2023; https://www.dbrsmorningstar.com/research/411694/ )

The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

A description of how DBRS Morningstar analyzes corporate finance transactions and how the methodologies are collectively applied can be found at: https://www.dbrsmorningstar.com/research/397223.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link under Related Documents or by contacting us at [email protected].

The credit rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit rating action.

DBRS Morningstar had access to the accounts, management and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.

This is a solicited credit rating.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar trends and credit ratings are under regular surveillance.

Information regarding DBRS Morningstar credit ratings, including definitions, policies, and methodologies, is available on www.dbrsmorningstar.com or contact us at [email protected].

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