April 18, 2017 / 3:48 PM / 3 months ago

Fitch Assigns Emlak Konut Local Currency and National Ratings

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(The following statement was released by the rating agency) LONDON/DUBAI, April 18 (Fitch) Fitch Ratings assigned a Long-Term Local-Currency Issuer Default Rating (IDR) of 'BB+' and National Rating of 'AA(tur)' to Turkish residential developer Emlak Konut Gayrimenkul Yatirim Ortakligi A.S. (Emlak Konut). The Outlooks are Stable. Fitch had assigned Emlak Konut a Long-Term Foreign-Currency IDR of 'BB+' on 3 April 2017. The ratings reflect Emlak Konut's unique revenue sharing model (RSM), which generates guaranteed income and a share of upside gains, and passes nearly all design, building, financing and marketing risks to developers. Emlak holds a competitive advantage owing to its privileged position with its controlling shareholder, Turkey's Housing Development Administration (TOKI). Other credit strengths include a significant land bank, largely in Istanbul, as well as sound financials. The ratings also reflect the company's exposure to potential volatile housing demand and prices, as well as regulatory and political risks. The risk of contractor failure is also mitigated by a number of protections. The Stable Outlooks reflect our expectations that Emlak Konut will be able to maintain its operating margins and financial metrics, despite a downturn in the economy and probable volatility in the housing market. KEY RATING DRIVERS Revenue-Sharing Model Secures Revenue: Emlak Konut primarily uses a low-risk revenue-sharing model (RSM) to develop most projects which provides strong revenue visibility and protects the company from short-term market volatility. This is unique among its peer group. Under the RSM, Emlak Konut passes operational risk through to contractors. Contractors must guarantee Emlak Konut's minimum revenue, as well as a share of any upside gains. Emlak Konut supervises the project and collects and distributes all project cash flows including the contractor's revenue share at defined milestones. Self-Development Limited: Ninety-two percent of Emlak Konut's revenues were driven by the RSM in 2016. It generally self-develops projects outside Istanbul. In this case, the company passes only building risk to contractors. The company can also use this approach to increase interest in developing areas, which will allow the use of the RSM for future projects. Competitive Advantage: Emlak Konut's exclusive priority agreement with the Housing Development Administration (TOKI) enables it to buy land from TOKI at independently appraised values without a tendering process. The company's quick access to large, attractive parcels of land provides a significant advantage over other developers, particularly in Istanbul where housing demand is high. Mutually Beneficial Relationship: Any deterioration in relations with TOKI would affect Emlak Konut's operations, but this risk appears low as the arrangement is mutually beneficial: Emlak Konut's access to valuable land sustains its own business model; the resulting dividends help TOKI fund its development programme. Significant Land Bank: Emlak Konut has a 10 million square metre land bank valued at nearly TRY5.2 billion, largely in key or developing areas of Istanbul where demand is high. This is in spite of completing or still developing more than 70 projects. The land bank ensures the company will continue to have the ability to develop projects, which it must do to sustain its operations, and the good locations mean contractors, as well as consumers, are like to be attracted to its projects. Exposure to Contractor Performance: Under the RSM, contractors are responsible for virtually all development risks. Emlak Konut is substantially exposed to contractor failure. It has a two-stage mechanism in place to ensure only financially strong companies are contracted. Participants must first submit financial and technical requirements before moving to the second stage if they meet the requirements. In the second stage, bidders must propose estimated project values and revenue sharing. The preferred bidder is obliged to provide a down payment of generally about 10% of the minimum revenue, as well as a letter of guarantee equating to 6% of the estimated total project value. Strong Fundamentals: Turkish house values have risen steeply in recent years, driven by strong economic growth and a housing shortage. Fundamentals including a young and growing population, improvements in the housing stock, requirements to meet earthquake-proof building regulations, steadily increasing mortgage take-up as well an increase in foreign buyers all support continued demand. Revenue Protected: Guaranteed revenue under the RSM would protect the company in the near term if house prices fall. In addition, the government has demonstrated a willingness to support the sector through various incentives and tax relief. A steep fall in the housing values could depress long-term returns and affect the company's ability to attract contractors to their projects. Financial Strength: Emlak Konut has healthy financials, generating sound EBITDA margins and steadily expanding the value multiplier under the RSM business. Its total returns on completed RSM projects have steadily increased, averaging 2x the appraised value of the land since 2012. Emlak Konut's strong cash generation means the company has large cash holdings with little debt, helping it manage volatile working capital, but also to react quickly to new land opportunities. RATING DERIVATION Emlak Konut's operational model carries lower risk than most peers' and includes guaranteed minimum revenue irrespective of a project's success. By passing nearly all project risks to contractors, the company is able to develop multiple projects simultaneously with lower operating costs than developments of comparable size. This means margins and profits are higher than peers', reflecting the level of risk. Emlak Konut has a competitive advantage compared to other developers, owing to its preferential position with TOKI. This also exposes Emlak Konut to potential political or regulatory risks that do not affect other peers. Like all developers, a decline in the housing market will affect operations, but the guaranteed revenue stream would cushion the impact in the short to medium term. KEY ASSUMPTIONS Fitch's key assumptions within the rating case for Emlak Konut include: - healthy EBITDA margin averaging 38% supported by the revenue sharing model; - significant growth in 2016 revenues supported by two large projects; - significant cash outflow in 2017 exceeding TRY4 billion with some recovery in 2019 FCF; - flexible dividend policy up to 40% of net income for the next four years. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action - Consistently strong economic and GDP growth, along with political stabilisation. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action - Gross debt to work-in-progress (WIP) ratio consistently above 50% - Any material change in the relationship with TOKI causing deterioration in the financial profile and financial flexibility of Emlak - Deterioration in liquidity profile over a sustained period of time - Order backlog to WIP ratio below 150% over a sustained period of time - EBITDA margin below 30% for a sustained period LIQUIDITY Healthy Liquidity: Emlak Konut has low debt with upcoming scheduled payments only in 2018, which the company will service by readily available cash. It reported TRY2.5 billion of cash at year end 2016, of which Fitch views TRY1.5 billion as being restricted. Restricted cash mainly constitutes TRY368 million of deposits related to contractor's portion of the residential unit sales, as per the RSM agreement, and TRY1.1 billion relating to the cost of land purchased by Emlak Konut, held in its accounts on behalf of TOKI, until the payment is dispersed Our forecasts for cash balances, which are adjusted for working capital swings and land purchases, amount to TRY2 billion pa. for 2016-2020. The company has undrawn, available facilities totalling TRY4.8 billion, but these are all not formally committed and have no commitment fees. Contact: Principal Analyst Samer Haydar Associate Director +971 4424 1240 Supervisory Analyst Bram Cartmell Senior Director +44 20 3530 1874 Fitch Ratings Ltd 30, North Colonnade London E14 5GN Committee Chairperson Paul Lund Senior Director +44 20 3530 1244 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. 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