The issuer rating is predominately driven by the industry specific risks and the currently low diversification of the issuer, but also by it’s low leverage.
Scope Ratings assigns initial issuer rating of B+ to JSC Lisi Lake Development. The Outlook is Stable.
The B+ issuer rating for JSC Lisi Lake Development (‘LLD’), a Georgia-based premium residential real estate developer, is supported by the company’s: i) conservative financing structure that relies on equity with negligible net debt; ii) above-average cash profitability that partially offsets external financing needs; and iii) strong local brand recognition and industry network that enables off-market deals, particularly on new attractive plots for large residential developments.
The issuer rating is negatively affected by LLD’s current small size and scope compared to other European residential property developers and its full dependency on the sale of properties and/or land to end-customers. The pure-play developer business model implies a small share of recurring revenues, which risks high cash flow volatility should property sales drop. Diversification is deemed low given the substantial cluster risk posed by the Lisi Lake projects, which will comprise more than 75% of the value of all the issuer’s investment properties for the next two years. The issuer rating is also limited by the fact that the company operates entirely in Georgia, generating risks related to a less resilient economy, inflation and foreign exchange rates as well as the low liquidity of the country’s premium real estate market compared to that of the more mature markets in western Europe.
Key rating drivers
Business risk profile
Scope assesses industry risk for LLD to be high. As a pure-play developer, the company is exposed to the most cyclical part of the real estate industry. The agency’s short-term credit view for the industry is stable but increasingly sensitive to changes in politics, economic conditions and interest rates. Scope also takes account of the higher volatility of Georgia’s less mature market. The core activity consists of developing premium residential real estate in Tbilisi and other cities in Georgia. For the time being, the company has a very concentrated project pipeline with a focus on Lisi Lake projects and another major early-stage project on the Black Sea shoreline. However, there are plans to expand the number of projects, targeting other regions in Georgia.
With total assets of c. USD 144m at year-end 2017 and funds from operations (FFO) of USD 4m in 2017, LLD is a small company, but exhibits strong growth in its Georgian home market. Scope judges the issuer’s average asset quality as credit-positive because all residential units are newly built at a premium quality and the company’s land bank to date consists of prime Georgian locations only.
Size is expected to grow further in the next two years thanks to an expanding project pipeline. However, the company’s limited size and market position also indicate a heightened sensitivity to unforeseen shocks and volatility in cash flows, particularly as LLD is highly exposed to inherent cyclicality in the real estate market, with almost 100% of revenues currently linked to development activity.
LLD’s potential cash flow volatility is negatively affected by its very concentrated pipeline of two main projects (divided into several sub-projects and phases that can be managed and timed separately to a certain extent), the largest of which (Lisi Lake) represents the lion’s share of expected revenue within the next 30 months. This very modest diversification may affect future cash flows if the projects suffer delays or cost overruns. However, Scope and other third-party market observers predict excess demand for premium residential real estate in Tbilisi in the coming years, provided there is no major external economic shock. Moreover, management intends to improve geographical diversification by investing in more Georgian projects, with the exception of further projects in Tbilisi. Scope views this strategy positively.
LLD’s profitability has been above industry average and is relatively less volatile regarding its business model. EBITDA margin stood at more than 30% in the 2016 and 2017 business years, when significant sales volume was recorded. Scope believes this margin will decrease over time: the significant competitive advantage of having acquired the land bank at low prices in 2010 to 2011 is now shrinking as new projects are acquired at current market prices. Nevertheless, Scope sees substantial volumes of land at Lisi Lake that can be developed in later project stages. In a conservative scenario, the agency expects EBITDA margin to remain at or above 20% for the next two to three business years due to increasing competition.
Financial risk profile
LLD’s EBITDA interest cover stood at very comfortable levels of c. 12x in 2016 and 18x in 2017. This ratio has been unusually high due to negligible debt levels in recent business years as more than 90% of the balance sheet was equity-financed. Even after assuming an additional USD 15m in debt from the issue of a corporate bond in the second half of the 2018 business year, Scope expects EBITDA interest coverage to stay in a range of 7x to 10x. Nevertheless, operating profit at EBITDA level depends entirely on ongoing land and property sales owing to LLD’s pure-play developer business model.
The company’s cash flow generation was sufficient in the past two to three business years, during which substantial volumes of properties were sold to clients for the first time. Free operating cash flow was positive for the past four years despite the business expansion over the same period. Scope expects free operating cash flow to become slightly negative in the single-digit USD millions for the next two business years, owing to both the expectation of further growth and the nature of real estate development. Furthermore, LLD’s credit rating at this point is constrained by its limited size and scope, which creates a very clustered project pipeline.
The company’s loan/value ratio (LTV) has stayed at very conservative single-digit percentages in past business years, indicating very low net debt of less than USD 10m. Scope expects LTV to remain below 10% in the next two business years, even after assuming a USD 15m bond issue in the second half of the current 2018 business year.
While the company’s strong financial metrics like SaD/EBITDA of around 1.0x, FFO/SaD of 141% and FOCF/SaD of 68% (2017) would typically imply a higher sub-score for the financial risk profile, Scope assesses the sub-score at BB due to the uncertainty over future sales and thus EBITDA levels. The inability to generate significant recurring revenue without selling properties limits the analytical value of leverage ratios based on projected operating income. The company is targeting more properties in asset classes that contribute recurring rental income in the near future such as hotels or office properties, starting with hotel revenues from Tsikhisdziri, but development will remain the core business according to the management. This diversification of revenues should mitigate cash-flow volatility in the future. However, in Scope’s opinion, high cash flow volatility is typical for a developer, with projects not assessed and financed in annual tranches but over the whole development period.
- Good market position due to large land bank, established brand and excellent network within the local real estate and financial industry
- Track record from the construction and sale of the existing residential units in Lisi Lake
- LLD’s development portfolio as well as land bank in Tbilisi and Tsikhisdziri is in good locations within the Georgian market and should offer above-average liquidity
- Strong operating cash profitability thanks to i.a. very low land bank acquisition costs among other factors
- Single digit loan/value ratio (LTV), even after the assumed issue of a USD 15m bond
- Low SaD/EBITDA leverage of c. 1x to 1.5x and excellent liquidity situation thanks to strong cash generation and only negligible short-term debt
- High dependency on the main development project in Lisi Lake, despite recent diversification efforts
- Exposure to the still relatively volatile Georgian economy with inherent risks such as high inflation and (indirect*) FX risk
- Pure play developer without significant recurring (rental/other) income resulting in weak visibility regarding future SaD/EBITDA leverage
- Small player with lack of scale when compared to other International/European upscale residential developers
- For the time being, unproven access to capital markets
* the issuer is not exposed to material direct foreign exchange risks since the functional currency (construction costs as well as unit sales prices) is USD. Nevertheless, we hint at the potential risks that would arise from a sharp decline in value of the local currency (Georgian Lari) due to the resulting loss of purchasing power of local clients. We therefore deem this a potential indirect currency risk.
There has been sufficient operating cash flow generation in recent years that is expected to further increase and free cash flows in a range of USD -2.5m to -1m for the next years according to our financial forecast, despite the significant expansion plans. Furthermore, the issuer has only little short-term debt going forward (USD <4m) that is covered more than 3x by unrestricted cash plus free cash flow according to our forecast.
The rating Outlook is Stable, supported by Lisi Lake’s development pipeline and the Georgian premium residential real estate market that shows growing demand. The Stable Outlook incorporates Scope’s expectation that the EBITDA margin will remain at more than 20% going forward, and that the project pipeline can be developed and sold without a major drop in demand and/or prices that would cause a slump in operating cash flows.
Rating Change Driver
The rating Outlook is Stable, supported by the Lisi Lake development pipeline and growing demand in Georgia’s premium residential real estate market. The Outlook incorporates Scope’s expectation that EBITDA margin will remain at more than 20% going forward and that the project pipeline can be developed and sold without a major drop in demand and/or prices that would impair operating cash flows.
A negative rating action is possible if the company’s sales volume fell sharply or if a serious deterioration in Georgia’s real estate market negatively affected LLD’s overall business prospects.
Scope would consider a positive rating action if LLD managed to significantly improve its business risk profile by further diversifying its development portfolio and/or creating a substantial share of recurring cash flows independent from continual asset sales in order to mitigate potential cash-flow volatility and provide sufficient interest coverage from recurring EBITDA.
For the detailed research report please click HERE.
Why brands harnessing the power of digital are winning in this evolving business landscape
By Justin Pike, Founder and Chairman, MYPINPAD
Delivery of intuitive, secure, personalised, and frictionless user experiences has long been table stakes in digital commerce, well before the era of COVID-19. As businesses harness the revolutionary power of digital technologies, they have pursued large-scale change to adapt to evolving consumer preferences (some more successfully than others, but that’s a blog for another day). Digital transformation is a term we hear repeatedly, and it looks different for each organisation, but essentially, it’s about utilising technology and data to digitise, automate, innovate and improve processes and the customer experience across the entire business.
As I said, this was already well underway but then came 2020 and no industry escaped the disruption of the coronavirus outbreak, which has had an indelible impact on businesses performance, operations, and revenue. Regardless of whether the impact of COVID has been very positive or very challenging, it has forced organisations globally to re-evaluate and re-orient strategies to adapt.
As lockdowns and pandemic-related restrictions continue to change daily life, this raises the question of how we can balance a dramatic shift to digital and the benefits it brings, while ensuring business continuity and innovation both during and post-COVID, and protecting everyone against fraud?
Digital is an essential survival tool, and even more so in a COVID world
No one could have predicted the dramatic digital pivot that has taken place over this year. Indeed, within weeks of the COVID outbreak cash usage in the UK dropped by around 50%. Digital solutions including delivery applications, contactless payments, mobile commerce, online and mobile banking have become essential components of a touchless customer experience in the era of social distancing. It’s no longer just about an enhanced and superior customer experience, it’s also about health, safety and survival.
In store, businesses have benefited from contactless payments enabling faster throughput and reduced need for consumers to touch payment terminals (therefore requiring greater cleaning, which degrades the hardware much faster). Mastercard reported a 40% increase in contactless payments – including tap-to-pay and mobile pay – during the first quarter of the year as the global pandemic worsened. Digital has also become an essential sales channel for many B2C brands. Where brick and mortar stores have been required to close, digital commerce enables continuity of customer relationships and revenue. This channel also provides brands with rich customer data, which can be used to enhance and personalise the customer experience and typically results in greater levels of engagement and uplifts in revenue.
Industry forecasts estimate that worldwide spending on the technologies and services enabling digital transformation will reach GBP 1.8 trillion in 2023 – a clear indication that the process represents a long-term investment and a global commitment to digital-first strategy. The key point here is that digital brings significant benefits, and regardless of COVID, is here to stay.
The challenges that rapid digital transformation brings to businesses
Regardless of whether businesses are operating in developed or less-developed economies, these times of crisis have levelled the playing field in the sense that all businesses are facing similar issues. Access to products and supplies, maintaining customer relationships, accelerating sales for some and declining sales for others, health and hygiene are just a few of the unique challenges brought about by COVID.
Many businesses in physical environments have had to swiftly implement changes to significantly reduce safety risks for staff and customers, such as contactless payments, mobile ordering and delivery options. But with these changes come a host of other benefits of digitisation, such as faster transactions, and reduced human error at the point-of-sale.
The reliance on technology, however, can also expose organisations and consumers to certain vulnerabilities. In particular, the risks of fraud and cybercrime have dramatically increased since the onset of the pandemic as scammers have taken advantage of digital technologies to target both businesses and individuals.
As a McKinsey report illustrates, new levels of sophistication in the activities of fraudsters have placed more pressure on companies that have been previously slow to go digital, bringing “into sharp relief how vulnerable companies really are”, and damaging the financial health of small and large businesses. In fact, the Bottomline 2020 Business Payments Barometer reveals that only one in 10 small businesses across the UK report recovering more than 50% of losses due to fraud.
But take these stats with a grain of salt. While it is important to be aware of the risks and challenges this new business landscape brings, it’s equally as important to have a lens firmly across your own business, industry and audience, and to identify the changes you can make internally to mitigate risk as well as improve your customer experience. Where can you make some quick wins? Do you have the right skillsets internally to achieve what you need to achieve? What technology is out there that will enable your business goals? There are tech companies like MYPINPAD that are making huge strides in software development, which will transform businesses globally.
A digital world post-COVID
Almost a year in, the line between business success and failure remains fragile. However, an ongoing transition towards greater digitisation will be the difference between survival and the alternative.
There is a wide range of initiatives businesses can implement to weather this storm. If we look at the space MYPINPAD operates within, secure digital consumer authentication is crucial to the ongoing success and security of not only financial products but also identification and verification across a range of different industry verticals. Shifting the authentication of consumers securely onto mobile devices enables businesses to completely reshape their customer experiences. By bringing together a more seamless, frictionless customer experience, accessibility, privacy, security and access to consumer data, businesses are able to drive digital transformation across day-to-day activities.
Against this backdrop, software with stronger security standards continue to play an ever more vital role in supporting society, protecting consumers and businesses from the increase in risks that rapid digitisation brings. Already, merchants can deploy PIN on Mobile technology from companies like MYPINPAD, onto their smart devices to speed up the digitisation process many are now tackling.
Essentially, opening up universal payments and authentication methods that feel familiar, for both online and face-to-face transactions, will be key to opening up a world of possibilities when it comes to redefining how businesses engage with consumers.
Brexit responsible for food supply problems in Northern Ireland, Ireland says
LONDON (Reuters) – Food supply problems in Northern Ireland are due to Brexit because there are now a certain amount of checks on goods going between Britain and Northern Ireland, Irish Foreign Minister Simon Coveney said.
British ministers have sought to play down the disruption of Brexit in recent days.
“The supermarket shelves were full before Christmas and there are some issues now in terms of supply chains and so that’s clearly a Brexit issue,” Coveney told ITV.
The Northern Irish protocol means there are “a certain amount of checks on goods coming from GB into Northern Ireland and that involves some disruption,” he said.
(Reporting by Guy Faulconbridge; Editing by Tom Hogue)
2021: a new tipping point for digital commerce
By Damien Perillat, SVP Digital Commerce at Worldline Global
2020 was a year of significant change for all of us, impacting businesses and their customers heavily. While several industries struggled, the demand for digital commerce and alternative ways to pay took off as nation-wide lockdowns meant customers needed to shop from the safety of their homes. This forced many businesses that previously relied on their bricks and mortar stores into the online space. And now, consumers are increasingly comfortable with ecommerce being a crucial part of their shopping experience – even those who were previously reluctant to adopt a digital life. It took ecommerce 20 years to reach about 15% penetration of consumer spending and in just a few months we jumped five to ten years forward. This isn’t likely to change in 2021.
Even in physical stores, customers are looking for safer alternatives to cash and chip-and-PIN payments. UK Finance revealed that contactless spending was up 18% across the UK in September last year when compared to the same time in 2019 – 64 percent of debit card transactions and 46 percent of credit card transactions were contactless. The use of digital and contactless payment methods will be much more widespread in 2021 as we enter this new normal.
K-shaped economic recovery will continue
With that said, economic recovery won’t take place at the same rate for everyone. Different industries have been impacted in their own unique ways by the pandemic. Leisure and travel continue are ranked as the most one missed activities by consumers and the first signs of recovery will be in the form of an increase in domestic and regional travel.
At the same time, the way consumers are interacting with different industries has changed. For example, millennials are looking for more experiential holidays with strong social aspects, where they can make a positive impact on the destination and people they are visiting. And, younger generations are displaying more conscious buying behaviour, focusing on sustainability.
Other industries have faced difficulties throughout the pandemic. Challenged with economic uncertainty, customers have cut back on spending on non-essential, luxury items, instead favouring spending that has enabled low-touch and home-based activities, such as food delivery, electronics, home entertainment and online marketplaces.
A shift in payment preferences
What has been uniform across many industries though, is that consumers now have high expectations surrounding not only the user experience (UX) but also the payment process itself. They anticipate an easy shopping experience where payments are almost invisible. Having the right payments mix will therefore be the key ingredient for success this year for many. Companies will need to ensure that their payment processes are fast, simple and frictionless as online checkout experiences have been raised to the next level.
At the same time, demand for digital goods and services surged last year as people were stuck indoors during lockdowns so purely digital players benefitted. By the end of Q3 2020, Netflix had a huge 195 million subscribers registered, while from February to June, Zoom saw a 677% increase in usage – attributed to increased remote working.
Clearly the digital transformation boosted the subscription economy, and that didn’t stop at just digital goods. People took to subscription services that regularly delivered anything from food to supplies to their doorsteps. This has been a much safer and convenient way to purchase goods during the pandemic.
So, with subscription services establishing a foothold last year, 2021 will be the time for businesses to invest in understanding the dynamics of what a truly optimised subscription payment customer acquisition looks like.
More online payments means more online fraud
Last year it wasn’t all plain sailing for everyone operating in the digital space. The increase in online payments presented more opportunity for fraud to take place and that’s exactly what happened. Between May and July 2020, when certain lockdown measures were eased and customers became more willing to spend, fraud volumes rose 61%, according to figures published by Barclays Bank.
Similarly, chargebacks became more prevalent. When shops are more reliant on deliveries than ever before, there is more opportunity for things to go wrong with orders and customers to be dissatisfied with what has been purchased. Fraudulent chargebacks have also become much easier to commit as it is increasingly difficult to prove when deliveries arrive safely.
Therefore, in 2021, not only will it be important to have a frictionless UX, but security measures must be effective without impeding on checkout processes and refund management will remain critical.
Greater risk of fraud didn’t stop businesses from embracing their new-found digital capacities while physical stores were closed though. Many have ventured into international territory with the aim sharing their services with other countries around the world.
This year, focusing on high-growth markets such as India, Brazil, Russia, and China will be hugely beneficial for companies looking to operate internationally and we could see cross-border sales continuing to take off in these regions. South-East Asia and Latin America have some of the greatest potential for digital commerce growth and I would urge those operating across borders to consider offering services there.
Key to achieving this is the ability to provide payments services that meet the needs of customers in different localities. Worldline research has found up to 42% of customers are likely to drop off and search for an alternative website if their preferred payment method is not offered at the checkout. Therefore, businesses must integrate with payment networks in different regions to provide locally relevant payment methods.
Yet, the web of complexity is increasing for online merchants, especially for those that want to expand internationally. As such, next year we can expect to see the growing popularity of payment solutions that seamlessly support the international reach of consumers and that enable businesses to integrate with local payment networks, while minimizing the need for local establishments and resources.
In a similar fashion, supply and logistics is becoming more localized. Lockdown measures hugely impacted supply chains around the globe and businesses resorted to new sourcing strategies and business models which will continue to be used this year.
Facing up to the change
2021 will be another extraordinary year for many businesses, as the world begins to find its feet again following COVID-19. Businesses must assess their position in the market and ability to meet the changing needs of customers’ when it comes to preferred commerce and payment methods.
Not only will this be critical when operating in the bustling online space, but it gives them scope to diversify, bringing in new revenue streams as we face the current economic downturn. When used to their full potential, payments will also ensure that companies can continue expanding online and abroad, even if the economy is going through a long K-shaped recovery period.
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