The RWN reflects the increased risk of potential lockdowns and work stoppages on operations, project deliveries and liquidity. However, we believe Azizi's current business model, targeting the affordable segment, will enable it to benefit from a recovery in the residential market when and if it recovers.
Key Rating Drivers
RWN Resolution Requires Greater Visibility: Fitch expects to resolve the RWN when there is greater visibility on working capital movement and liquidity position, encompassing practical project completions and completion payments to suppliers versus customers' receipts.
Residential Market on Negative Trend: The decline in demand in the residential sector continues to adversely affect homebuilders in 2020, with clear signs of depressed sale prices and rental yields for several consecutive quarters. The delay in government-sponsored events and projects will negatively affect the market's ability to absorb available homebuilder stock from existing players.
Earlier this year, the Dubai government introduced initiatives to limit the competition between the public and private sector in the real estate market and measures to slow the flow of new units into the market. The current pandemic will delay the crystallisation of those initiatives, particularly from a consumer demand perspective.
Leverage Commensurate With 'B': Our base case forecasts funds from operations (FFO) leverage to increase above 3.5x in 2020 and 2021, as the company deals with thinner profit margins and increased debt to finance contractual payments. We expect overall outstanding debt to increase to around AED800 million between 2020 and 2021, which should help finance forthcoming construction projects (largely comprising Riviera projects in Meydan).
Moderate Speculative Business Model: The risk of further delays in delivering key projects of around six months, will weaken Azizi's ability to maintain adequate working capital and sustain cash flow from operations. The business model requires 30% of pre-sales prior to the start of a project's construction. The business model continues to perform well as it has in the recent past. The first two phases of the Riviera project are well funded with 75%-95% of pre-sales. For past projects, such as Aliyah and Plaza Hotel, almost 90% of units were sold prior to project completion
Capex and Land Bank: Pending infrastructural works around Azizi's projects in Meydan are not expected to negatively impact its working capital needs. However, it is essential for the company to deliver current projects and start collecting the remaining portion of customer payments. Azizi acquires further land plots from Meydan as per market demand as it has in the past. However, we do not expect management to undertake significant land bank acquisitions in 2020.
Azizi currently bids and pays for land upfront from master developers (as do most private developers in Dubai) prior to constructing new projects. The delivery schedule of units is uncertain for 2020, given coronavirus-related disruptions. Azizi previously announced that 13 out of 52 announced projects would be delivered in 2020, which would allow it to collect on receivables exceeding AED1 billion.
Flexible Payment Structure: Given current market conditions, we believe the company might adopt flexible payment plans on selected on-going projects to prevent an increase in unsold stock. Azizi's payment terms include a down-payment of around 10% and further staged construction progress payments, varying between 20% and 40% with the balance collected at handover.
The company follows the relevant Dubai regulations for utilising escrow accounts. All cash proceeds are deposited in a project-specific escrow account, and disbursed throughout the project as staged payments when completion milestones are met. Consequently Azizi needs funding to complete projects to those milestones before purchasers' escrowed payments are advanced. This also assumes that purchasers' defaults remain moderate.
Project Concentration Mitigated: We forecast that the Riviera project in Meydan will represent more than 75% of revenues for the forecast period, leading to a high level of project concentration. However, this is mitigated by the pre-sales and staged-payments profile, and the fact that the company has already locked in 60%-70% of the required sales for this project, supporting the majority of the forecast revenues for the next three to five years.
Limited Scale: Azizi is a private real estate developer with a primary focus on the residential market in Dubai. The company operates on a smaller scale compared with regional and European Fitch-rated peers. The company also has a limited record in executing projects as it delivered its first project in 2016. Fitch believes that real estate market conditions in Dubai limit the scalability of Azizi over the forecast period.
Flexible Operating Structure: Our base case scenario reduces EBITDA margins forecasts to below 18% for the forecast period. The revised margins reflect downward trends in real estate prices in the market. Positively, Azizi has introduced effective measures in 2019 and 2020 to manage operating expenses and reduce sales and marketing expenses to cope with from the downward pressure on margins.
Azizi is a mid-size player operating on a smaller scale compared with PJSC PIK Group (BB-/Stable), for instance, and is a newly-formed entity with a limited record, and high exposure to the Emirate of Dubai.
Europeans peers such as Consus Real Estate (B/Stable) benefit from favourable regulatory frameworks, land option systems, scalability and supportive market conditions. Azizi operates in a weaker operating environment with challenging sector conditions (notably an imbalance between demand and supply).
Azizi's business model has inherent adverse working capital swings, although the company maintains a conservative financial policy with a balance sheet mainly funded by equity. The company's leverage profile is set to increase over the next two years with FFO- leverage rising above 3.5x (December 2019: 0.7x).
Azizi's 2020 leverage profile is expected to be worse than PJSC PIK Group (1.6x), close to PJSC LSR Group (B+/Stable; 3.7x) and lower than Consus Real Estate (6x). The historical profitability margins for Azizi were lower than peers operating in the UK such as Miller Homes Group Holdings plc (EBITDAR margin of 19.7%), and Russian peers PIK (17.5%) and LSR Group (16%). We expect Azizi's profitability to remain stable but lower than its European peers.
Factors That Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade:
- A sustained improvement in the financial metrics including EBIT margin around 20%
- Fitch FFO leverage below 3.0x on sustained basis
- FFO interest coverage ratio above 3.0x on a sustained basis
- Positive free cash flow on sustained basis
- Improved project and developer diversification
Factors That Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade:- Deterioration of the market environment impacting revenues or weakening EBIT margins
- Negative free cash flow on a sustained basis
- Reduction of pre-construction pre-sales rates below 30%
- FFO leverage above 4.0x on a sustained basis
- FFO interest charge coverage ratio below 2.5x on a sustained basis
- Changes to market regulation leading to a delay in project execution or limitation/restrictions placed on project development.
Best/Worst Case Rating Scenario
Ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings
Liquidity and Debt Structure
Near-term Funding Requirements: As of end of December 2019, Azizi Developments had AED530.9 million of cash, of which AED456 million was in various escrow accounts. Fitch believes that Azizi will require additional borrowings to meet the ongoing contractor and subcontractor payments of AED1.54 billion due 2020 and 2021.
Azizi has a challenging projects delivery schedule with 53 ongoing projects, of which 13 are due for handover during 2020. We believe that a possible delay in the handover schedule or construction work would weaken Azizi's liquidity position, leading to higher borrowing requirements.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
Azizi Developments LLC; Long Term Issuer Default Rating; Downgrade; B; RW: Neg
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Secondary Rating Analyst
Aurelien Jacquot, CFA
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+44 20 3530 1061
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Corporate Rating Criteria (pub. 27 Mar 2020) (including rating assumption sensitivity)
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