Detailed Rationale

CRISIL Ratings has revised its outlook on the long term bank facilities of Schloss Udaipur Private Limited (SUPL) to ‘Stable’ from ‘Negative’ while reaffirming the ratings at ‘CRISIL A-‘

 

SUPL is a special purpose vehicle (SPV) formed by Brookfield Strategic Real Estate Partners III fund (BSREP III) to acquire The Leela Palace, Udaipur

 
Brookfield Asset Management (BAM; rated 'A-/Stable' by S&P Global Ratings) and Brookfield Property Partners (BPY; wholly owned subsidiary of BAM; rated 'BBB-/Stable' by S&P Global Ratings) are the anchor investors in BSREP III.  BSREP III is the latest flagship global opportunistic private real estate fund.

 

The outlook revision reflects the expectation of CRISIL Ratings that the business risk profile of SUPL will recover in fiscal 2023 and reach pre-pandemic levels on a sustained basis, driven by strong pent-up demand for leisure travel coupled with reviving corporate and inbound international travel. In fiscal 2022, post the disruption caused by the second wave of the Covid-19 pandemic, occupancy and ADRs had rebounded strongly, as the management shifted focus towards domestic meetings, incentives, conferences and exhibitions (MICE), weddings and sports events, as international tourist inflow remained negligible. Impact of the third wave of the pandemic was benign and largely confined to January 2022.  Furthermore, various cost control initiatives undertaken are expected keep the cost structure lean, which should result in sustained healthy profitability. Impact of any subsequent surge in Covid-19 cases resulting in severe restriction on economic activity or movement of people will remain a key monitorable

 

The rating continues to reflect the presence of strong sponsor (BAM/BPY) who have competent management with extensive experience in the real estate and hospitality segments. The rating also factors in financial and operational support from Brookfield.

 

The rating reflects the strong Leela brand in the hospitality segment and presence of co-obligor structure. These strengths are partly offset by average financial risk profile and exposure to risks related to cyclicality and seasonality in the hospitality industry.

Analytical Approach

CRISIL Ratings has combined the business and financial risk profiles of six SPVs in-line with its criteria for rating entities in homogeneous groups and has equated the rating of the individual SPVs to that of the group. The six SPVs are SUPL, Schloss Chanakya Pvt Ltd (SCHPL; rated 'CRISIL A-/Stable'), Schloss Chennai Pvt Ltd (SCPL; rated 'CRISIL A-/Stable'), Schloss Bangalore Pvt Ltd (SBPL; rated 'CRISIL A-/Stable'), Schloss HMA Pvt Ltd (SHPL) and Leela Palace and Resorts Ltd (LPRL).All the entities are collectively referred to as the Schloss group.

 

All the SPVs have business linkages, common management and 100% fungibility of funds. Each SPV acts as a co-obligor to the others. Post debt servicing in each, excess cash flow is available for debt servicing of all the other SPVs.

 

CRISIL Ratings has also notched-up the rating assigned to the group to factor in the strong managerial, business and financial benefits of Brookfield, being a sponsor through BPY. CRISIL Ratings has also noted the corporate guarantee (for a total quantum of Rs 300 crore) provided by Brookfield to the lenders of the Schloss group for meeting any shortfall in debt servicing or fund requirement over the tenure of the debt.

 

Furthermore, CRISIL Ratings has treated the compulsorily convertible debentures (CCDs), carrying 10.5% coupon, as equity given the expectation that they will be subordinated to external debt and the principal (along with accrued coupon payments) will stay in the SPVs till the external debt is fully paid-off.

 

Please refer Annexure - List of Entities Consolidated, which captures the list of entities considered and their analytical treatment of consolidation.

Key Rating Drivers & Detailed Description

Strengths:

• Operating performance likely to rebound to pre-pandemic level in fiscal 2023

Before their acquisition by Brookfield, the performance of the Leela properties had weakened over the five fiscals through 2019 because of shrinking marketing spends, funding constraints for maintenance of properties, as well as increasing overheads. As a result, growth in occupancy and room rental was significantly lower than that of peers in each of the micro-markets.

 

Post disruptions caused by Covid-19, the company’s revenue has recovered because of improved ADRs and occupancy, driven by staycations and leisure demand. In addition to recovery in revenue, profitability improved because of continued cost-cutting measures implemented by Brookfield post acquisition. Furthermore, revival in corporate travel and MICE segments, coupled with restarting of inbound international travel, will help the sector achieve pre-pandemic level ADRs and occupancy in fiscal 2023, resulting in better revenue and profitability.

 

• Strong brand in the luxury hospitality segment and strong sponsor providing operational and financial support

Leela is an established brand in the luxury hotel space and has presence in key Indian markets, which have high entry barriers and are strategically important. Presence in prime locations has helped these properties attract both leisure as well as business demand.

 

Given the strong brand position, these properties have maintained occupancy and average room rentals higher than the industry average over the past three years. As this is the first hospitality investment of Brookfield in India, it has continued to support SUPL by extending operational support, sharing global expertise in managing properties and providing need-based financial support to meet cash flow mismatch.

 

• Co-obligor structure and creation of debt service reserve account DSRA

With the presence of a co-obligor structure, surplus cash flow after debt servicing in any SPV will be available to fund shortfall in others, thus supporting the consolidated debt service coverage ratio (DSCR). Liquidity, equivalent to three months of principal and interest obligation, shall be maintained from the end of the fourth year (fiscal 2023).

 

Besides, the long-term debt has a ballooning repayment structure with only 1-3% due over the first three years and around 25% due over the subsequent five years, giving ample time for the properties to stabilise operations under the current management. Also, the corporate guarantee provided by Brookfield to the lenders provides additional comfort. Ability of BSREP III to provide need-based support supports liquidity and financial flexibility.

 

Weaknesses:

• Exposure to risks related to cyclicality and seasonality in the hospitality industry

The hospitality sector is susceptible to downturns in the domestic and international economies. Business destinations are more sensitive to macroeconomic factors. For example, growth in revenue per available room (RevPAR) in business destinations is more sensitive to macroeconomic indicators, such as nominal growth in gross domestic product. On the other hand, leisure destinations are more sensitive to non-economic factors, such as terror attacks and health-related travel warnings, as seen in light of the pandemic. Besides, RevPAR of premium hotels declines more sharply during downturns in comparison with mid-sized or economy hotels, but operating cost remains high. Thus, cash flow from these properties is more susceptible to downturns

 

• Average financial risk profile

Consolidated debt is estimated at Rs 3,023 crore as on February 28, 2022. Ballooning repayment starting from the second half of fiscal 2023 coupled with repayment of the emergency credit line guarantee scheme loan has resulted in DSCR of less 1 than over the medium term. However, cash surplus of around Rs 500 crore as on March 31, 2022, will support debt servicing over the medium term, apart from accrual from regular business activity. Additionally, support from Brookfield is expected as and when needed.

 

The cushion in debt servicing may erode in later years given the higher quantum of debt repayment from the eighth year. However, the overall debt burden in later years could be significantly lower as Brookfield plans to deploy surplus cash generated each year towards prepayment of debt.

 

Gearing is expected to remain high over the next few years. Debt protection metrics will remain subdued, with interest coverage ratio (excluding interest on CCDs) expected at 1.0-1.2 times.

Liquidity: Adequate

The group’s liquidity is adequate with cash surplus of approximately Rs 500 crores as on March 31, 2022 which will be sufficient to pay its debt obligations for the next 12-18 months. Liquidity is also aided by the availability of working capital limit of Rs 50 crore, which was utilised at 65% on average in the last 12 months. Furthermore, the surplus liquidity available with the SPVs will be deployed to support debt servicing. Need-based funding support from Brookfield is expected to continue throughout the tenure of the loan.

Outlook: Stable

The Schloss group's business risk profile will recover to pre-pandemic levels, coupled with premium positioning of the respective hotel in the geographies. The financial risk profile is expected to remain modest, though need-based support from Brookfield will be forthcoming.

Rating Sensitivity factors

Upward Factors:

• Upgrade in rating of the parent, BPY, by S&P Global Ratings (S&P) by one notch or more could result in similar rating action on the SPVs provided there is significant improvement in standalone credit quality
• Sustenance of improved occupancy levels and average room rentals leading to improved debt protection metrics, for instance, DSCR of over 1.3 times
• Sustained, healthy double-digit revenue growth at the group level

 

Downward Factors:

• Change in outlook to ‘Negative’ or further downgrade in the rating of the parent, BPY, by S&P by one or more notches may result in similar rating action on the SPVs
• Material change in shareholding or support philosophy of Brookfield towards the SPVs
• Moderation in occupancy levels arising from recurrence of closures and travel restrictions
• Additional debt taken by the group for capital expenditure or meeting operational and marketing expenses weakening the debt protection metrics, for instance, DSCR moderating to less than 1.10 times
• Non-adherence to the co-obligor structure

About the Company

SUPL is one of the six SPVs incorporated in 2019 for Brookfield’s acquisition of real estate assets from Hotel Leela Ventures Ltd (HLVL) housing the Leela Palace, Udaipur. SUPL is 100% owned by Brookfield through its fund BSREP III, wherein Brookfield and its fully owned subsidiary, BPY, are the anchor investors.

 

About the sponsor fund

BSREP III, the fund through which the investment is being done, has a fixed tenure of 10 years (with an option for two one-year extensions) with investments typically happening in the first four years. 

Any other information: Not applicable