These strengths, however, are tempered by JRF's somewhat weak financial profile compared with its business profile, given that its debt-to-capital ratio remains slightly high, at a level near the upper end of the target range set under its financial policy. We view this as a risk factor for the J-REIT's credit quality. The ratings also reflect JRF's relatively weak profitability and interest coverage indicators, due to its purchase of some properties at low yields under its slightly aggressive investment policy prior to the onset of the global financial crisis in 2008, when market prices were inflated. A slower recovery in rent levels at its urban retail properties has also caused these indicators to remain relatively weak. To strengthen its profitability, JRF has started to incorporate into its existing portfolio various types of retail properties with high yields. This, in our view, leads to somewhat unclear prospects over the J-REIT's ability to maintain asset quality at its traditionally high levels. We consider this as a constraining factor for the ratings.
Standard & Poor's views JRF's business risk profile as "strong." JRF's highly diversified real estate portfolio comprises 70 properties with a total value of about JPY664.1 billion (based on purchase price). Its average portfolio occupancy rate was high, at 99.8%, as of the end of the 20th fiscal term (ended Feb. 29, 2012), and the proportion of long-term lease agreements in its portfolio is also high. These factors support our view that JRF is likely to continue to generate largely stable cash flows.
Standard & Poor's views JRF's financial risk profile as "modest." We base this view on JRF's somewhat weak financial profile compared with its business profile, given that its debt-to-capital ratio remains slightly high and its interest coverage indicators are relatively weak. Although we consider its improved debt profile as a positive factor for the J-REIT's credit quality, we view the high proportion of its floating-rate loans to overall debt as a negative factor. However, JRF also has favorable relationships with many financial institutions and maintains relatively high financial flexibility, and we view these as positive factors.
Liquidity
Our short-term rating on JRF is 'A-1', reflecting our long-term corporate credit rating and our assessment of JRF's liquidity as "adequate." We expect JRF's sources of liquidity--such as liquidity on hand and funds from operations (FFO)--to be sufficient in the 21st fiscal term (ending Aug. 31, 2012) to cover its uses of liquidity--including debt repayments, capital expenditures, and dividend payments. In our view, the amount of long- and short-term funding available to JRF does not constrain its ability to repay its near-term debt or acquire additional properties to further expand its portfolio. To reinforce its liquidity, however, JRF increased its committed credit lines to JPY50.0 billion from JPY40 billion in the 20th term, none of which it had used by the end of the same term. In addition, JRF had about JPY15.8 billion in cash and deposits as of the end of the 20th term. Although JRF has pledged 21 properties in its portfolio as collateral for security deposits and "hoshokin" liabilities (hoshokin liabilities are deposits, usually interest-bearing, with multiple, scheduled repayments regardless of the leasing period, and thus have similar characteristics to conventional debt), JRF maintains financial flexibility, given that: (1) pledged security deposits and hoshokin liabilities account for a reasonably small share of total assets; and (2) all of its current interest-bearing debt is unsecured.
Outlook
The outlook remains stable, reflecting Standard & Poor's expectation that JRF will maintain generally stable earnings from its high-quality and well-diversified portfolio, which has a relatively high proportion of long-term leasing agreements. We continue to regard conditions in the retail industry, profitability indicators, and financial indicators, such as debt levels and interest coverage indicators, as important factors for JRF's credit quality. To revise the outlook upward, we need to see clear signs of improvement in the J-REIT's profitability and financial indicators; however, we believe that JRF's currently weak financial indicators limit this likelihood for the foreseeable future. On the other hand, JRF's credit quality may come under downward pressure if its debt-to-capital ratio [interest-bearing debt including hoshokin liabilities/(interest-bearing debt including hoshokin liabilities + total net assets), as defined by Standard & Poor's] exceeds and remains above 55%; its EBITDA interest coverage ratio falls below 5x; and its cash flow deteriorates substantially due, for example, to departures of major tenants.
