The latest information on the rating, including rating reports and related methodologies are available on this LINK.

Rating action

Scope Ratings assigns a BB- first-time issuer rating to Duna Aszfalt Kft. The senior unsecured debt category is rated BB. The issuer rating has a Stable Outlook.

Rating rationale

Scope believes that Duna Aszfalt’s B rated business risk profile is held back by the company’s focus on local industrial and civil engineering projects. We rate this construction industry segment B, given its comparatively high cyclicality and low entry barriers. The company’s business risk profile is also restrained by its limited geographical diversification. At present, Duna Aszfalt generates all of its revenues in Hungary. The company’s very concentrated business model further weakens its business risk profile. We note that, with a share of more than 90% in total revenues, construction works dominate business activities. Within construction works, Duna Aszfalt has relatively high exposure to motorway construction, where it generated more than 60% of revenues in 2018. The company’s business risk profile is further restrained by its dependency on state tenders: around 80% of Duna Aszfalt’s revenues in 2018 were generated from Hungarian state-owned entities. We view negatively the relatively short project length (three years on average), the low backlog-to-sales ratio (2x at year-end 2018) and low predictability for the period following the execution of the current backlog. Profitability supports the company’s business risk profile. Adjusted for the booking and release of provisions, the EBITDA margins in 2016, 2017 and 2018 were 6%, 26% and 23%, respectively. We note that before 2017, Duna Aszfalt’s EBITDA margin of around 10% was significantly lower and comparable to sector peers (around 10% on average). Consequently, the sustainability of the current level of profitability is not certain. Having said that, given the order backlog at year-end 2018, which corresponds to 2x the company’s revenues in 2018, the current margin level should be maintained for a while.

Duna Aszfalt’s overall credit risk is strongly supported by its BB+ rated financial risk profile. Due to the considerable jump in EBITDA in 2017 and 2018 following the new state tenders for motorway projects won in 2016, the company’s credit metrics improved. At year-end 2018, we calculate Scope-adjusted debt (SaD)/EBITDA of 2.6x (year-end 2017: 3.5x) and funds from operations (FFO)/SaD of 37% (year-end 2017: 27%). Cash flow metrics improved considerably in 2017 and 2018 in line with higher revenues and EBITDA. Operating cash flow in 2016 and 2017 was also positively impacted by large advance payments. The advance payments amounted to around HUF 73bn at year-end 2018, accounting for around 70% of total liabilities. Duna Aszfalt expects customer advances to run-off after the end of the current EU budget period. We have not included future advances in our rating assumptions.

We expect significantly higher FFO for 2019F due to the expected increase in the company’s EBITDA. Having said that, we expect free cash flow to be around the zero line for 2019F due to the substantial anticipated reduction in advances. The company had no financial liabilities at year-end 2018. In order to calculate SaD, we made adjustments for: i) guarantees, we added 100% of performance and default guarantees; and ii) advances, given the expected reduction, we considered 100% of liabilities from advance payments. As a result, we calculate SaD of approx. HUF 77bn at end-December 2018. The increase by around HUF 7bn is largely explained by lower cash on balance due to the dividend payment of HUF 12bn in 2018. We expect the company’s SaD to increase to around HUF 85bn at year-end 2019F because we believe the positive effects from the substantial anticipated increase in FFO will be outweighed by the negative effects from the expected reduction in advances, M&A and the dividend payment. Given our expectation of higher EBITDA, we expect SaD/EBITDA of around 2.5x at year-end 2019F.

Based on our recovery analysis performed on the year 2020F, we calculate a recovery rate of around 80% for senior unsecured debt. This leads us to rate the senior unsecured debt one notch above the issue rating.

Rating-change drivers

• Scope may upgrade its rating if Duna Aszfalt manages to diversify its order backlog thus increasing visibility and lowering dependency on state orders and/or demonstrates its ability to generate SaD/EBITDA in a range of 2-3x with new tenders.
• A negative rating action could result if SaD/EBITDA moves above 3.5x on a sustained basis, due to less profitable new contracts for example.

Stress testing & Cash flow analysis
No stress testing was performed and Scope performed its standard cash flow forecasting for the company.

Methodology
The methodologies used for these ratings and/or rating outlook (Corporate Rating Methodology, European Construction Corporates) are available on www.scoperatings.com.
Historical default rates of the entities rated by Scope Ratings can be viewed in the rating performance report on https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA Please also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope’s definition of default as well as definitions of rating notations can be found in Scope’s public credit rating methodologies on www.scoperatings.com.
The rating outlook indicates the most likely direction of the rating if the rating were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The rating was not requested by the rated entity or its agents. The rated entity or its agents participated in the rating process. Scope had access to accounts, management and other relevant internal documents for the rated entity or related third party.
The following substantially material sources of information were used to prepare the credit rating: public domain, the rated entity, the rated entities' agent, third parties and Scope internal sources.
Scope considers the quality of information available to Scope on the rated entity or instrument to be satisfactory. The information and data supporting Scope’s ratings originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the rating or outlook action, the rated entity was given the opportunity to review the rating and outlook and the principal grounds on which the credit rating and outlook is based. Following that review, the rating was amended before being issued.

Regulatory disclosures
This credit rating and/or rating outlook is issued by Scope Ratings GmbH.
Lead analyst: Gennadij Kremer, Associate Director
Person responsible for approval of the rating: Olaf Tölke, Managing Director
The ratings/outlooks were first released by Scope on 6 September 2019.

Potential conflicts
Please see www.scoperatings.com for a list of potential conflicts of interest related to the issuance of credit ratings.

Conditions of use / exclusion of liability
© 2019 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Analysis GmbH, Scope Investor Services GmbH and Scope Risk Solutions GmbH (collectively, Scope). All rights reserved. The information and data supporting Scope’s ratings, rating reports, rating opinions and related research and credit opinions originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data. Scope’s ratings, rating reports, rating opinions, or related research and credit opinions are provided ‘as is’ without any representation or warranty of any kind. In no circumstance shall Scope or its directors, officers, employees and other representatives be liable to any party for any direct, indirect, incidental or other damages, expenses of any kind, or losses arising from any use of Scope’s ratings, rating reports, rating opinions, related research or credit opinions. Ratings and other related credit opinions issued by Scope are, and have to be viewed by any party as, opinions on relative credit risk and not a statement of fact or recommendation to purchase, hold or sell securities. Past performance does not necessarily predict future results. Any report issued by Scope is not a prospectus or similar document related to a debt security or issuing entity. Scope issues credit ratings and related research and opinions with the understanding and expectation that parties using them will assess independently the suitability of each security for investment or transaction purposes. Scope’s credit ratings address relative credit risk, they do not address other risks such as market, liquidity, legal, or volatility. The information and data included herein is protected by copyright and other laws. To reproduce, transmit, transfer, disseminate, translate, resell, or store for subsequent use for any such purpose the information and data contained herein, contact Scope Ratings GmbH at Lennéstraße 5 D-10785 Berlin.
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