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Rating action

Scope Ratings GmbH (Scope) has today affirmed its B+ issuer rating on Zalaco Sütőipari Zrt. (Zalaco) and revised the Outlook to Positive from Stable. Scope has also affirmed its B+ rating for the senior unsecured debt category.

Rating rationale

Zalaco’s business activities were partially interrupted by the impact of Covid-19 in 2020. The crisis led to a delay in the implementation of the company’s automatic production line of frozen product, while lockdown regulations strongly affected wholesale and retail sales, which resulted in lower-than-expected top-line performance (based on 2020 preliminary figures). Nonetheless, we believe new product portfolio and increased production capacity will help the company to achieve double digit revenue growth and protect cash flow generation in the next few years.

At the beginning of the second half of 2020, the company issued a senior unsecured bond for a total of HUF 4.4bn. Proceeds were partially used to re-finance existing bank loans and to fund capital investments; The pandemic postponed M&A negotiations.

Zalaco’s business risk profile (affirmed at B+) continues to benefit from stable underlying demand in the non-durable consumer products industry, which has low cyclicality, medium barriers to entry and low substitution risk. The rating is also supported by the company’s profitability (relatively high EBITDA margins compared to local peers) which further improved in 2020 thanks to the high margins of the frozen products line. Geographical diversification remains the main constraint on Zalaco’s business risk profile. Furthermore, Zalaco’s sales are highly concentrated on international retail chains: ‘Lidl’ accounted for 53% of 2020 sales and this is not expected to change in medium term.

The company does not use its own brand in its wholesale business segment. However, Scope views positively the ‘Zalaco’ brand value, which is limited to the region in which the company operates.

Zalaco’s financial risk profile (affirmed at B+) supported by comfortable operating profitability, reflected to substantial cash flow generation that puts leverage in the low BB category. As was anticipated in Scope’s previous rating report, Zalaco’s liquidity profile improved after the successful bond placement. Despite a lack of committed credit lines, the company’s liquidity profile is benefiting from the bond’s repayment structure after refinancing all short-term working capital loans (HUF 1.2bn) in 2020.

There are no explicit adjustments for supplementary rating drivers. Scope deems positively recent changes in organizational structure of Zalaco and asset consolidation from sister companies which aims to provide outside investors with better transparency and increase operational efficiency. While the owner’s commitment and transparency are positive, we also see key person risk.

Outlook and rating-change drivers

The positive Outlook reflects Scope’s expectation that the company will execute its M&A plans after 2022 while existing long term investment loans are expected to be repaid in 2021, leading to the SaD/EBITDA ratio advancing towards 3.5x by 2021. The positive rating outlook also reflects successful implementation of frozen products automated production line.

A positive rating action could be warranted if FFO/SaD exceeds 20% on a sustained basis and SaD/Scope-adjusted EBITDA consistently trends below 3.5x. A decrease in leverage may be achieved by an increase in profitability following the successful implementation of the company’s expansion strategy.

The Outlook change back to stable from positive could be triggered by a failure to reduce leverage from present levels. A negative rating action could result from a deterioration in credit metrics, as indicated by FFO/SaD of below 10% and SaD/EBITDA of above 5.0x on a sustained basis. An increase in leverage could be triggered by an adverse operational development, leading to reduced profitability or the need for additional external financing for capital expenditure, M&A or unplanned intercompany loans.

Long-term and short-term debt ratings

The rated entity issued a HUF 4.4bn senior unsecured corporate bond (ISIN HU0000359765) in the second half of 2020. Scope’s recovery analysis is based on a hypothetical default scenario in 2022 that assumes outstanding senior unsecured debt of HUF 4.4bn in addition to HUF 1.9bn senior secured loans. Although recovery analysis indicates a relatively high recovery rate for senior unsecured debt, Scope has limited the uplift for the instrument to zero notches due to the small scale of the company.

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

Methodology
The methodologies used for these Credit Ratings and Outlook, (Corporate Rating Methodology, 26 February 2020; Rating Methodology: Consumer Products, 30 September 2020), are available on https://www.scoperatings.com/#!methodology/list.
Scope Ratings GmbH and Scope Ratings UK Limited apply the same methodologies/models and key rating assumptions for their credit rating services, while Scope Hamburg GmbH’s methodologies/models and key rating assumptions are different from those of Scope Ratings GmbH and Scope Ratings UK Limited.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other Services’, published on https://www.scoperatings.com/#!governance-and-policies/rating-scale. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. 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 Ratings’ definitions of default and Credit Rating notations can be found at https://www.scoperatings.com/#governance-and-policies/rating-scale. Guidance and information on how environmental, social or governance factors (ESG factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://www.scoperatings.com/#!methodology/list.
The Outlook indicates the most likely direction of the Credit Ratings if the Credit Ratings were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The Credit Ratings were not requested by the Rated Entity or its Related Third Parties. The Credit Rating process was conducted:
With the Rated Entity or Related Third Party participation YES
With access to internal documents                                    YES
With access to management                                             YES
The following substantially material sources of information were used to prepare the Credit Ratings: the Rated Entity, public domain and Scope Ratings’ internal sources.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting the Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and Outlook and the principal grounds on which the Credit Ratings and Outlook are based. Following that review, the Credit Ratings were not amended before being issued.

Regulatory disclosures
These Credit Ratings and Outlook are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and Outlook are UK-endorsed
Lead analyst: Zurab Zedelashvili, Analyst
Person responsible for approval of the Credit Ratings: Olaf Toelke, Managing Director
The Credit Ratings/Outlook were first released by Scope Ratings on 24 April 2020.

Potential conflicts
See www.scoperatings.com under Governance & Policies/EU Regulation/Disclosures for a list of potential conflicts of interest related to the issuance of Credit Ratings.

Conditions of use/exclusion of liability
© 2021 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Ratings UK Limited, Scope Analysis GmbH, Scope Investor Services GmbH, and Scope ESG Analysis 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.