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Rating action

Scope Ratings GmbH (Scope) has today upgraded Hungary-based Pannon Work Zrt’s issuer rating to B+/Stable from B/Stable. The issued senior unsecured guaranteed bond rating (ISIN: HU0000360052) has been upgraded to BB- from B+.

Rating rationale

The rating action reflects the closed acquisition of 5MW solar energy power generation plants with excellent cash flow generation potential, the acquisition of HR-Face Kft. (a payroll provider company) to broaden services and an increasing margin despite the pandemic.

Pannon-Work’s business risk profile (assessed at B+) is driven by its position as the fourth largest personnel service provider in Hungary. The Hungarian market is very fragmented, with the top four players holding a market share of around one-third. Industry risk is blended (assessed at BBB+) between business services and renewables (one-fifth of EBITDA from mid-2021).

Growth over the years has been driven by the labour shortage and companies’ need for an intermediary to offer flexibility by leasing out personnel when required. Despite Pannon-Work’s efforts to expand its range of services, it faces concentration risk due to its sole exposure to Hungary, dependence on the Hungarian labour market and low customer diversification. Although the top 10 clients contribute more than 50% of revenues, most of them are bound to Pannon-Work for more than five years. The coronavirus crisis led to the default of one large client, while others decreased their leased worker headcount temporarily between Q1 and Q3 2020. However, clients returned after this period and Pannon-Work successfully secured new, large clients and diversified its service offering by providing payroll services. Despite the pandemic, profitability as measured by the company’s Scope-adjusted EBITDA margin improved to 4.9% in 2020 (+0.3pp YoY). Furthermore, Scope expects it to increase to around 6% after Q2 2021 as the 10 new 0.5MW solar power generation assets were acquired with a feed-in tariff system fixed for over 14 years¹. The company also faces the challenge of rising operating expenditures due to an increase in wage costs. This is mitigated by decreasing taxes and social security contributions in Hungary since Q3 2020.

Pannon-Work’s financial risk profile is driven by: i) increasing indebtedness following the issuance of a HUF 3.5bn senior unsecured guaranteed bond and additional HUF 700m long-term senior secured loans for capex and acquisitions; ii) weakening but still reasonable credit metrics as a result, especially EBITDA interest cover; iii) investments in recurring cash flow producing assets enabled by bond proceeds and additional debt issued, which will bear fruit in the coming years, supporting EBITDA growth and allowing gradual deleveraging.

Scope forecasts Scope-adjusted debt (SaD)/Scope-adjusted EBITDA of slightly above 5x, which should follow a decreasing trend towards 4x in the coming years. This will mainly be due to increased profitability and relatively small growth of business at 3%-4% p.a. as well as the amortisation of the acquisition/capex loans. EBITDA interest cover is decreasing but remains at a good level. The fall to just over 8x due to the HUF 4.2bn debt issued between Q3 2020 and Q2 2021 is mitigated by the increased profitability of HR services and new EBITDA generated by HR payroll services and solar energy production. Free cash flow has fluctuated in previous years due to the continued expansion and restructuring. However, funds from operations/SaD is around 20% and free operating cash flow/SaD should stay well above 10% from 2021 going forward.

Scope deems Pannon-Work’s liquidity adequate. The internal liquidity ratio should be in the range of 5-13x in the coming two to three years. Part of the bond proceeds were used to repay HUF 1.1bn in interest-bearing short-term debt and for acquisitions, while investments are financed via contracted long-term loan facilities. The company also has an available HUF 950m factoring line and HUF 1.05bn working capital facility to help pay any intra-month tax and meet social security payment deadlines, which are currently not extensively used, providing the issuer with cash flow headroom.

Outlook and rating-change drivers

The Outlook for Pannon-Work is Stable and incorporates Scope’s view that the business is stable and the company is able to generate cash. The Stable Outlook also reflects Scope’s expectation that indebtedness will remain high, at SaD/Scope-adjusted EBITDA of above 4x over the next few years, as a result of the bond issuance and related investments. Scope expects dividends to the owners of Pannon-Work of up to one-third of profit after tax in the next few years, the distribution of dividends to owners is subject to the approval of the bank providing the investment loan.

A positive rating action is remote at this stage but could be warranted if Pannon-Work grows significantly in size benefiting the company’s diversification, especially regards customers, while SaD/Scope-adjusted EBITDA stays significantly below 4x or if Scope gains higher visibility on free operating cash flow/SaD exceeding 20%. This could be achieved by improving profitability, a higher EBITDA contribution from HR services or reduced shareholder remuneration.

A negative rating action could occur if SaD/EBITDA exceeds 6x on a sustained basis or if free operating cash flow/SaD were to fall below 5% on a sustained basis. This could result from lower EBITDA than planned from either HR-related services or the solar energy production assets or from further debt-funded capital expenditure or acquisitions.

Long-term and short-term debt ratings

Scope assesses the issued senior unsecured bond of Pannon Work Zrt. (ISIN: HU0000360052) guaranteed by Gamax Kft. at BB-, one notch above the issuer rating. The bond rating reflects the ranking status of the debt, ranking below senior secured loans (for capex, acquisition and working capital) as well as above-average recovery potential due to the high market value of the standardised 0.5MW solar power plants and insured receivables. 

1. see KÁT system

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

Methodology
The methodology used for these Credit Ratings and/or Outlook, (Corporate Rating Methodology, 6 July 2021), is 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: public domain, the Rated Entity, the Rated Entities' Related Third Parties 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/or Outlook and the principal grounds on which the Credit Ratings and/or Outlook are based. Following that review, the Credit Ratings were not amended before being issued.

Regulatory disclosures
These Credit Ratings and/or Outlook are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and/or Outlook are UK-endorsed.
Lead analyst: Barna Szabolcs Gáspár, Associate Director
Person responsible for approval of the Credit Ratings: Philipp Wass, Executive Director
The Credit Ratings/Outlook were first released by Scope Ratings on 14 August 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.