Scope affirms B+/Stable issuer rating of Kometa
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Scope Ratings GmbH (Scope) has affirmed the B+/Stable issuer rating of Kometa 99 Zrt (Kometa) as well as the B+ senior unsecured debt rating.
The issuer rating reflects Kometa’s high indebtedness and negative free cash flow amid expansionary capex that will intensify over the next years. Other rating constraints include a still limited size, concentration on domestic sales, and a low-margin core business that is highly dependent on pork prices and under pressure from its large food retail customers. The rating benefits from Kometa’s leading domestic position within pork products, the resilient demand of its industry, the comfortable liquidity buffer and its operational efficiency thanks to its ‘all under one roof’ concept.
Scope continues to assess Kometa’s business risk profile at BB-. Key supports are: i) Kometa’s resilient industry of non-durable consumer products; ii) its leading market positions in Hungary, ranking third by pork sales volume and dominating the growing market of fresh meat in modified atmosphere packaging; iii) higher operating cost savings compared to peers thanks to having all production processes performed in one location (from slaughtering to packaging) and having by-product processing; and iv) a diversified product portfolio across fresh and processed pork products. Key constraints are: i) the low-margin core fresh meat business, which is highly dependent on livestock prices and subject to pressure from large international food retailers (especially discounters); ii) product concentration on pork products, with limited contribution from processed poultry; iii) small size and geographical concentration on Hungary with above 50% of sales; iv) still relatively weak brand value, as the core fresh meat business is based on private-label agreements while processed product brands are still emerging; and v) tail risk in terms of asset concentration on one plant.
Profitability remains volatile and susceptible to changes in the raw materials price. Food inflation in Hungary has been the highest in the European Union at 35% YoY during 2022. Kometa tackled this through by strong pricing actions but could not avoid a temporary pressure on profitability.
After a solid 2021 with a HUF 3.2bn EBITDA and a 5.5% Scope-adjusted EBITDA margin, profitability is expected to bottom out in 2022 at a HUF 2.3bn EBITDA and a 3% margin. This will be due to rapidly increasing energy and livestock prices that cannot be offset by timely price increases. After benefiting from declining livestock prices in 2020-21, price increases in 2022 for both pig and turkey were more adverse than in 2019. Despite Kometa’s ability to increase sales prices accordingly, the time delay in the adjustment negatively impacted profitability, with a 3.5% EBITDA margin as of June 2022. This was most evident within processed products, where contracts are renegotiated less frequently. Scope expects the EBITDA margin to decline further for FY 2022 to 3%. This will be on the additional burden of high energy costs and despite the build-up of frozen raw meat stock at beginning of the year at cheaper prices that can be sold later at a higher price. Nevertheless, profitability will remain well above the almost 2% margin in the most recent low-cycle year of 2019; the improvement is mainly due to a better portfolio mix within the fresh meat segments and more frequent price adjustments within processed products (annually in the past).
Until 2024, Scope expects EBITDA to increase to HUF 4.7bn, with margins of 4%-5% during 2023-24. Despite inflation continuing to affect raw materials and staff costs, Kometa will benefit from recent price increases and Scope does not forecast further abrupt increases in livestock and energy prices. Energy saving initiatives will also save costs, including a change of utility contract terms, the installation of solar panels in 2023 (covering up to 15% of electricity needs) and investments in more energy-efficient technology. Lean operation projects with external consultants will also save costs. Personnel expenses will increase due to inflation but the delayed capex will provide some short-term relief.
Scope continues to assess the financial risk profile at B+. Kometa will breach the negative driver of Scope-adjusted debt/EBITDA of 5.0x in 2022, yet this will be compensated for by the high liquidity cushion, due to the prudent decision to postpone most of the year’s expansion capex and invest well over half of proceeds of the HUF 12bn green bond issued in Mar 2022 in interest-yielding term deposits.
After better-than-forecasted leverage in 2021 of 3.2x, the combination of lower EBITDA and higher Scope-adjusted debt during 2022 will lead to a deterioration in leverage. For 2022, leverage will exceed 6x based on Scope cash adjustments (leverage would be below 3.5x if netting 100% of available cash), improving to almost 5x in 2023 and only able to return below 5.0x in 2024 thanks to the gradual EBITDA recovery. Leverage as measured by Scope-adjusted funds from operations/debt supports the overall leverage score as Scope foresees it ranging within 15%-17% over the medium term.
Interest cover will remain strong at above 4x over the entire forecast period despite the lower EBITDA and materially higher Scope-adjusted debt in the short term. This will be supported by interest income on term deposits, expected in large part to be held at least until mid-2023 and to generate interest income of above HUF 800m during 2022-23. The interest income will compensate for the higher interest expense on the increased debt, at HUF 1.0bn-1.3bn a year, thereof HUF 600m includes the yearly bond interest payment (5% fixed coupon). Notwithstanding the high interest rates in Hungary, 70% of interest-bearing debt is based on fixed interest rates and bank credit lines permit borrowing in euro.
Cash flow cover (Scope-adjusted free operating cash flow/debt) was positive at 4% in 2021 thanks to capex postponement but will turn negative in 2022 and further deteriorate when capex (net of received subsidies) later intensifies. Scope projects net capex in 2023 to remain below HUF 5.5bn before increasing to around HUF 7.5bn in 2024. Consequently, cash flow cover is estimated to be deeply negative for 2023-24. A more meaningful analysis would be to adjust free operating cash flow by excluding the impact of growth capex. Such an approach leads to a minimal cash flow cover metric of around zero given the low profitability margins and expected working capital needs. No dividends or material acquisitions were modelled in the base case scenario.
Liquidity is adequate and supported by cash and equivalents of HUF 12.2bn as of June-2022 (vs HUF 1.1bn as of December 2021), a strong liquidity buffer of well above the HUF 3.0bn of short-term factoring lines. Kometa also received HUF 5.0bn in three-year working capital lines guaranteed at 75% by state-owned credit guarantee institution Garantiqa Hitelgarancia Zrt. The combined HUF 8bn in bank credit lines were provided by two large banks and around HUF 3.2bn of them are kept as cash. Liquidity ratios are expected to remain above 110%.
Supplementary rating drivers are neutral for Kometa. Scope expects the financial policy to remain conservative. Management delayed capex in 2022 to preserve liquidity and comply with its net leverage target of below 4x during expansion. In terms of discretionary spending, management pursued only a few small acquisitions of established business partners in the past years and historically did not distribute dividends to founding shareholders. Parent support continues to be credit-neutral despite the presence of government-related entities as these stakes are either of a temporary nature (MFBI) or not large enough (Municipality of Kaposvar’s 3.7%).
Outlook and rating-change drivers
The Outlook is Stable and reflects the expectation that Scope-adjusted debt/EBITDA on a gross debt basis will return below 5.0x within the next 18 months while the liquidity cushion remains strong (Scope-adjusted debt/EBITDA on a net debt basis to remain around 3.5x because of the large cash reserves). The Outlook assumes a gradual improvement in EBITDA, which assumes livestock and energy prices will not increase materially from 2022 peaks. The base scenario also assumes net capex will remain below HUF 5.5bn in 2023 and the large liquidity buffer will remain in place until EBITDA can reach around HUF 4bn.
A positive rating action could derive from an improvement in Scope-adjusted debt/EBITDA to 3.5x or below on a sustained basis. This could follow higher EBITDA thanks to a quick ramp-up in capacity, increased market shares in export countries, especially in processed products, and/or a stronger brand.
A negative rating action could materialise if Scope-adjusted debt/EBITDA reached above 5.0x on a sustained basis or EBITDA interest cover deteriorated below 4.0x. This could be driven by further large increases in livestock and energy prices not offset by sales price adjustments, and/or a quick usage of the liquidity buffer for expansionary capex without a significant improvement in EBITDA.
Long-term and short-term debt ratings
Kometa issued a HUF 12bn green bond under the Hungary’s Bond Scheme in February 2022 (ISIN: HU0000361464). The bond’s tenor is 10 years with 10% of its face value subject to amortisation in 2027, 10% yearly in 2028-31 and the remaining 50% in 2032. The coupon is fixed at 5% and payable annually, which is beneficial in the current interest rate environment in Hungary where deposit rates are 18%. The bond ranks senior unsecured.
Scope has affirmed the senior unsecured debt rating at B+, same level as the issuer rating, in view of an ‘average’ recovery in a hypothetical default scenario based on liquidation value in 2024. Scope applies conservative recovery assumptions in view of the risk of additional secured debt entering the financing structure in case of a significant increase in capacity, as well the presence of real estate pledges for the subsidy providers (state-linked). The removal of the technology and brand pledges from the investment loan refinanced by the green bond is on the other hand positive for recoverability.
Stress testing & cash flow analysis
No stress testing was performed. Scope Ratings performed its standard cash flow forecasting for the company.
The methodologies used for these Credit Ratings and/or Outlook, (General Corporate Rating Methodology, 15 July 2022; Consumer Products Rating Methodology, 4 November 2022), are available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.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-governance/definitions-and-scales. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://scoperatings.com/governance-and-policies/regulatory/eu-regulation. 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-governance/definitions-and-scales. 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://scoperatings.com/governance-and-policies/rating-governance/methodologies. 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 Rated Entity and/or its Related Third Parties participated in the Credit Rating process. The following substantially material sources of information were used to prepare the Credit Ratings: public domain, the Rated Entity 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.
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: Eugenio Piliego, Director
Person responsible for approval of the Credit Ratings: Henrik Blymke, Managing Director
The Credit Ratings/Outlook were first released by Scope Ratings on 21 December 2021.
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.
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