Scope affirms Szabó Fogaskerékgyártó Kft.’s B issuer rating, changes Outlook to Negative
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Scope Ratings GmbH (Scope) has affirmed the B issuer rating on Hungarian metalworking company Szabó Fogaskerékgyártó Kft. and changed the Outlook to Negative from Stable. Scope has also affirmed the B+ rating for the senior unsecured debt category, one notch above the issuer rating.
The negative outlook reflects the expected deterioration in credit metrics in 2022 due to the expected decline in EBITDA, as reflected in the Scope-adjusted debt/EBITDA ratio of 6.2x at YE 2022. Although Scope expects leverage to decline in its base case scenario, the change in outlook considers the increased risks to Scope’s forecasts due to the deteriorating economic environment as well as the company's weak diversification, making it vulnerable to economic shocks. Scope also points to the apparent delay in raising prices with key customers in 2022, which led to a decline in the EBITDA margin to around 17% after 9M 2022, compared to around 35% in the same period last year. The protracted price negotiations, just recently concluded, raise the question of the company's ability to raise its prices further if needed.
The affirmed B issuer rating is based on the assessments of the business risk profile, which remains unchanged at B-, and the financial risk profile, which was downgraded from BB to BB-.
Szabó Fogaskerékgyártó’s business risk profile continues to be constrained by the company’s size, low product diversification, and high customer and end-market concentration.
With revenues of around HUF 1.8bn (roughly EUR 5m), Szabó Fogaskerékgyártó is still a small niche player in the European capital goods market. In addition to its relatively weak market positioning, weak diversification remains another rating restraining factor.
Despite the declines in 2021-22, profitability compared to peers remains the key support for the company's risk profile. Scope-adjusted EBITDA declined to HUF 612m in 2021 compared to HUF 798m in 2020. While revenues stagnated at HUF 1.77bn in 2021 compared to HUF 1.78bn in 2020, the EBITDA decline was due to the higher material costs and a 25.5% YoY increase in personnel expenses, reducing the gross profit margin to 51% in 2021 (58% in 2020). Likewise, the Scope-adjusted EBITDA margin slipped from 44.8% in 2020 to 34.5% in 2021. After 9M 2022, the Scope-adjusted EBITDA margin decreased to 16.7% due to the strong increase in raw material prices and a further increase in staff costs. Scope also points to the apparent delay in raising prices with key customers in 2022, which led to a decline in profitability. The protracted price negotiations, just recently concluded, raise questions about the company's ability to further increase its prices if needed. For the full year 2022, Scope expects a Scope-adjusted EBITDA margin of 16% and a Scope-adjusted EBITDA of HUF 360m. As Scope expects cost pressures to continue, the company's profitability should not return to the pre-2022 level of more than 30% in the foreseeable future. However, the recently concluded price negotiations with an agreed price increase of 23% should have a positive impact on the gross profit margin in 2023 and more than compensate for the expected further increase in personnel costs. Scope expects a Scope-adjusted EBITDA of HUF 509m (margin: 21%).
Szabó Fogaskerékgyártó’s issuer rating benefits from its BB- (previously BB) assessed financial risk profile. The one-notch change reflects the expected increase in the leverage ratio to around 6x at YE 2022 due to the expected increase in Scope-adjusted debt to around HUF 2.2bn (HUF 1.0bn at YE 2021) following the issuance of a HUF 1.5bn bond and the significant decrease in Scope-adjusted EBITDA. Although Scope expects this ratio to improve to below 4.0x by the end of 2023 in its base case scenario, there are increasing risks to the scenario as the economic environment deteriorates and the company is only weakly diversified, making it highly vulnerable to economic shocks. Regarding Scope’s adjusted debt expectation, Szabó Fogaskerékgyártó plans to reduce its financial debt by around HUF 950m by the end of 2024, as bank debt is due for repayment in 2022-24 and equipment used under finance leases is replaced by machinery purchased in-house. Therefore, Scope expects Scope-adjusted debt to decrease to around HUF 1.7bn by YE 2024.
Scope expects Scope-adjusted FOCF to remain weak at least until 2023, reflecting the planned investment cycle and lower EBITDA. Scope-adjusted FOCF was negative in 2021 at around minus HUF 505m, burdened by the investment programme in production capacity. Reported FOCF after 9M 2022 was HUF 835m, mainly due to the state subsidy of around HUF 1bn. Adjusted for this non-operating effect, the Scope-adjusted FOCF was negative at around minus HUF 165m, mainly due to the decline in EBITDA. For the full year 2022, Scope expects capex of around HUF 440m (HUF 371m after 9M 2022) and a Scope-adjusted FOCF of around HUF 70m. While capex after 9M 2022 was still relatively high due to the ongoing investment programme, it was lower than previously guided due to postponements caused by difficulties in the operating business. The investments postponed in 2022 will be made up in 2023. Therefore, Scope expects capex to increase to around HUF 2.1bn in 2023 and Scope-adjusted FOCF to turn negative in 2023 at around minus HUF 1.8bn. Most of the investments should be completed in 2023, therefore Scope expects lower capex and a return to a positive Scope-adjusted FOCF in 2024.
In the past years, Szabó Fogaskerékgyártó Kft. often distributed its total FOCF or even more through dividends to shareholders. In 2021, Szabó Fogaskerékgyártó Kft. distributed a dividend of HUF 220m. As provided for in the bond prospectus, Szabó Fogaskerékgyártó will reduce the annual dividend distribution to HUF 50m during the investment cycle from 2022 to 2024.
Scope rates Szabó Fogaskerékgyártó's liquidity and financial flexibility as ‘adequate’ given the significant cash inflows in 2022, the HUF 1.5bn proceeds from the February 2022 bond issue and the HUF 1bn subsidy, as well as the well-stretched maturity structure.
There is a key person risk (ESG factor) as the entire management of the company rests with the current CEO Ferenc Szabo - 100% sole owner of Szabó Fogaskerékgyártó Kft. - and his son Krisztian Szabo, the executive vice president. Ferenc Szabo and Krisztian Szabo entered into an official agreement on the joint management of the company in February 2022, whereby Krisztián Szabó became the managing director of the company (alongside his father) and was given independent signing authority.
One or more key drivers for the credit rating action are considered ESG factors.
Outlook and rating-change drivers
The Negative Outlook reflects the anticipated deterioration in credit metrics in 2022 due to the expected drop in Scope-adjusted EBITDA, as reflected by the Scope-adjusted debt/EBITDA ratio of 6.2x at YE 2022. It also reflects the deteriorating economic environment, which increases the risks to Scope’s forecast, especially due to the company's weak diversification, which makes it vulnerable to economic shocks. Scope also notes the apparent difficult price negotiations with key customers in 2022, which were only recently concluded. The delayed price increases were responsible for the decline in profitability. This raises questions about the company's ability to raise its prices further if needed. It also reflects Scope’s expectation that the company's profitability should not return to pre-2022 levels of more than 30% in the foreseeable future due to continued cost pressures.
To return to a stable outlook, Szabó Fogaskerékgyártó needs to demonstrate its ability to restore its Scope-adjusted EBITDA margin to above 25% on a sustained basis while increasing revenues. Scope deems a rating upgrade to be remote at this stage, but it is possible if the company can grow with high margins while deleveraging.
A negative rating action could result from Scope-adjusted debt/EBITDA staying at above 4x on a sustained basis, e.g. caused by lower revenues or EBITDA margin pressure from rising material or personnel costs. It could also result from weaker liquidity or the loss of a major customer. In this context, Scope notes that Szabó Fogaskerékgyártó’s senior unsecured bond issued under the Hungarian Central Bank’s Bond Scheme has an accelerated repayment clause. The clause requires Szabó Fogaskerékgyártó to repay the nominal amount (HUF 1.5bn) within 10 business days after the bond rating falls below a B-, which could have a default implication.
Long-term debt rating
In line with the affirmed issuer rating, Scope has affirmed the B+ rating for senior unsecured, one notch above the issuer rating, debt based on an ‘above average’ recovery prospect in a simulated event of default.
In February 2022, Szabó Fogaskerékgyártó issued a HUF 1.5bn bond under the MNB Bond Funding for Growth Scheme with a tenor of 10 years, amortisation of the notional amount by 10% annually over 2027-2031 with a 50% bullet repayment in 2032, and a 5.5% fixed interest rate coupon payable annually. Proceeds from the bond are to be used for investments in a new production hall and logistics centre and to develop an automated warehouse structure. The remaining debt comprises bank debt and financial leases. Banking loans are secured by pledge on some selected machines, vehicles, trucks and cars.
Scope assumes that Szabó Fogaskerékgyártó will reduce its bank and lease debt by around HUF 950m by YE 2024 in line with its business plan and that the investment programme will be executed as planned with no additional bank debt or other senior-ranking financing ahead of the bond.
In 2022 Szabó Fogaskerékgyártó received a HUF 1bn state subsidy to finance its investments. To determine claimholders, Scope has ranked the repayment obligation for subsidies at the simulated point of default senior to the claims on the prospective bond.
Scope also assumes a significant increase in property, plant and equipment compared to the end of 2021, due to the ongoing investment programme.
Scope’s recovery analysis uses the liquidation value in a hypothetical default in 2024 of HUF 2.4bn. This value is based on a haircut on the assets and reflects liquidation costs of 10%. The haircut also assumes the receivable from the parent used to refinance the acquisition debt would become non-recoverable in the event of payment default.
Stress testing & cash flow analysis
No stress testing was performed. Scope Ratings performed its standard cash flow forecasting for the company.
The methodology used for these Credit Ratings and/or Outlooks, (General Corporate Rating Methodology, 15 July 2022), is 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 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 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 Outlooks and the principal grounds on which the Credit Ratings and/or Outlooks 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: Gennadij Kremer, Associate Director
Person responsible for approval of the Credit Ratings: Olaf Tölke, Managing Director
The Credit Ratings/Outlooks were first released by Scope Ratings on 31 January 2022.
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
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