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Rating action

Scope Ratings GmbH (Scope) has today downgraded the issuer rating of Hungarian construction company Vasútvill Kft. to B- from B+. At the same time Scope has downgraded the senior unsecured debt rating to B- from B+. Both ratings have been placed under review for a possible downgrade.

Rating rationale

Scope’s previous expectation of an increase in leverage and decrease in debt protection in 2022 materialised, and the company’s forecast for 2023 has been revised downwards, triggering the downgrade. Vasútvill’s situation worsened in the last quarters due to the cancellation of its participation in significant projects, resulting in a substantial deterioration of its backlog giving very limited visibility on the financial risk profile.

The under-review status reflects heightened uncertainty for Vasútvill’s business following the government announcement on 30 May 2023 regarding the planned budget for 2023 and 2024. The budget contemplates reduced spending in Vasútvill’s niche market, public railway investment and a fast recovery is not expected.

Vasútvill’s pipeline of projects is being affected by the shrinking pool of public construction projects in Hungary, a result of general budget restrictions and uncertainty surrounding EU funds. A dispute between Vasútvill’s ultimate owners is aggravating this situation, potentially causing a main customer to terminate major contracts and severely limiting the issuer’s ability to secure public infrastructure projects in Hungary in the future. The cancellation of the contracts has also forced the company to scale back capacity, which could cause problems once operations normalise.

The company is negotiating other projects in Hungary (totalling about HUF 3.1bn in potential orders) and plans to look for opportunities in neighbouring countries, where the railway industry offers growth potential, however this plan is at a very early phase and still uncertain. Scope does not see a fast recovery as feasible, given the still low visibility on the timing of a recovery in public procurement and the normal delay between the award of a new order and its execution.

Vasútvill’s business risk profile (assessed at B-) remains constrained due to its small scale in both a European and Hungarian context, which weakens its ability to mitigate economic cycles and changing market conditions. Limited size is a negative rating driver because it implies greater sensitivity to unforeseen shocks, greater cash flow volatility and limited economies of scale. Weak diversification is a further constraint, namely: i) a lack of geographical diversification; ii) the reliance on one end-market; and iii) the concentrated customer portfolio and backlog mostly dependent on government decisions. Also credit-negative are the weaker backlog and profitability assessment given the medium-term trend of deteriorating margins.

Profitability, as measured by the Scope-adjusted EBITDA margin, remained weak and stood at 3.9% in FY 2022. In view of Vasútvill’s shrinking revenues and cost structure, a strong fixed cost base (mainly salaries) will again hurt operating profit (EBITDA) in 2023 and likewise decrease the projected cash flow generation. Scope expects that profitability as measured by the company’s Scope-adjusted EBITDA margin and levered internal rate of return will not recover before 2024.

The re-assessment of the issuer’s financial risk profile to B- from B+ is driven by a weakening cash flow generation, which following the drop in EBITDA in 2022, turned negative and is expected to remain negative in 2023. Vasútvill has provided Scope with a cash flow plan for 2023, which shows the company’s reliance on a handful of minor projects in execution and receiving compensation for cancelled projects totalling about HUF 1.2bn, in order to generate operational cash flow that could cover operational expenses. Those expenses include about HUF 1.5bn in staff expenses and the repayment of a HUF 40m loan in 2023. Scope notes the existing risk that the plan might not be realised on time and that the expected recovery in 2024 may not meet current expectations, due to the non-successful tenders and uncertainty on the timing of a full construction market recovery.

Current liquidity is still deemed to be adequate, but as previously mentioned, it relies on the timely realisation of Vasútvill’s measures to maintain some cash cushion. It also benefits from a conservative debt strategy, as evidenced by a very low debt balance (mostly comprising the HUF 3bn bond issued in 2021 and only about HUF 40m of short-term loans) against the positive balance of unrestricted cash and cash equivalents (HUF 200m as at June 2023). Given the long maturity of the bond, upcoming short-term maturities will be manageable. Scope expects the company to maintain its low short-term debt levels and ensure that these are covered by available liquidity.

Outlook and rating-change drivers

The issuer credit rating is under review for a possible downgrade. Scope will closely follow developments in the company’s operations and, in particular, its assumptions with regard to a gradual resumption of the order intake in the next quarters. In addition, Scope will also closely monitor updates and developments regarding unused available capacities and expenditure cuts. The rating agency expects to resolve the review status within the next three months.

A downgrade of at least one notch might result from an inability to achieve a fast recovery in business conditions and/or liquidity concerns. This could happen if: i) the Hungarian construction market downturn lasted longer than expected; and/or ii) Vasútvill failed to implement is cost optimisation plan and/or there are delays in the cash sourcing execution which would put pressure on liquidity.

A rating confirmation could occur if liquidity is sustained at or above 100% at all times and interest cover would be well above 3x through the cycle. A rating confirmation would reflect Scope’s expectation that the issuer, despite the current market pressure, will restore a minimum level of order book that would guarantee top line figures in line with those observed in 2022.

An upgrade is remote and would require the company’s order backlog to recover quickly, improving operational visibility.

Scope notes that Vasútvill’s senior unsecured bonds issued under the Hungarian Central Bank’s bond scheme have several accelerated repayment clauses. The clauses require the issuer to repay the nominal amount (HUF 3bn) in case of rating deterioration (two-year cure period for a B- rating, immediate repayment below B-).

Long-term debt ratings

The rated entity issued a HUF 3bn senior unsecured corporate bond (ISIN HU0000360151) in 2021. The bond terms include amortisation of 20% yearly from 2026 until maturity, a fixed annual coupon and a 10-year tenor.

Scope’s recovery analysis is based on a hypothetical default scenario in 2024, factoring in Vasútvill’s liquidation value, and assumed outstanding senior unsecured debt of HUF 3bn. Scope expects an ‘average’ recovery for Vasútvill’s senior unsecured debt. Even though asset values are high (machinery valued at HUF 3.9bn as at March 2023), liquidation would be at distressed prices in a default. Scope has also downgraded the unsecured debt class rating to B- (in line with the issuer rating) from B+.

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/or Outlooks, (General Corporate Rating Methodology, 15 July 2022; Construction and Construction Materials Rating Methodology, 25 January 2023), 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 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.

Regulatory disclosures
These Credit Ratings and/or Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and/or Outlooks are UK-endorsed.
Lead analyst: Rigel Scheller, Director
Person responsible for approval of the Credit Ratings: Olaf Tölke, Managing Director
The Credit Ratings/Outlooks were first released by Scope Ratings on 7 July 2020. The Credit Ratings/Outlooks were last updated on 15 March 2023.

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

Conditions of use/exclusion of liability
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