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Rating action

Scope Ratings has today assigned a first-time issuer rating of BB- to Tegeta Motors LLC (Tegeta) and a BB- for the senior unsecured debt category. The agency has also assigned a preliminary first-time rating of BB- to the senior unsecured bond to be issued. All ratings have a Stable Outlook.

Rating rationale

The issuer rating is mainly supported by the company’s BB rated financial risk profile, based on its comparatively strong operating profitability, which enables good underlying free cash flow generation, and will continue to do so in future. Tegeta’s business risk profile (rated BB-) is supported by its good market position in the profitable Georgian market. The rating is constrained by low geographical diversification and by some execution risk associated with the company’s future expansion programme. The rating also reflects Scope’s view on the evolving macroeconomic and industrial environment in which the company operates: the risks and opportunities presented by expected industry consolidation and the significant changes likely in the retail segment in the future.

In terms of competitive positioning, Scope considers Tegeta’s market situation in Georgia to be sustainable. The group is the national leader in Georgia’s fragmented automotive market, holding an estimated share of 25% for new cars (16% including used cars). Tegeta benefits from commercial agreements with world-leading automotive suppliers such as Toyota, Porsche, Volvo, Shell, Bosch, MAN and JCB. This leading position is reinforced by the expected decline in non-professional markets (bazaars) and by laws requiring car owners to take their vehicles for regular technical inspections. Tegeta’s broad presence in Georgia has also helped the company to win significant national bus tenders. Scope believes that Tegeta will increase its share of public tenders on the back of large infrastructural reforms planned by the Georgian government.

Scope has a negative view of Tegeta’s diversification, given its dependency on the Georgian market. However, its strategic expansion into the Caucasus region is expected to support future diversification, as there are no clear market leaders in this region. Product diversification is the main positive rating driver as it distinguishes Tegeta from smaller domestic competitors, which usually offer only one product category. The company is present in vehicle sales (all types), car parts, as well as maintenance and specialised equipment. This broad product range is also complemented by a good split of customer types (40% retail / 35% corporate / 25% wholesale). Scope views this mix as positive because it balances the risks attached to a single group of customers.

With a Scope-adjusted operating profit margin consistently above 10% (12.5% in YE 2017, defined on an EBITDA basis), Tegeta’s profitability is high for a retailer. Scope considers this high margin to be supported by: i) a profitable after-sales business, accounting for most of current revenues; and ii) significant projected sales growth, allowing for better cost absorption.

With regard to corporate governance, Scope believes that Tegeta’s ownership structure – consisting of Georgian individuals, mainly the Kokhodze family which has 73% – is not comparable to those of public companies in the West. However, current plans include the setting-up of a supervisory board and the creation of greater transparency for outside investors. Scope therefore has a neutral view of Tegeta’s current corporate governance, as structures are expected to improve in the near term and no corporate governance-related concerns were identified during the rating process.

Tegeta’s financial risk profile is supported by its high operating profitability, which translates into a good ability to generate underlying cash flow, in particular after 2020 when the present expansion programme will end. Combined with the group’s growth potential, this is already likely to lead to significantly improved credit metrics in 2019 – in the middle of the investment programme. This expansion programme centres around Tegeta’s involvement in various Georgian infrastructure projects. As a consequence, capital expenditure and working capital are expected to increase markedly by 2020. The expansion in working capital will be driven both by expected sales growth and by Tegeta’s strategy to increase product availability (tyres and other spare parts). The planned capex will significantly exceed maintenance levels, meaning it is highly likely that free cash flows will turn negative during this period. However, capex in particular is flexible and could be considerably reduced if necessary. Scope believes that Tegeta can already improve its credit metrics in 2019 as, despite the spending programme, EBITDA growth is likely to outpace the increase in Scope-adjusted debt.

Tegeta is planning to use a good part of the GEL 30m bond placement, intended for the first half of 2019, to swiftly reduce its traditionally heavy reliance on short-term debt. This will affect liquidity positively (Scope considers liquidity to be ‘adequate’ assuming a successful bond placement) as the remaining short-term debt maturities will be fully covered by available liquidity as a result.

Thus, Scope’s underlying conservative base case foresees a considerable improvement in key credit metrics in 2019. On the other hand, free cash flows are likely to remain negative. In the rating agency’s view, execution risk for strong sales growth should not be high for Tegeta, as this is largely a function of receiving cars and buses on a timely basis from manufacturers. Assuming a stable EBITDA margin of 9% on a reported basis, and assuming that revenues will reach GEL 600m in 2019, leverage should improve from approximately 3x in 2018 to 2.3x in 2019. Tegeta is likely to generate negative free operating cash flows (FOCF) in 2019 and 2020 and Scope believes that most of the expected growth in EBITDA is likely to fund working capital expansion. Scope has therefore focused on the FOCF-to-Scope-adjusted debt (SaD) ratio which the rating agency expects will become positive again by 2021.

Scope has applied a negative one-notch adjustment for supplementary rating factors, primarily encapsulating emerging market risks, currency risk and growth plan execution risks as well as execution risk associated with the prospective bond placement and potential consequences for the company’s liquidity policy.

The rating agency also examines recovery values for bond holders in a hypothetical case of default. Scope has calculated a recovery rate of about 40% for the GEL 30m senior unsecured bond using a liquidation approach. This calculation is based on secured bank loans ranking ahead of the bond, the roll-over of existing bank guarantees, the first liens already held by banks on some of the assets, the possibility that some of Tegata’s foreign-currency denominated debt could appreciate relative to local currency, and the risks regarding bankruptcy resolution in the emerging market of Georgia. This results in the same bond rating as the issuer rating, based on Scope’s calculated value available at default.

 Outlook

The Outlook is Stable and reflects Scope’s expectation that Tegeta will successfully place its GEL 30m bond in 2019 thereby allaying current liquidity concerns that would otherwise exist. The Stable Outlook is likewise linked to the positive generation of free operating cash flows after 2020.

A positive rating action could be warranted if the company achieves positive free operating cash flow after 2020 of above 5% in relation to Scope-adjusted debt. A negative rating action could result from sustained negative free operating cash flows.

Rating-change drivers

• Upside: substantially positive FOCF. Scope would view the credit ratio FOCF/SaD in a range of 5%-10%
   
• Downside: significantly negative free operating cash flow on a sustained basis

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

Methodology
The methodology used for these ratings and rating outlooks: Rating Methodology: Corporate Ratings¹, is available on www.scoperatings.com.
Historical default rates of the entities rated by Scope Ratings can be viewed in the rating performance report on https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA Please 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’s definitions of default and rating notations can be found at https://www.scoperatings.com/#governance-and-policies/rating-scale.
The rating outlook indicates the most likely direction of the rating if the rating were to change within the next 12 to 18 months.

1 Editor's note (11 April 2019): A wrong publication date of the corporate rating methodology was deleted.

Solicitation, key sources and quality of information
The rated entity and/or its agents participated in the rating process.
The following substantially material sources of information were used to prepare the credit rating: public domain, the rated entity, third parties and Scope internal sources.
Scope considers the quality of information available to Scope on the rated entity or instrument to be satisfactory. The information and data supporting Scope’s ratings 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. Prior to the issuance of the rating or outlook action, the rated entity was given the opportunity to review the rating and/or outlook and the principal grounds on which the credit rating and/or outlook is based.

Regulatory disclosures
This credit rating and/or rating outlook is issued by Scope Ratings GmbH.
Lead analyst Olaf Tölke, Managing Director
Person responsible for approval of the rating: Werner Staeblein, Executive Director
The ratings/outlooks were first released by Scope on 22 March, 2019

Potential conflicts
Please see www.scoperatings.com for a list of potential conflicts of interest related to the issuance of credit ratings.

Conditions of use / exclusion of liability
© 2019 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Analysis GmbH, Scope Investor Services GmbH and Scope Risk Solutions 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.

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