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Rating action

Scope assigns a first-time issuer rating of B+ to West Hungaria Bau Kft., a construction company active in Hungary. The Outlook is Stable. Senior unsecured debt is rated B+.

Rating rationale

West Hungaria Bau Kft. (WHB) is one of the leading Hungarian construction companies, headquartered in Györ and predominantly involved in the construction and maintenance of buildings, monuments and sport facilities.

The B+ issuer rating is supported by WHB’s historically proven above-average profitability and adequate liquidity. Its domestic market position translates into market visibility and gives moderate access to third-party capital and guarantees.

The rating is mainly constrained by the company’s small overall scale in a European construction context, which lessens its ability to mitigate economic cycles. Weak diversification is a further constraint, namely a lack of geographical diversification (predominantly active in Hungary), segment concentration and a current dependency on government contracts. Scope judges the company’s backlog as short and concentrated (though somewhat mitigated by the investment grade counterparties) and the book-to-bill ratio as volatile.

Scope’s rating scenario assumes the following:

• Revenue growth of 26% in 2019 to HUF 62.5bn, shrinkage of -1% YoY to HUF 62.1bn, excluding a one-off write-up (19.5% including) in 2020 in line with current contracted backlog for 2019 and 2020. For 2021, Scope does not foresee the company to be able to fill the large upcoming contract gap (after the disappearance of government contracts) with market-based orders and estimates a 33% decline in revenues to HUF 41.9bn.
• Issuance of HUF 15bn (roughly EUR 45m) bond in Q1 2020 under the MNB Bond Funding for Growth scheme, with an expected coupon of 3% and a maturity of 10 years, with amortisation starting after five years. Half of the bond proceeds will be used for the acquisition and refurbishment of a multifunctional shopping centre and the other half for a green-field logistics development project in western Hungary.
• Capital expenditure of around HUF 4.4bn in 2019 and HUF 4.1bn in both 2020 and 2021 for the acquisition and refurbishment of a multifunctional shopping centre and WHB’s core business (the latter will purely be financed through operating cash flows, not bond proceeds). In addition, Scope factored in a discretionary HUF 2bn in 2020 and HUF 5bn in 2021 related to the green-field logistics centre.
• Dividend payouts of HUF 3.5bn in 2019, HUF 3.4bn in 2020 and HUF 1.5bn in 2021 as per the company’s dividend policy and covenant restrictions.
• Restricted cash relates to the cash pledged as collateral for banks to issue guarantees.

Positive rating drivers

• Historically above-average profitability, somewhat weakened by the lower margins expected in a downturn cycle
• Adequate liquidity, with limited short-term maturities
• A domestic market position that translates into market visibility as well as moderate access to third-party capital and guarantees

Negative rating drivers

• Small-scale construction company in European context with a lack of geographic and segment diversification, somewhat mitigated by its relatively strong fourth position in the domestic market
• Concentration issues in its backlog (top three account for 45%; top 10 for 80%), somewhat mitigated by the investment grade counterparties (Republic of Hungary)
• Recent dependency on government contracts that are expected to end and leave a large gap that is difficult to fill
• Exposure to overheated Hungarian construction industry
• Large upcoming capex programme, which will lead to very negative cash flows

Liquidity

Scope considers liquidity to be adequate. In detail:
Position: YE 2018 I YE 2019E
Unrestricted cash: HUF 5.5bn I HUF 14.0bn
Open committed credit lines: HUF 0.0m I HUF 0.0m
Free operating cash flow (t+1): HUF -0.6bn I HUF 1.2bn
Short-term debt: HUF 1.3bn I HUF 1.3bn

Coverage: 3.7x I 11.4x

Scope judges the company’s liquidity to be adequate, with unrestricted cash exceeding short-term debt, even if free operating cash flow turns further negative. Given the long maturity of the prospective bond, upcoming short-term maturities are likely to be manageable for the foreseeable future.

Senior unsecured debt

The rated entity plans to issue a HUF 15bn senior unsecured corporate bond under the MNB Bond Funding for Growth Scheme. The planned bond has a 3.0% coupon and is amortising after 5 years with a tenor until 2030. Proceeds from the bond are earmarked for the acquisition and refurbishment of a multifunctional shopping centre and for a green-field logistics development project in western Hungary.

Scope’s recovery analysis is based on a hypothetical default scenario occurring at year-end 2021, which assumes an outstanding senior unsecured bond debt of HUF 15bn in addition to the existing debt positions. An ‘average recovery’ is expected for the company’s unsecured debt, resulting in a B+ rating for this debt class (the same as the issuer rating).

Outlook

The Outlook for WHB is Stable and incorporates Scope’s view of the high transformation risk that the company is exposed to in 2020 when government contracts are executed and should be replaced by market contracts not known of as of today. Thus, a strong decline in Scope-adjusted EBITDA is anticipated in 2021 to HUF 2.7bn, leading to weakening credit metrics, with SaD to Scope-adjusted EBITDA of around 3x. Furthermore, the Outlook incorporates a successful placement of a HUF 15bn bond in H1 2020 to finance investments into two projects, namely the acquisition and refurbishment of a multifunction complex as well as the development of a green-field logistics facility, both in western Hungary. Both projects should benefit WHB’s recurring EBITDA in the medium term. Additionally, Scope expects dividend payouts to be in line with the current covenant of a maximum 50% of operational net income.

Rating-change drivers

A positive rating action is remote in Scope’s view but may be warranted if the company can increase visibility on revenues beyond 2020, helping to keep SaD to Scope-adjusted EBITDA below 2.5x on a sustained basis. This could be driven by, for example, i) an improving order backlog, benefitting from a higher granularity of customers and more complex projects extending the respective execution periods; or ii) a successful revamp of the multifunctional complex that supports cash flow beyond Scope’s current expectations.
A negative rating action could occur if SaD to Scope-adjusted EBITDA increases to above 3.5x on a sustained basis or liquidity were to worsen. An increase in leverage could be triggered by either i) an adverse operational development with reduced profitability and cash flows; or ii) more aggressive dividend payouts than currently allowed given the issuer’s loan covenants. Liquidity could worsen if, e.g. i) customers delay payments significantly; or ii) the company becomes exposed to the non-recoverable cost overruns of its projects.

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

Methodology
The methodologies used for this rating and/or rating outlook (Corporate Rating Methodology; Rating Methodology: European Construction Corporates) are 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.

Solicitation, key sources and quality of information
The rating was not requested by the rated entity or its agents. The rated entity and/or its agents participated in the rating process. Scope had access to accounts, management and/or other relevant internal documents for the rated entity or related third party.
The following substantially material sources of information were used to prepare the credit rating: public domain, the rated entity, the rated entities' agents, 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. Following that review, the rating was amended before being issued.

Regulatory disclosures
This credit rating and/or rating outlook is issued by Scope Ratings GmbH.
Lead analyst Thomas Faeh, Executive Director
Person responsible for approval of the rating: Philipp Wass, Executive Director
The ratings/outlooks were first released by Scope on 28 January 2020.

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
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