The latest information on the rating, including rating reports and related methodologies, is available on this LINK.

Rating action

Scope Ratings has today assigned a first-time issuer rating of B/Stable to D.V.M. Construction Kft (DVM). A first-time rating of B+ was also assigned to the company’s senior unsecured debt.

Rating rationale

The B issuer rating is driven by DVM’s good domestic network, including established and long-standing relations with its main clients. The rating is further supported by the company’s good vertical integration that includes a wide range of services in the different stages of the construction chain (design, project management, contracting, base building, and fit-out services).

The rating is mainly constrained by the company’s small scale in both a European and Hungarian context, which weakens its ability to mitigate economic cycles. Weak diversification is a further constraint, namely i) a lack of geographical diversification; ii) a high reliance on one segment (building activities); iii) a strong reliance on some key customers; and iv) limited cash flow visibility, with a concentrated and short-term backlog. A further rating constraint is the anticipated increase in leverage via the company’s expansion plans, involving the acquisition of two subcontractors and participation in early-stage development projects.

DVM’s liquidity is adequate from 2020 on. Liquidity benefits from a back-loaded debt maturity profile, with no significant amount due in the coming years. The company’s low short-term debt levels are likely to be maintained going forward and to be sufficiently covered by available financing sources. The company has a HUF 500m loan with Erste Bank, though this was fully drawn as of March 2020.

Outlook and rating-change drivers

The Outlook is Stable and incorporates our view that credit metrics will deteriorate as a consequence of the future negative Scope-adjusted free operating cash flow (SaFOCF), triggered by company’s expansion plans, namely the acquisition of two subcontractors and co-development projects for a total of HUF 6bn. Negative SaFOCF is anticipated to be financed with debt, one source being the prospective HUF 8bn bond under the MNB Bond Funding for Growth Scheme (HUF 6bn earmarked for expansion plans, and the remaining HUF 2bn for working capital financing). This will increase leverage, with Scope-adjusted debt (SaD) to Scope-adjusted EBITDA (SaEBITDA) jumping above 4.5x and Scope-adjusted funds from operations (SaFFO) to SaD falling to below 15%, by YE 2020.

The Outlook also incorporates our view that DVM will consolidate its two main business lines, base building and fit-out services, starting in 2020. These activities are currently divided and provided by two DVM group companies (DVM Fővállalkozás Kft and DVM construction Kft.). We expect at least all revenues from base buildings projects and fit-out services to be cashed out to the rated issuer, ensuring it can pay obligations on time, such as debt service and operating expenditure. In addition, DVM Fővállalkozás Kft is the second range guarantor in the Unicredit loan used to finance the development of Szervita Square, while Szervita Square, with a total estimated cost of EUR 70m (asset market value of EUR 38m as of March 2020), is the first range guarantee. The probability that the guarantee will be called upon is remote.

A positive rating action is seen to be remote but may be warranted if the company can keep Scope-adjusted debt (SaD) to EBITDA below 3.5x on a sustained basis.

A negative rating action could occur if projects suffered significant delays or cost overruns, or if liquidity worsened. The latter could happen if, for example, i) customers delay payments significantly; or ii) the company becomes exposed to the non-recoverable cost overruns of its projects.

Long-term and short-term debt ratings

The rated entity plans to issue a HUF 8bn senior unsecured corporate bond under the MNB Bond Funding for Growth Scheme. The planned bond has a 3% coupon with a tenor until 2030. Proceeds from the bond are earmarked for financing the acquisition of subcontractors (HUF 1bn), the acquisition of co-development early-stage projects (HUF 5bn) and working capital (HUF 2bn). The planned bond will be subject to the following covenants: i) no dividend payout in the first two business years following the bond issuance; from the third year, payout limited at 20% of the issuer’s annual profit after tax; and ii) Loan-to-value (LTV) ratio will not exceed more than 30% on aggregate for all co-development projects; or more than 50% LTV for each co-development project.

Our recovery analysis is based on a hypothetical default scenario in 2021 and is based on DVM’s liquidation value, considering its planned investment (acquisition of co-development projects and subcontractors in the form of financial investments). For the recovery analysis, we assume all covenants are met and senior-ranked bank loans financing the co-development projects reach only a maximum LTV of 30%.

We expect an ‘above average’ recovery for DVM’s senior unsecured debt (HUF 8bn), allowing a one-notch uplift on the company’s issuer rating. We therefore assign a debt class rating of B+.

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(s) and/or rating outlook (Corporate Rating Methodology, 26 February 2020; Rating Methodology: European Construction Corporates, 17 January 2020) are available on https://www.scoperatings.com/#!methodology/list.
Information on the meaning of each rating category, including definitions of default and recoveries can be viewed in the “Rating Definitions - Credit Ratings and Ancillary Services” published on https://www.scoperatings.com/#!governance-and-policies/rating-scale. 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. Guidance and information on how Environmental, Social or Governance factors (ESG factor) are incorporated into the rating can be found in the respective sections of the methodologies or guidance documents provided on https://www.scoperatings.com/#!methodology/list.
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 rating process was conducted:
With 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 rating: public domain, the rated entity, third parties, agents of the rated entity 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, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0 .
Lead analyst Rigel Patricia Scheller, Director
Person responsible for approval of the rating: Olaf Tölke, Managing Director
The ratings/outlooks were first released by Scope on 26 May 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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