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 Hungarian turkey producer and processor Gallfood Kft. as well as a B+ senior unsecured debt rating.

Rating rationale

Gallfood’s issuer rating reflects Scope’s business risk assessment of B+. This is supported by the company’s good market position as the second largest turkey producer and turkey meat processor in Hungary and the Central Eastern European area. Based on about 20,000 tons of meat processed, Gallfood and its related group companies (which are fully owned by Hungarian businessman Otto Kövesi) control about 20% of the total domestic market. The rating is also supported by Gallfood’s good geographical diversification, as only about 40% of total sales are generated by domestic customers. Gallfood delivers its products to a number of international wholesalers, meat processors and supermarket chains, which account for the remainder of sales. The latter provide significant growth potential in Scope’s view, following new management’s strategy to focus more on the consumer segment. This will mean a move away from the company’s currently high exposure to the low-margin, cyclical B2B segment (wholesalers and meat processors), which absorbed about two-thirds of 2019 sales.

Gallfood’s business risk profile is held back by comparatively low profitability. In 2019, EBITDA was at only 3.4% of sales, mainly reflecting the unfavourable business mix described above. The coronavirus crisis only affected Gallfood to a minor extent in the first half of 2020, namely within the B2B division and specifically in the Horeca segment, as most facilities were closed from March to May. Scope expects Gallfood’s revenues to catch up in the second half of 2020 and to perform as planned overall. This is based on the relaxation of crisis-related restrictions and the fact that the B2C division continued to perform as normal during the first six months of the current year. Management believes that it can generate significant growth in the full year 2020, based on its strategy to create additional B2C business with international supermarkets, even in the short term. Most of the proceeds of the planned HUF 3bn bond under the Hungarian National Bank’s Bond Funding for Growth Scheme are earmarked for the expansion and modernisation of production and logistics facilities, mainly to increase B2C business and group profitability.

Gallfood’s financial risk profile (rated B) is constrained by the company’s low and historically volatile operating cash flow levels and substantially increasing debt from 2020. This is due to management’s plan to issue a HUF 3bn bond as part of the Hungarian Central Bank’s Bond Funding for Growth Scheme. Scope expects Scope-adjusted debt (SaD) to increase by about HUF 2.5bn in 2020, compared to end-2019 levels, stripping out available cash elements. Most of the cash proceeds – together with about HUF 2bn in government grants to be received over three years, starting in 2020 – will be used to modernise and enlarge production facilities, which will be much more geared towards the B2C segment. This will significantly depress free cash generation via substantially increased capital expenditure up to 2022. At the same time, the hoped-for substantial increase in EBITDA and operating cash flow should materialise, albeit with a certain time lag.

Given the execution risk linked to Gallfood’s business transformation, which should eventually bring EBITDA levels to new heights, Scope based its assessment on 2021 with an EBITDA margin of 4.7%, which appears possible from today’s perspective. In this scenario, the company would be able to improve leverage, as expressed by SaD/EBITDA, to about 4.5x (from about 10x in 2020). While this would still be equivalent to the high single B category, it would nevertheless mean a very fast deleveraging compared to expected year-end 2020 levels, mainly supported by a significant rise in operating profit (helped by the low base in 2020). Free operating cash flow/SaD would still remain in negative territory in 2021, and slightly so in the year after, according to Scope’s base case.

Scope believes Gallfood’s liquidity is adequate. This is based on annual liquidity (on balance sheet cash plus free committed bank lines) of about HUF 1-2bn and short-term debt maturities of HUF 1-1.5bn. Coverage over the next few years is not ample but sufficient in Scope’s view. It will not be supported by negative free operating cash flows until 2022. Scope does not expect the current coronavirus crisis to have a meaningful impact on credit metrics in 2020, based on Gallfood’s business risk profile.

Outlook and rating-change drivers

The Outlook is Stable, reflecting Scope’s expectation of a significant improvement in profitability from 2021 on. It also includes Scope’s assumption of a successful bond placement in 2020 (volume: up to HUF 3bn), which is mainly earmarked for the modernisation and expansion of production facilities.

A positive rating action could be warranted by initial evidence of management’s success in markedly improving Gallfood’s low profitability to levels of above 5% (EBITDA margin) on a sustained basis. It could also be a consequence of more rapid deleveraging, expressed by SaD/EBITDA of below 4x on a sustained basis. This could be achieved via a faster than expected business transformation with greater B2C exposure.

A negative rating action could be required if SaD/EBITDA does not improve significantly from the very high levels expected for 2020, namely if SaD/EBITDA stays above 4.5x on a sustained basis. This could, in particular, occur if the company does not manage to improve EBITDA margins substantially, thereby improving free cash flow generation.

Long-term and short-term debt ratings

Scope has assigned a B+ debt rating to senior unsecured debt issued by Gallfood Kft. The debt category rating reflects the ranking status of the debt, ranking below a significant amount of HUF 2.2bn senior secured bank debt as well as HUF 2bn in state subsidies to be received. Scope expects an ‘average’ recovery (30%-50%) for outstanding senior unsecured debt in a hypothetical default scenario based on year-end 2021 default, i.e. a scenario in which the company has issued the new senior unsecured bond and proceeds have been used as planned. Scope’s recovery analysis is based on significant asset haircuts reflecting about HUF 4.2bn of asset pledges, mainly for the HUF 1.5bn Exim loan, and indicates an average recovery for senior unsecured debt. This translates into no uplift for the instrument relative to the issuer rating. Scope’s assessment assumes a liquidation value of about HUF 5.6bn, after accounting for 10% of liquidation costs. Some of the existing asset pledges for the over-collateralised Exim loan are likely to be released due to the refinancing of the loan at the end of the year. Scope’s calculation also reflects the expected HUF 2bn in state subsidies as senior secured debt, ranking ahead of the bond in a default scenario.

Gallfood plans to issue a HUF 3bn senior unsecured corporate bond under the MNB Bond Funding for Growth Scheme. The planned bond with an amortising loan structure (20/20/60) has a maturity of eight years and benefits from additional guarantees from other group companies owned by Mr Otto Koevesi (namely Koevesi Ltd, Pa-Tak Ltd, Tap-Loevoe Ltd and Tak Ltd). Proceeds from the bond are earmarked for the financing of new group investments.

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 (Corporate Ratings, dated 26 February 2020) is 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: issuer, agents of the issuer, public domain 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 not 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 Olaf Toelke, Managing Director
Person responsible for approval of the rating: Henrik Blymke, Managing Director
The ratings/outlooks were first released by Scope on 21 August 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
© 2020 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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