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Rating action

Scope Ratings has today upgraded its issuer rating on German consumer goods direct-selling company LR Global Holding GmbH (LR) to BB-/Stable. The senior secured debt category rating of BB- has also been upgraded.

Rating rationale

The rating action reflects a combination of three recent, favourable developments, with a significant impact on credit metrics in Scope’s new base case scenario. Firstly, business conditions in the three months of August, September and October proved significantly stronger than expected by the rating agency. The additional volume is likely to have a considerable effect on EBITDA generation in 2020, which is now projected at EUR 35m on an adjusted basis, compared to Scope’s expectation of EUR 31m before. Secondly, the expected bond volume is now lower at EUR 125m, compared to EUR 140m previously, owing to stronger assumed cash generation. And lastly, the EU Commission recently decided to restrict the use of hydroxyanthracenes in food and food supplements to certain thresholds which is by far complied with by LR’s aloe vera products.

All of this is positive from a ratings perspective, as it results in a marked improvement in key credit metrics as reflected in Scope’s base case. In particular, the coverage of net interest by EBITDA is likely to improve to about 3.5x in 2021 and 2022. Given Scope’s previous ratio guideline of “significantly above 3x” for a positive rating action on the former B+ issuer rating, the agency is upgrading LR’s issuer rating accordingly.

The issuer rating reflects Scope’s business risk assessment, supported by the company’s good position as a manufacturer of premium non-durable consumer goods with health and lifestyle-related attributes. The largely inhouse-produced goods are distributed in a direct-selling concept. The risks posed by LR’s small absolute size (about EUR 270m in sales estimated for 2020) are, in Scope’s view, effectively mitigated by a favourable positioning both on the product side and with regard to its addressable market of direct-selling. Additional rating support is provided by LR’s comparatively good operating margins, although Scope believes the company’s diversification is a drag on the ratings.

The issuer’s financial risk profile benefits from its comparatively good cash-interest coverage in a leverage buyout (LBO) context as well as its ability to generate sustained free cash flow. However, leverage and some credit metrics volatility in the past are constraints.

The business risk profile (rated BB-) benefits from high monthly revenue growth since 2019 of at least 20% that has even accelerated during the coronavirus crisis. In Scope’s view, this is due to the long-term customer trend for increased healthcare awareness and sustainable, quality-oriented fast-moving consumer goods with perceived health and nutritional benefits. LR almost solely relies on a direct-selling concept involving a self-employed sales force with entrepreneurial incentivisation. Revenue generation within this referral model, without a physical shop network, thus depends on the sales force’s motivation and drive towards affluent and less price-sensitive consumers. An additional support for the business risk profile is the company’s comparatively good operating margins and high operating leverage. In 2020, Scope expects LR to generate an EBITDA margin of more than 12%, a solid level relative to retailing peers. With the exception of 2018 (an outlier for several reasons), profitability ranged between 6% and 12%, a good level for a retailer, although at a relatively high volatility. Since 2018, the operating margin has continued to increase, fuelled by significant sales growth. While sustainability is a valid question in the context of the coronavirus, which is positive for health-related products, LR’s sales have grown 20% every month since October 2019 – thus already well in advance of the current crisis. The ability to achieve both significant sales growth and strong margin expansion is a function of the company’s comparatively low fixed cost base as the whole sales force is not employed by LR. Scope believes diversification is not a support to the ratings as there is exposure to a niche market and a relatively high concentration on certain product groups. Especially the aloe vera products generate about 40% of total sales, with an increasing trend (just about 33% in 2016). This is partly mitigated, in Scope’s view, by good customer and geographic diversification as the company is active in about 28 mainly European countries in total, comparing well to similarly sized peers.

LR’s financial risk profile (rated BB-) is supported by the comfortable cash coverage of about 3.5x, estimated to remain at that level even after the placement of the high-yield EUR 140m bond later in 2020. (Scope’s financial risk assessments of LBO companies with sizeable shareholder loans, like LR, use cash coverage as it correctly reflects the economic consequence of financial debt, whereas leverage-based credit metrics in an LBO context are strongly distorted by large shareholder loans). An additional support to the financial risk profile is the issuer’s ability to generate free operating cash flows, due to its very low maintenance capital expenditure and well-managed working capital. The financial risk profile is constrained by some historical volatility in operating performance, which appears to relate only to conditions in Turkey in 2018, which was a much more important country to LR at the time. During recent years, sales have rebounded strongly in line with significant EBITDA growth – additionally confirmed by 2020 interim results – while gross financial debt has been scaled back gradually.

Scope believes that LR’s liquidity is adequate as it benefits from solid cash buffer of around EUR 30m in 2020-2021, positive free operating cash flow and immaterial short-term debt.

Outlook and rating-change drivers

The Outlook is Stable, reflecting Scope’s expectation of cash-interest cover remaining at above 3x after the bond issuance.

A positive rating action could be warranted by a demonstration that the company can continue to grow sales significantly even after the Covid-19 crisis, allowing it to benefit from critical size. In addition, cash-interest cover of above 4x on a sustained basis could be supportive, e.g. driven by the continued acceleration of sales and operating performance after Covid-19 and significantly diminished churn rates of sales channels.

A negative rating action may be possible if cash-interest cover falls below 2.5x on a sustained basis, e.g. resulting from a deterioration in operating performance or the further recapitalisation of shareholder loans.

Long-term debt ratings

LR plans to issue a EUR 125m senior secured corporate bond with a four-year maturity later in 2020. Bond proceeds are earmarked for the refinancing of existing bank loans (EUR 94m) and the partial repayment of the shareholder loan (by EUR 41m) granted in the context of the LBO in 2014.

Scope set the bond’s hypothetical default year in 2022, simulating a scenario in which the company had issued the new senior secured bond and proceeds had been used according to plan. The recovery analysis was based on a distressed enterprise value of EUR 61m. The recovery expectation translates into the same rating as the issuer rating. 

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 Rating Methodology, 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 rated entity participated in the rating process.
The following substantially material sources of information were used to prepare the credit rating: the rated entity, the rated entities' agents, 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 Tölke, Managing Director
Person responsible for approval of the rating: Werner Stäblein, Executive Director
The ratings/outlooks were first released by Scope on 23 October 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.
Scope Ratings GmbH, Lennéstraße 5, 10785 Berlin, District Court for Berlin (Charlottenburg) HRB 192993 B, Managing Director: Guillaume Jolivet.