Rating action

Scope Ratings GmbH (Scope) has today assigned a first-time issuer rating of BB-/Stable to Hungarian public transportation services provider and vehicle manufacturer ITK Holding Zrt. (ITK). Senior unsecured debt is also rated BB-.

Rating rationale

The BB- rating on ITK incorporates a three-notch uplift for strong support from majority shareholder MOL Group, which adds financial stability, risk management and professional backing to the company.

ITK’s business risk profile (assessed at B+) is underpinned by a stable public transportation services business. The company has four long-term (over 10-year) contracts for the provision of bus services in Budapest, Debrecen and Kecskemet, with a high certainty of cost recovery over the term of the contracts. ITK also benefits from a relatively modern bus fleet. Its smaller business services operations also have a long track record of stable margins. This is balanced by higher risk in its newly established vehicle manufacturing business, which started production in 2019. This business benefits from a partnership with Daimler, whereby all vehicles (buses and vans built on Mercedes-Benz base vehicle/product) produced by ITK carry the Mercedes-Benz brand and the two firms cooperate in the production of new vehicle models. ITK produces vehicles to order, most of which are lower value-added modifications to near-ready vehicles, although a growing share of production comprises ‘bodybuilding’ on Mercedes-Benz drivable chassis. The key to success will be the ability to ramp up the production volume and to increase the share of higher value-added units. Profitability is strong and stable in business and transportation services, but vehicle manufacturing has been operating at a loss due to start-up costs and sub-optimal production volumes. Scope expects profitability to improve gradually over the next three years, and for the entire group to generate a positive net profit over the 2021-2023 period. Supplier and customer concentration is high, but most are well-established industry players with high credit standing.

ITK’s financial risk profile (assessed at B-) reflects very high leverage, measured by Scope-adjusted debt/EBITDA estimated at 11x at the end of 2020. The high leverage stems from significant investments of around HUF 11bn in PPE, working capital for vehicle manufacturing operations and the bus services fleet in 2019 and 2020, far exceeding operating cash flow generation of about HUF 1.5bn. Scope expects sizeable investments in the bus fleet to continue in 2021-2023 of around HUF 9.2bn. With a ramp up of vehicle production and growth in revenues from services operations, Scope expects the company to reach free operating cash flow breakeven in 2024. Scope understands that shareholders do not expect to extract dividends from the company in this period, but will prioritise growth. The company is looking to issue a HUF 20bn bond under the Hungarian National Bank’s Bond Funding for Growth Scheme. This will refinance most of its existing debt and provide it with a long-dated debt maturity, matching the long-term cash flow profile of its public transportation services business.

ITK had HUF 1.8bn of liquid assets and HUF 3.9bn of short-term debt at the end of 2020. Scope considers ITK’s liquidity position to be adequate however, due to limited short-term debt outstanding after the planned bond issuance and financial support from MOL Group for planned projects and temporary liquidity needs. The company aims to finance working capital for vehicle manufacturing and fleet expansion from bank loans going forward. In addition to funding support, MOL Group also provides support in risk management and IT, resulting in a three-notch uplift to the ratings on ITK. Scope understands that the planned bond indenture will include a change of control provision.

Rating-change drivers

The Stable Outlook reflects the stability of revenues and earnings from long-term public transportation contracts, and the assumption that ITK successfully places the HUF20 billion bond to strengthen its liquidity position and that financial support from MOL Group remains available, if needed. Scope expects the company to gradually improve its profitability and move towards free operating cash flow neutrality over the next three years.

A negative rating action is possible if free operating cash flow remains negative and the company is unable to reduce leverage (Scope-adjusted debt/EBITDA). This could result from a failure to increase sales and production of higher value-added vehicles. MOL Group exiting the joint venture or not extending financial support when needed could also trigger a downgrade.

Stronger than anticipated growth in sales and/or margins, resulting in leverage sustainably below 6x (12x in 2019), could trigger an upgrade. Closer integration with MOL Group could also warrant a higher rating.

Long-term and short-term debt ratings

Scope rates senior unsecured debt in line with the issuer rating, based on pari passu ranking and a negative pledge provision in the planned bond documentation, limiting the extent of secured debt in the capital structure.

Scope’s base case financial forecast assumes the successful placement of a HUF 20bn senior unsecured bond with a fixed annual coupon under the Hungarian National Bank’s Bond Funding for Growth Scheme. Scope expects the bond to have a 10-year tenor, with amortisation of 10% per annum in 2027 and 2028, 20% per annum in 2029 and 2030 and a 40% bullet maturity in 2031.

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

Methodology
The methodologies) used for these Credit Ratings and Outlook, (Corporate Rating Methodology, 26 February 2020; Rating Methodology: European Automotive and Commercial Vehicle Manufacturers, 14 February 2020), are available on https://www.scoperatings.com/#!methodology/list.
Scope Ratings GmbH and Scope Ratings UK Limited apply the same methodologies/models and key rating assumptions for their credit rating services, while Scope Hamburg GmbH’s methodologies/models and key rating assumptions are different from those of Scope Ratings GmbH and Scope Ratings UK Limited.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other 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 Credit Rating performance report at https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. 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 Ratings’ definitions of default and Credit 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 factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://www.scoperatings.com/#!methodology/list.
The Outlook indicates the most likely direction of the Credit Ratings if the Credit Ratings were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The Credit Ratings were not requested by the Rated Entity or its Related Third Parties. The Credit Rating process was conducted:
With the 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(s): public domain, the Rated Entity and Scope Ratings’ internal sources.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting the Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and Outlook and the principal grounds on which the Credit Ratings and Outlook are based. Following that review, the Credit Ratings were not amended before being issued.

Regulatory disclosures
These Credit Ratings and Outlook are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and/or Outlook are UK-endorsed
Lead analyst: Tommy Träsk, Director
Person responsible for approval of the Credit Ratings: Olaf Tölke, Managing Director
The final Credit Ratings/Outlook were first released by Scope Ratings on 14 April 2021.

Potential conflicts
See www.scoperatings.com under Governance & Policies/EU Regulation/Disclosures 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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