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Rating action

Scope Ratings GmbH (Scope) has today assigned a first-time issuer rating of B+/Stable to Bayer Construct Zrt. A first-time rating of B+ was also assigned to the company’s senior unsecured debt.

Rating rationale

The rating for Bayer Construct, a manufacturer-developer-designer-contractor-sales platform, benefits from a relatively high level of vertical integration, although its main activities are currently focussed on construction (60% of 2020’s EBITDA based on pro-forma consolidated results). Bayer Construct intends to keep its EBITDA contribution from non-construction activity at around 40% going forward, with the main contributor after construction being real estate development (planned EBITDA contribution of between 10%-15% up to 2023). A breadth of activities helps to limit cash flow volatility by benefitting from different underlying demand patterns. Moreover, it leads to profitability levels, as measured by the company’s Scope-adjusted EBITDA margin, above those of peers. These are forecasted to stay between 15%-20% (2020: 18% based on pro-forma consolidated results). The creation of a real estate development arm (Bayer Property Zrt.) is expected to increase visibility on the Hungarian market. It should also support total output growth in the short term, as Bayer Construct intends to act as a general contractor for its own projects.

However, the company’s sole exposure to Hungarian construction and its small size lead to relatively high customer concentration (the ten largest projects account for 88% of Bayer Construct’s backlog as at end-June 2021; approximately 50% are from contracts with affiliates). This leaves cash flow vulnerable and earnings visibility limited, especially beyond 2022, as the main part of the company’s backlog (equal to less than two years of 2020 revenues) will be executed in the next 12 to 18 months.

The financial risk profile (assessed at B+) is mainly supported by the company’s debt protection, with Scope-adjusted interest cover at between 7x-10x (2020: 9x), a level seen as sufficient to enable Bayer Construct to service interest payments, even providing some headroom to cover for potential volatility in cash flow driven by high customer concentration.

Still, the pursuit of growth starting in 2019 left a mark on the company’s indebtedness, which climbed to Scope-adjusted debt (SaD) of HUF 42bn as at YE 2020, a twofold increase from 2019. Scope anticipates SaD to grow further to around HUF 60bn at YE 2021, driven by negative Scope-adjusted free operating cash flow due to capital expenditure of HUF 15bn, as well as a negative change in working capital of HUF 9bn, both mainly driven by the company’s own projects. As a result, leverage increased considerably after 2019 (2020: 6.2x SaD/EBITDA; 14% Scope-adjusted funds from operations/SaD, both based on pro-forma consolidated accounts) and is anticipated to stay at elevated levels going forward. While the company is expected to show some improvement in leverage in 2021 and 2022 versus 2020, Scope lacks visibility as regards future business prospects beyond 2022. Thus, leverage is expected to be volatile, with SaD/EBITDA broadly between 4x-6x and Scope-adjusted funds from operations/SaD between 15% and 30% in the coming years. The relatively high leverage forecasted points to the issuer’s limited access to external financing needed to tackle any unforeseen operational events or severe declines in the market value of its real estate assets (especially the Zugló City Centre project that is due to be sold to institutional investors in several tranches in the coming years).

Liquidity has been below par during the last couple years, mainly driven by consistently high short-term debt, and negative Scope-adjusted free operating cash flow, driven by a build-up of working capital. However, the agency considers Bayer Construct’s liquidity to be adequate as short-term debt repayments for 2021 (HUF 2.2bn) are fully covered by available sources, namely cash (HUF 1.0bn as at YE 2020) and available credit lines (HUF 14.0bn as at YE 2020). Forecasted negative Scope-adjusted free operating cash flow of HUF 14.7bn for FY 2021, mainly driven by the company’s capex programme (HUF 15bn for a factory for bathroom pods and HUF 10bn for a new headquarters and logistics centre, with spending to be spread across 2021 and 2022), is to be covered by available credit lines as well as additional debt to be issued. Scope believes the latter to be possible as proven in the past by the company’s ability to access to external financing to cover negative free operating cash flow. In addition, liquidity is supported by management’s decision to not plan any relevant dividend pay-outs – up to HUF 1bn per year – for subsequent years, with the aim of safeguarding the working capital and cash reserve needed for stable operations. However, Scope highlights the issuer’s continuous need to access external financing going forward to pursue further growth.

Outlook and rating-change drivers

The Outlook is Stable and reflects Scope’s view that leverage on a consolidated basis remains at SaD/EBITDA of broadly between 4x-6x (averaging 4.7x in the three years to 2023) and Scope-adjusted funds from operations/SaD of between 15% and 30% (21%). However, credit metrics will remain volatile due to a concentrated backlog and an uneven project pipeline. The Stable Outlook also reflects a successful HUF 27.4bn bond issuance under the Hungarian National Bank’s Bond Funding for Growth Scheme.

A positive rating action is seen to be remote but may be warranted if the company manages to keep leverage, as measured by SaD/Scope-adjusted EBITDA, below 4x (consolidated level) on a sustained basis. This could be achieved with a successful ramp-up of construction works for the company’s own projects beyond 2022, fee income (success fees, service revenues), or exit proceeds from its own projects that exceed Scope’s expectations and are then used to prepay debt.

A negative rating action could occur if liquidity were to worsen or SaD/EBITDA were to increase towards 6x (consolidated). Liquidity could worsen, for example, if: i) customers delay payments significantly, ii) the company becomes exposed to non-recoverable cost overruns and/or delays in its projects or iii) the company does not manage to issue the HUF 27.4bn bond. Leverage might increase if the company’s focus on its own projects does not pay off, with limited end-investor demand leading to delays or cancelled projects.

Long-term and short-term debt ratings

Bayer Construct plans to issue a HUF 27.4bn senior unsecured corporate bond. Proceeds from the bond are earmarked for refinancing of working capital loans with the Hungarian Development Bank. The bond’s tenor is ten years, and it will amortise from year five to year nine in equal instalments with a 50% balloon at maturity. The coupon will be fixed and payable on an annual basis.

Scope’s recovery analysis assumes a potential default in 2022 and is based on Bayer Construct’s liquidation value, as the agency assumes the sum of the company’s parts to be of a higher value than the whole group. Scope’s view is driven by the relatively high level of vertical integration represented by individual companies that form part of the group. Based on the recovery analysis, Scope expects an ‘average recovery’ for the company’s senior unsecured debt, resulting in a B+ rating for this debt class (in line with that of the issuer).

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, 6 July 2021; Rating Methodology: European Construction Corporates, 15 January 2021), 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 Rated Entity and/or its Related Third Parties participated in the Credit Rating process.
The following substantially material sources of information were used to prepare the Credit Ratings: public domain, the Rated Entity, the Rated Entities’ Related Third Parties, third parties 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 Outlook are UK-endorsed
Lead analyst: Philipp Wass, Executive Director
Person responsible for approval of the Credit Ratings: Henrik Blymke, Managing Director
The Credit Ratings/Outlook were first released by Scope Ratings on 31 August 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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