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Rating action

Scope Ratings GmbH (Scope) has today affirmed the BB- rating of Bonafarm Zrt. and changed the Outlook to Positive from Stable. Senior unsecured debt has also been affirmed at BB-.

Rating rationale

The Positive Outlook reflects the already improved profitability, which resulted in a lower leverage than previously anticipated. The lower leverage is also due to the delay in contracting the once-in-a-lifetime capex programme for Bonafarm Zrt’s wholly owned subsidiary Pick Szeged Zrt. With construction costs soaring of late, the final budget may change, though this is mitigated by the increased government subsidies.

The credit rating mainly reflects the leading positions in Hungary’s meat and milk processing industries of Bonafarm Zrt. and its consolidated subsidiaries (Bonafarm Group). This is attributed to: i) two of the group’s brands, PICK and Sole-Mizo, being among the most valued in Hungary; ii) its high vertical integration for its agriculture assets (crops, animal feed, livestock, wine); iii) solid profitability (EBITDA margin of 7.5% in 2020); and iv) continuously strong parent support. The rating is held back by delayed modernisation of acquired production plants across several locations. The low automation in the plants has not only resulted in headcount being double that of main competitors but also made operating expenses and EBITDA more vulnerable to market prices, especially the recently increasing animal feed price, the fluctuating ZMP index (German slaughter pigs index), the milk price and increasing labour costs. This vulnerability is compounded by the delayed execution of investments after the bond issuance in 2019 in the context of soaring construction prices in Hungary.

The issuer rating also reflects a one-notch upgrade for parent support, reinforced by the recent equity increase for Pick Szeged’s capital expenditure. Bonafarm Group is fully owned by billionaire Dr Sándor Csányi through holding company Bonitás 2002 Zrt. Dr Csányi has supported the group significantly with equity and owner loans since its inception.

Bonafarm Group’s industry rating remains at A-, with a portfolio consisting one-third of agribusiness and two-thirds of non-durable consumer products. Bonafarm Group is the largest fresh food producer in Hungary and operates in a controlled vertical integration model, from crop production to a large-scale animal farming business. In the agricultural and food industries, its market leadership in meat and milk processing gives it pricing power in Hungary. However, Scope’s assessment of market share is held back by the group’s production output, which is much lower than European competitors’, although the medium-term target of expanding its regional presence may lead to an improvement.

Customer diversification is broad. Meat and milk products of the group are present in all Hungarian retail chains. In addition, export markets, mainly to Germany and Romania, made up more than 20% of group revenues (with HUF 59bn out of HUF 247bn) in 2020. Third-party suppliers are well diversified. Strategic partnerships are strong with the group owner’s other assets such as MCS Slaughterhouse, one of largest such establishments in the region. However, the product offering, while improving, remains limited. Processed meats focus on salami (around 50% of Pick Szeged’s revenues), with a low share of high-protein products such as premium ham. The milk processing segment mainly relates to milk-fat-based products and lacks the protein-based (whey/added milk protein) and plant-based milk products offered by competitors.

The financial risk profile is based on the reasonable leverage metrics, with a Scope-adjusted debt (SaD)/EBITDA ratio projected below 3x despite the ongoing capex and potential for M&A. The good projected leverage is supported by prior deleveraging to 2.5x as of 2020, by way of the 62% EBITDA increase since 2017 (to HUF 18.4bn from HUF 11.3bn) due to increases in sales by 25% and in the EBITDA margin to 7.5% from 5.7%. EBITDA/interest cover has always been strong at Bonafarm Group. Bonafarm Group also receives interest from affiliates and related parties to the extent that interest received may exceed interest payable in 2021. The financing structure includes low amortisation and high balloon or bullet facilities, which allow a good debt service coverage ratio. The issued HUF 27bn bond is repayable only at maturity in 2029, which provides great cash flow headroom. Funds from operations/SaD has been well above 30% since 2019 due to the improving EBITDA margin and good working capital management.

The main rating constraint, however, is free operating cash flow/SaD, which has been as low as -50% in 2017, due to the acquisition of large production sites in need of modernisation and efficiency and capacity expansion. Scope expects very negative values once the Pick Szeged brownfield investment kicks in.

Since the plans for the Pick Szeged facility were made and the related bond was issued in 2019, construction costs in Hungary have soared. The Hungarian Investment Promotion Agency recently granted a HUF 10.6bn non-refundable investment subsidy to the HUF 39bn investment budget; the previous plan calculated conservatively only a HUF 2bn subsidy, leaving room for cost overruns.

Liquidity is improving due to the small chunks of short-term debt and increasing cash flow. Bonafarm Zrt. has a HUF 7.3bn overdraft facility, which is currently mainly unused, and a small factoring facility at fully consolidated subsidiary Sole-Mizo Co., also unused. However, due to the short tenor of these facilities, Scope has excluded them from the liquidity calculation.

Outlook and rating-change drivers

The Outlook was changed to Positive from Stable reflecting the already improved profitability, which resulted in a lower leverage than previously anticipated. Scope may expect better future metrics subject to uncertain investment budget.

A positive rating action is possible upon i) a free operating cash flow/SaD sustained at more than 5% as a result of the executed investment strategy and production ramp-up; and/or ii) the contracting of Pick Szeged’s investments within budget despite the soaring construction costs.

A negative rating action could be warranted by i) a funds from operations/SaD sustained below 15%; and/or ii) a SaD/EBITDA sustained above 4x. The latter could be caused by more debt taken on due to: i) higher construction costs; ii) a slow production ramp-up; iii) a significant change in market input prices; and/or iv) weaker pricing power in main segments due to further delays in modernisation that result in shrinking market shares and/or mergers and acquisitions.

Long-term and short-term debt ratings

Scope has affirmed the BB- debt rating on senior unsecured debt issued by Bonafarm Group. The debt category rating reflects the ranking of debt issued by wholly owned subsidiary Pick Szeged Zrt., which is below the HUF 32bn senior secured bank debt and Bonafarm Group’s unfunded commitments of HUF 8.3bn. Scope expects an ‘average’ recovery for outstanding senior unsecured debt in a hypothetical default scenario in 2023. 

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/or Outlook, (Corporate Rating Methodology, 6 July 2021; Rating Methodology: Consumer Products, 30 September 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 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, 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/or Outlook and the principal grounds on which the Credit Ratings and/or Outlook are based. Following that review, the Credit Ratings were not amended before being issued.

Regulatory disclosures
These Credit Ratings and/or 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: Barna Szabolcs Gáspár, Associate Director
Person responsible for approval of the Credit Ratings: Henrik Blymke, Managing Director
The Credit Ratings/Outlook were first released by Scope Ratings on 6 September 2019. The Credit Ratings/Outlook were last updated on 21 September 2020.

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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