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Rating action

Scope Ratings GmbH (Scope) has affirmed the B+ issuer rating of Metál Hungária Holding Zrt. (MHH) with the Outlook revised to Positive from Stable. Concurrently, Scope has affirmed the senior unsecured debt rating at B+.

Rating rationale

Despite the impact of Covid-19 in 2020, MHH generated HUF 34bn in revenues (-3% YoY) and HUF 3.1bn in Scope-adjusted EBITDA (-9% YoY). Drivers of negative YoY growth were: i) developers’ postponement or cancellation of several large projects; and ii) the surge in material prices as the pandemic disrupted supply chains for raw materials.

Both revenues and EBITDA have grown strongly since late 2020, thanks to MHH’s access to larger-scale projects. Here, the company has benefitted from its long-term relationship with key customers as well as its ability to provide necessary capacities and a functioning supply chain for raw materials. This has allowed it to deliver projects in time and quality, thus stabilising its market share. Scope forecasts that the company’s top line will increase to above HUF 40bn in 2021 and 2022. This is based on: i) the order backlog of HUF 44bn as at end-July 2021, providing revenue visibility until YE 2022; and ii) the agency’s view that MHH will benefit from its market position to secure some of the larger projects currently up for tender with a total construction value of HUF 159bn.

The company’s heightened exposure to larger-scale projects has increased the customer concentration in its backlog (top three: 59% of backlog as at YE 2020 / + 22pp YoY). However, larger projects lead to higher payment certainty as these are mostly subject to a beneficial payment scheme enforced by Hungarian law. Furthermore, the company still executes 60-90 projects each year. Together with the typically longer duration of larger projects, Scope therefore believes that revenue diversification is comparatively stronger (the top three accounted for 29% of 2020’s revenues). Thus, MHH is well positioned to partially mitigate the impact of contract cancellation on its cash flow generation.

The Scope-adjusted EBITDA margin stood at 9% for 2020. Scope anticipates an increase in profitability to above 10% for 2021 and beyond. This improvement should mainly be driven by the implementation of a new corporate structure in 2021, which will significantly reduce operational expenses. Further support stems from cost savings enabled by investments in machinery, the company headquarters and a painting facility as well as the higher-margin real estate business (all contributing around HUF 0.4bn per year). MHH was also able to pass on most of its additional costs for ongoing contracts and significantly raised its construction fees for new projects to cover increased raw material prices.

Functioning supply chains for basic materials – key to MHH’s success in keeping market shares stable and gaining access to larger scale projects – came at the expense of weakening negotiation power with suppliers, who are now requesting a down payment when orders are placed. According to the company, it will need an additional HUF 4.2bn to HUF 4.9bn in working capital financing to fund the envisaged project pipeline and keep its competitive edge. This is likely to lead to negative Scope-adjusted free operating cash flow in 2021, although Scope sees this as a one-off effect.

In order to finance the HUF 4.2bn to HUF 4.9bn investment in working capital, MHH plans to issue a second senior unsecured corporate bond under the MNB Bond Funding for Growth Scheme in Q4 2021. The planned HUF 6.5bn bond’s tenor is 10 years, with HUF 406m in annual amortisation from the second year after its issuance (2023). The coupon will be fixed and payable on an annual basis. In addition to working capital financing, proceeds from the bond are earmarked for the refinancing of currently existing working capital facilities, the refinancing of 70% of the HUF 2.3bn loan for the Palazzo Dorottya property – the remainder will be repaid from cash available – as well as up to HUF 0.7bn for developing or purchasing equipment.

As anticipated by Scope, discretionary capital expenditure in 2020/21 financed with debt (a HUF 8.0bn bond under the MNB Bond Funding for Growth Scheme and a HUF 2.4bn secured bank loan) increased leverage. Scope-adjusted debt (SaD)/Scope-adjusted EBITDA was above 3x (2020: 3.2x) while Scope-adjusted funds from operations/SaD fell to below 30% (2020: 27%). The targeted debt-financed build-up of working capital will further increase SaD to HUF 16.5bn-17.5bn by YE 2021, from HUF 9.9bn as at YE 2020. However, Scope forecasts that leverage will remain at current levels, with SaD/Scope-adjusted EBITDA of between 3-4x.

Scope forecasts that interest cover will decrease, following the rise in the company’s indebtedness in 2020 and 2021. However, it will remain comfortably above 4x thanks to MHH’s relatively low cost of debt (YE 2020: 2.75%) and improved top line and EBITDA going forward.

Liquidity improved to above 1x in 2020 after the repayment of all revolving working-capital credit facilities, which led to a continuously high portion of short-term debt in the past. Scope believes that cash sources will comfortably cover cash needs going forward, even if increased working capital outflow forecasted for 2021 will burden free operating cash flow (a one-off effect as it only brings forward cash payments to adapt to vendors’ payment policies).

Scope notes that the company’s financial policy tolerates a certain exposure to foreign exchange rate risk. On the one hand, most of MHH’s contracts with suppliers and customers are denominated in euros, on the other hand, the company intends to swap its entire corporate financing structure to Hungarian forints following a successful second bond issuance. A further strengthening of the Hungarian forint against the euro is therefore likely to impair leverage and debt protection alike. However, this additional forex risk has not been addressed by the company so far.

The company is owned in equal shares by József Kreinbacher (CEO) and Josef Unger, with no independent board to provide oversight functions. The credit-negative procedure whereby MHH provides, on a recurring basis, non-business-related grants to Mr. Kreinbacher’s other ventures (HUF 0.3bn to HUF 1.7bn accounted for as other expenses) will be eliminated in FY 2021. This is a consequence of a restructuring of ownership interests in the company to be executed by YE 2021. For tax and structural reasons Mr. Kreinbacher has contributed all of his shares in MHH to the newly established Kreinbacher Invest Zrt. (a holding company for Mr. Kreinbacher’s equity stakes in different undertakings, including MHH) as a payment in kind. As a consequence, earnings will solely be distributed to Kreinbacher Invest Zrt. via dividends and the holding company will finance Mr. Kreinbacher’s other ventures. In addition, both owners have agreed on a significant reduction of Mr. Unger’s interest in MHH. Over the course of six years, Mr. Kreinbacher will acquire a 30% equity interest in MHH from Mr. Unger, increasing his interest in MHH to 80%. Acquisition costs will be paid by Kreinbacher Invest Zrt.

Outlook and rating-change drivers

The Outlook is Positive and reflects Scope’s view that credit metrics will remain at current levels, with SaD/Scope-adjusted EBITDA around 3x. Furthermore, the agency assumes that dividend and dividend-like pay-outs to entities owned by MHH’s shareholders will not exceed the company’s free operating cash flow on average. The Outlook also incorporates the successful issuance of a second bond under the MNB Bond Funding for Growth Scheme (HUF 6.5bn), mostly to finance an inventory build-up in order to remain competitive in Hungarian construction.

A positive rating action may be warranted if the company’s leverage, as measured by SaD/Scope-adjusted EBITDA, remains around 3x on a sustained basis paired with no significant deterioration on the company's competitive positioning.

A negative rating action could occur if SaD/Scope-adjusted EBITDA increases to significantly above 3x. An increase in leverage could be triggered by either: i) an adverse operational development leading to reduced profitability and cash flows; or ii) higher dividend and dividend-like pay-outs in excess of free operating cash flow.

Long-term debt rating

Scope’s recovery analysis assumes a potential default in 2022 and is based on MHH’s going concern status. As the company is a specialist contractor (façade cladding and roof covering), its enterprise value is linked to ‘soft’ assets (access to long-term customers and technical knowledge in engineering and manual labour) rather than ‘hard’ assets.

The estimated EBITDA at default is HUF 1.4bn (implied enterprise value at default of HUF 4.8bn). Based on its recovery analysis, Scope expects an ‘average recovery’ for the company’s senior unsecured debt (HUF 14.0bn in bonds, HUF 0.3m in guarantees), resulting in the affirmation of the B+ rating for this debt class (the same rating as the issuer rating).

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 Rating if the Credit Rating 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 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: Sebastian Zank, Executive Director
The Credit Ratings/Outlook were first released by Scope Ratings on 30 March 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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