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Rating action

Scope Ratings GmbH (Scope) has today affirmed the BB-/Stable issuer rating of Hungarian construction company EPKAR Zrt. Scope has also affirmed the company’s BB senior unsecured debt rating.

Rating rationale

The credit rating is supported by EPKAR’s strong credit metrics, which have also been resilient during the pandemic.

The financial risk profile has been upgraded to BBB since the last yearly review, based on higher cash flows due to a stronger-than-expected business environment and a strong order intake that increased the backlog to 2.5 years (as of June 2021) from around 1.8 years, providing long-term cash flow visibility.

In terms of leverage, the Scope-adjusted debt/Scope-adjusted EBITDA ratio (SaD/SaEBITDA) peaked at 3.0x at year-end 2020 (adjusting for cash earmarked for property acquisitions) and is expected to reduce to 1.7x at year-end 2021, while funds from operations/SaD is expected at 51% once proceeds from the bond issued in late 2020 are used to acquire an office in central Budapest, as intended in the bond prospectus. Scope’s base case assumes this to happen in Q4 2021. A delay in the acquisition while positive cash flows are generated would reduce SaD going forward and positively affect leverage metrics.

Interest coverage is expected to remain strong at above 10x after bond proceeds are deployed. Cash flow cover remains strong with positive free operating cash flows. However, the company’s backlog remains concentrated, with the top three projects providing 50% of future revenues, posing a risk in the event of cost overruns or delays.

The rating is mainly constrained by the business risk profile (assessed at B). The company is small in a European construction context, which lessens its ability to mitigate economic downturns. Weak geographic diversification (predominantly active in Hungary), segment concentration, and a dependency on government contracts, which increased further during the pandemic, are further constraints. Scope also judges the issuer’s backlog as concentrated, though somewhat improved over the last 12 months and mitigated by the investment grade counterparties. The book-to-bill ratio is volatile, though mitigated by its level remaining above 1x.

On the other hand, the above-average profitability continues to be a strength for the business risk profile. With increased visibility through the prolonged backlog, Scope foresees profitability to remain above the peer average, at a 13%-15% Scope-adjusted EBITDA.

Outlook and rating-change drivers

The Outlook is Stable and incorporates Scope’s expectation of healthy cash flow through the construction backlog and the rental income from the office property in central Budapest to be acquired. With increased cash flow visibility through its prolonged and slightly less concentrated backlog, Scope foresees SaD/SaEBITDA at around 1.7x and towards 1x after deployment of bond proceeds.

A positive rating action may be warranted if the business risk profile significantly improved while SaD/SaEBITDA remained at around or below 2x. An improved business risk profile would be evidenced by a higher market share, larger and more diversified order backlog, improved segment diversification, and increased exposure to private projects.

A negative rating action could occur if SaD/SaEBITDA increased above 3.5x on a sustained basis. This could be triggered by i) an operational development leading to reduced profitability and cash flows; or ii) additional debt-funded real estate acquisitions.

Long-term and short-term debt ratings

Scope still expects an ‘above average’ recovery for the company’s unsecured debt and has affirmed the senior unsecured debt rating at BB (one notch above the issuer).

Scope’s recovery analysis is based on a hypothetical default scenario occurring at year-end 2022, assuming outstanding senior unsecured debt of HUF 11.8bn (bond loan and payables) in addition to senior secured bank debt of HUF 1.5bn (loan facility, cash advances guarantee).

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, (Rating Methodology: European Construction Corporates, 15 January 2021; Corporate Rating Methodology, 6 July 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 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 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/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: Thomas Faeh, Executive Director
Person responsible for approval of the Credit Ratings: Olaf Tölke, Managing Director
The Credit Ratings/Outlook were first released by Scope Ratings on 28 February 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
© 2021 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Ratings UK Limited, Scope Analysis GmbH, Scope Investor Services GmbH, and Scope ESG Analysis 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.