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Rating action

Scope Ratings GmbH (Scope) has today affirmed its BB-/stable issuer rating on German consumer goods direct-selling company LR Global Holding GmbH (LR). The senior secured debt category rating of BB- has also been affirmed.

Rating rationale

The rating action reflects LR’s generation of double-digit sales growth rates for a number of quarters now, which were also maintained in the first six months of 2021. This has paved the way for a marked improvement in key credit metrics compared to 2019. In particular, the coverage of Scope-adjusted net interest by EBITDA improved significantly in 2020, although this was also supported by the slight delay of the bond issuance to 2021. Even factoring in the bond’s higher interest burden in 2021, Scope believes that interest coverage will stay comfortably above 3x, the threshold for the present ratings. For the time being – and ahead of a likely IPO later in 2022 – Scope has mainly considered LR’s interest coverage because adjusted debt is ‘inflated’ by the EUR 140m shareholder loan issued by the company’ private equity owner Quadriga Capital.

The issuer rating continues to reflect Scope’s business risk assessment, supported by the company’s good position as a manufacturer of premium non-durable consumer goods with health and lifestyle-related attributes. The largely inhouse-produced goods are distributed as part of a direct-selling concept. The risks posed by LR’s small absolute size (about EUR 300m in sales estimated for 2021) are, in Scope’s view, effectively mitigated by a favourable positioning both on the product side and with regard to its addressable direct-selling market. Additional rating support is provided by LR’s comparatively good operating margins (about 13% on EBITDA). Scope continues to see diversification as a drag on the ratings, as LR is active in one niche market and has fairly high product concentration.

LR’s business risk profile (assessed at BB-) benefits from high double-digit monthly revenue growth since 2019, which has even accelerated during the coronavirus crisis and was still at 13% for the first half of 2021. In Scope’s view, this is due to the long-term customer trend for increased healthcare awareness and sustainable, quality-oriented fast-moving consumer goods with perceived health and nutritional benefits. LR almost solely relies on a direct-selling concept involving a self-employed sales force with entrepreneurial incentivisation. Revenue generation within this referral model, without a physical shop network, thus depends on the size and motivation of the sales force, which is catering to rising demand from affluent and less price-sensitive consumers.

The company’s business risk profile is further supported by its comparatively good operating margins and high operating leverage. In 2020, LR had an EBITDA margin of 13%, a solid level relative to retailing peers. With the exception of 2018 (an outlier for several reasons), profitability ranged between 6% and 12%, which is a good level for a retailer, although relatively volatile. Since 2018, the operating margin has continued to increase, fuelled by significant sales growth. LR’s ability to achieve both significant sales growth and strong margin expansion is a function of its comparatively low fixed cost base as the whole sales force is not employed by the company. Scope believes diversification does not support the ratings due to LR’s exposure to a niche market and relatively high concentration on certain product groups. The aloe vera products in particular generate about 40% of total sales, with an increasing trend (just about 33% in 2016). This is partly mitigated, in Scope’s view, by good customer and geographic diversification as the company is active in 28 mainly European countries in total, comparing well to similarly sized peers.

LR’s financial risk profile (assessed at BB-) is supported by the comfortable interest coverage with EBITDA of above 4x. Scope estimates that it will remain at this level even after the full-year impact of the high-yield EUR 125m bond (not effective on a twelve-months basis for 2021). Scope’s financial risk assessments of leveraged buyout (LBO) companies with sizeable shareholder loans, like LR, use interest coverage because it correctly reflects the economic consequences of financial debt, whereas leverage-based credit metrics in an LBO context are strongly distorted by large shareholder loans, which usually accrue interest. While Scope’s assessment thus focusses on interest cover, the agency has also taken the effect of the shareholder loan on other credit metrics into account.

LR’s financial risk profile is further supported by the company’s ability to generate free operating cash flows, due to its very low maintenance capital expenditure and well-managed working capital. However, Scope expects working capital to absorb more cash than usual in 2021, as supply-side bottlenecks have prompted management to accelerate raw material purchases. This will constrain free operating cash flow generation to EUR 8m in 2021 according to Scope’s base case, also reflecting higher tax and interest payments than last year. LR’s financial risk profile is constrained by some historical volatility in operating performance. This appears to relate only to conditions in Turkey in 2018, which was a much more important country to LR at the time. In recent years, sales have rebounded strongly in line with significant EBITDA growth – also confirmed by 2020 interim results – while gross financial debt has been scaled back gradually.

Scope believes that LR’s liquidity is adequate as it benefits from a solid cash buffer of around EUR 30m in 2020-2021, positive free operating cash flow and immaterial short-term debt.

Outlook and rating-change drivers

The Outlook is Stable, reflecting Scope’s expectation that cash interest cover will remain above 3x after the bond issuance.

A positive rating action could be warranted by a demonstration that the company can continue significant sales growth even after the Covid-19 crisis, benefitting critical size. In addition, cash interest cover of above 4x on a sustained basis could be supportive, e.g. driven by an extended/continued acceleration of sales and operating performance after Covid-19.

A negative rating action is possible if cash interest cover falls below 2.5x on a sustained basis. This could result from a deterioration in LR’s operating performance or the further recapitalisation of shareholder loans.

Long-term debt ratings

Scope set the bond’s hypothetical default year in 2022, simulating a scenario in which the company had issued the senior secured bond and proceeds had been used according to plan. The recovery analysis was based on a distressed enterprise value of EUR 68m. The resulting ‘average’ recovery expectation translates into 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/or Outlook, (Corporate Rating Methodology, 6 July 2021; Rating Methodology: Consumer Products, 30 September 2021; Rating Methodology: Retail and Wholesale Corporates, 17 March 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 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: Olaf Tölke, Managing Director
Person responsible for approval of the Credit Ratings: Henrik Blymke, Managing Director
The Credit Ratings/Outlook were first released by Scope Ratings on 23 October 2020. The Credit Ratings/Outlook were last updated on 7 December 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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