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Rating action

Scope Ratings GmbH (Scope) has today assigned Szabó Fogaskerékgyártó Kft. a first-time issuer rating of B/Stable. Senior unsecured debt has been rated B+, one notch above the issuer rating.

Rating rationale

Szabó Fogaskerékgyártó plans to issue a HUF 1.5bn bond under the Hungarian National Bank’s Bond Funding for Growth Scheme. The bond will feature a tenor of 10 years, 10% annual amortisation of the notional value between 2027-31, a 50% bullet repayment in 2032, and a fixed interest rate coupon payable annually. Proceeds from the bond are to be used for investments in a new production hall and logistics centre and to develop an automated warehouse structure.

Szabó Fogaskerékgyártó’s business risk profile, assessed B-, is constrained by the company’s size, low product diversification, and high customer and end-market concentration. With sales of around HUF 1.8bn (roughly EUR 5m), Szabó Fogaskerékgyártó is a very small niche player in the European capital goods market. It specialises in gear manufacturing, and its main product lines are spur gears, helical gears, worm gears, planetary gears, spline shafts, straight bevel gears, and geared axes. Unlike companies in the automotive sector, Szabó Fogaskerékgyártó does not produce parts with a high level of standardisation, i.e. high volume. Instead, the company has a multitude of gear types (over 1,000 varieties), which it usually produces in small to mid-size batches (10-500 pieces per order). Key constraints in terms of diversification are the limited product range with no aftermarket business, significant customer concentration with the top five customers representing more than 85% of revenues, and high concentration on the end-market side. While the company has little exposure to highly cyclical end markets like automotive, trucks, and consumer products, around 90% of its revenues are generated from companies in the agricultural machinery sector.

Profitability is the main support for the business risk profile. The EBITDA margin reached 44.8% in 2020, a significant increase versus 38.7% in 2019 due to a higher gross profit margin. After 9M 2021, the EBITDA margin decreased to 35.1%, reflecting a lower gross profit margin due to higher raw materials prices and steel shortages. Higher personnel expenses due to an increased headcount and higher average wages are also expected to weigh on profitability. Szabó Fogaskerékgyártó’s guidance for the full year 2021 puts EBITDA at around HUF 550m (EBITDA margin of around 31%) and attributes the decrease to a large purchase of raw materials at the end of 2021 that was intended to secure margins in 2022. Scope expects EBITDA margins in the range of 30%-35% in 2022-23.

The financial risk profile is assessed BB. Reported debt stood at HUF 549m at year-end 2020 (HUF 1.1bn at end-September 2021). This comprises bank loans (HUF 526m; HUF 599m at end-September 2021) and leases (HUF 23m, HUF 475m at end-September 2021).

Scope has made an adjustment for an EU investment grant of HUF 25m (part of accrued liabilities), which will terminate in 2025. Based on this adjustment, Scope calculates Scope-adjusted debt (SaD) of HUF 549m at year-end 2020 (HUF 572m at year-end 2019). Scope expects SaD to increase to around HUF 1.03bn at year-end 2021, largely reflecting an increase in financial leases due to new leases of additional machines in 2021. Assuming a successful bond issue, Scope expects SaD to rise to around HUF 2.34bn at year-end 2022.

Leverage as measured by SaD/EBITDA is expected at 1.9x for 2021. This is an increase from 0.7x due to higher-than-expected SaD and lower expected EBITDA. We anticipate this ratio will increase further after the planned bond issuance, to a range of 3.5x-4.0x at year-end 2022. After that, we expect the ratio to improve to around 3.0x at year-end 2023. Cash flow cover as measured by free operating cash flow/SaD decreased to negative 20% in 2020 (28% in 2019), reflecting negative free operating cash flow due to loans to a subsidiary. In view of the planned investment cycle, Scope believes cash flow cover will remain negative in 2021, 2022 and 2023.

Operating cash flow was positive between 2012-19. Negative operating cash flow of HUF 62m in 2020 reflects an increase in other receivables due to loans to subsidiary Szabo Hajtástechnológia Kft. as well as higher shareholder loans. This caused free operating cash flow to turn negative in 2020 (negative HUF 114m) after being in positive territory in previous years. According to the company, loans provided to the subsidiary have been largely reimbursed in 2021 and no further support is planned in the near future.

Scope expects higher net working capital in 2021 because of the company’s strategic decision to make a large purchase of raw materials at the end of 2021 in order to secure profitability in 2022. This weighed on cash flow in 2021.

Szabó Fogaskerékgyártó has informed us that its preliminary figures indicate its 2021 capex was around HUF 1bn. Based on our revenue and EBITDA margin assessment, Scope expects capex of around HUF 1.6bn in 2022 and around HUF 550m in 2023. Increased capex compared to previous years reflects planned investments in a new production hall and logistics centre and the development of an automated warehouse structure. In view of this increased capex, Scope expects FOCF to turn negative, falling to negative HUF 450m, negative HUF 940m, and negative HUF 40m (all approximate) for 2021, 2022 and 2023 respectively.

Scope considers Szabó Fogaskerékgyártó’s liquidity and financial flexibility to be ‘adequate’. This view is supported by a new HUF 200m loan that the company raised from Erste Bank in 2021 to repay maturities in 2021, the reimbursement of the loan to the company’s subsidiary in 2021, and Scope’s assumption of a successful HUF 1.5bn bond issue in 2022.

Outlook and rating-change drivers

The Stable Outlook incorporates a successful placement of the HUF 1.5bn bond under the Hungarian National Bank’s Bond Funding for Growth Scheme. It also includes Scope’s expectation that proceeds from the bond will be used for investments and that Szabó Fogaskerékgyártó will retain its main customers and return to growth in 2022 after an expected small dip in growth in 2021. Furthermore, the outlook reflects Scope’s expectation that dividends will be limited to HUF 50m during the investment cycle and no further subsidiary loans or shareholder loans will be approved.

Scope deems a rating upgrade to be remote at this stage but it is possible if the company can grow while achieving deleveraging.

A negative rating action could result from SaD/EBITDA staying at around 4x on a sustained basis, e.g. caused by EBITDA margin pressure from rising material or personnel costs or increased financial debt. It could also result from weaker liquidity, the loss of a major customer, or the use of bond proceeds for purposes other than those announced.

Long-term debt rating

In view of the ‘above average’ recovery prospects for bondholders in a simulated event of default, Scope has assigned a rating of B+ to the senior unsecured debt class, one notch above the issuer rating.

The company currently has credit/leasing facilities of HUF 1.07bn, of which HUF 598m is bank credit and HUF 475m is financial leasing. Bank loans are secured by a pledge on selected machines, trucks and cars.

The company plans to issue a HUF 1.5bn bond under the Hungarian National Bank’s Bond Funding for Growth Scheme. The bond will feature a tenor of 10 years, 10% annual amortisation of the notional value between 2027-31, a 50% bullet repayment in 2032, and a fixed interest rate coupon payable annually. Proceeds from the bond are to be used for investments in a new production hall and logistics centre and to develop the production structure (automated warehouse structure).

Scope assumes that Szabó Fogaskerékgyártó will reduce its bank and lease debt by around HUF 385m until year-end 2023 and the business plan and investment programme will be executed as planned with no additional bank debt or other senior-ranking financing ahead of the planned bond.

Scope’s recovery analysis uses a liquidation value of around HUF 2.1bn for a hypothetical default in 2023. This value is based on a haircut on assets and reflects liquidation costs of 10% for assets. The agency assumes that the liquidation value will benefit from the high level of ongoing investments. Scope also assumes that shareholder and subsidiary receivables from the parent would become non-recoverable in the event of payment default.

Stress testing & cash flow analysis
No stress testing was performed. Scope Ratings performed its standard cash flow forecasting for the company.

Methodology
The methodology used for these Credit Ratings and/or Outlook, (Corporate Rating Methodology, 6 July 2021), is 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-EU. 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 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: Gennadij Kremer, Associate Director
Person responsible for approval of the Credit Ratings: Olaf Tölke, Managing Director
The Credit Ratings/Outlook were first released by Scope Ratings on 31 January 2022. 

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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