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Rating action

Scope Ratings GmbH (Scope) has today affirmed its B+ issuer rating on Hungarian baked goods manufacturer Zalaco Sütőipari Zrt. (Zalaco) and revised the Outlook to Stable from Positive. Scope has upgraded its rating for the senior unsecured debt category to BB- from B+.

Rating rationale

The Outlook change back to Stable from Positive is mainly driven by an EBITDA generation that was 28.6% lower than expected in FY 2021. Despite organic growth in most business lines and the successful implementation of an automated frozen product line, significant increases in raw material and utility costs have put under pressure EBITDA generation potential of company (based on 2021 preliminary figures). The increase in the company’s cost base was mitigated by the increase in selling prices (retail +10%, frozen +6% and wholesale +16%) in FY2021. However, lower-than-expected EBITDA for YE 2021 and following change of cash generation potential in upcoming years limits deleveraging potential of company. While the company has announced additional price increases on some products, Scope does not expect any significant improvement of EBITDA margins in the short term.

Zalaco’s business risk profile (assessed at B+) continues to benefit from stable demand in the underlying non-durable consumer products industry, specifically food production, which has low cyclicality, medium entry barriers and low substitution risk. While the main positive element is the company’s profitability (relatively high EBITDA margins compared to local peers), raw material and utility cost increases in FY 2021 have hampered overall profitability. This was partially mitigated by the high-margin nature of a fully ramped-up frozen product automated production line.

Geographical diversification remains the main constraint in Zalaco’s business risk profile, as the Covid-19 pandemic interrupted frozen product exports and limited the company’s exposure to one specific region. This is expected to remain so until end-2022 as international retail chains are postponing commercial negotiations. Furthermore, Zalaco’s sales remain highly concentrated on international retail chains. For example, Lidl accounted for about 57% of sales in FY 2021 (53% in FY 2020) and this share is expected to increase in the medium term as frozen product sales develop. The risk of this significant exposure to Lidl is partially mitigated by Zalaco’s ability to deliver quality-oriented products and maintain sustainable business operations.

Zalaco’s financial risk profile (assessed at B+) supported by a still comfortable operating profitability reflected by substantial cash flow generation. The significantly lower-than-expected EBITDA for FY 2021 has restrained the deleveraging potential of the company going forward. The capital expenditure required for the new production line is expected to fully repay in FY 2022, which will result in negative free operating cash flow. Scope expects the heavy capex phase to dissipate after YE 2022 but steady demand for frozen products from international retail chains might trigger a new expansion phase if the company needs to increase production capacity. Zalaco’s liquidity profile remains adequate.

Significant cash cushion at around HUF 1.0bn together with expected free operating cash flows starting from YE2023 minimizes short-term refinancing risks of company.

There are no explicit adjustments for supplementary rating drivers. Scope views the group’s restructuring finalised at YE 2021 positively. The restructuring aims to provide outside investors with better transparency and increase operational efficiency. While the owner’s commitment and transparency are positive factors, there is a key person risk.

Outlook and rating-change drivers

The Stable Outlook reflects Scope’s expectation that the company will maintain organic growth while profitability margins remain stable, leading to the Scope-adjusted debt (SaD)/EBITDA ratio remaining at around 4x.

A positive rating action is possible if funds from operations/SaD exceeds 20% on a sustained basis and SaD/Scope-adjusted EBITDA consistently trends below 3.5x. A decrease in leverage may be achieved through an increase in profitability following the successful implementation of additional production capacity in frozen products.

A negative rating action could result from a deterioration in credit metrics, as indicated by a funds from operations/SaD of below 10% and a SaD/EBITDA of above 5x on a sustained basis. An increase in leverage could be triggered by an adverse operational development, leading to reduced profitability or the need for additional external financing for capital expenditure, M&A or dividend payments.

Long-term and short-term debt ratings

Scope has upgraded the senior unsecured debt rating to BB-, including the HUF 4.4bn bond (ISIN HU0000359765). The new bond rating reflects above average recovery for senior unsecured debt positions in the hypothetical event of a company default. The updated recovery analysis is based on a hypothetical default scenario in 2024, which assumes outstanding senior secured debt of HUF 975m including financial guarantees and higher liquidation value, mainly driven by the successful integration of capex investment that mitigate project execution risks.

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 ), are available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
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-governance/definitions-and-scales. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://scoperatings.com/governance-and-policies/regulatory/eu-regulation. 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-governance/definitions-and-scales. 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://scoperatings.com/governance-and-policies/rating-governance/methodologies.
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, 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: Zurab Zedelashvili, Senior Analyst
Person responsible for approval of the Credit Ratings: Henrik Blymke, Managing Director 
The Credit Ratings/Outlook were first released by Scope Ratings on 24 April 2020. The Credit Ratings/Outlooks were last updated on 8 April 2021.

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
© 2022 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.