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Rating action

Scope Ratings GmbH (Scope) has today affirmed its B/Stable issuer rating on DVM Group Kft. (DVM). Scope has also affirmed its B+ rating for the senior unsecured debt category.

Rating rationale

The rating affirmation reflects a recovery in profitability margins in 2021 despite sharp material cost inflation, but also weaker-than-expected earnings in the same year. The pandemic has led to project delays and changes in end-user demand, while some contracted work has been put on hold, resulting in revenue declines. In 2021, revenues declined by 12% (preliminary figures) compared to the 2020 level (22% compared to Scope’s rating case), though Scope-adjusted EBITDA increased by 20% (excluding provisions of about HUF 346m). Profitability, as measured by the Scope-adjusted EBITDA margin, recovered to 7.9% in 2021 (5.8% in 2020), supported by stronger demand for complex high-margin projects, even in the base-building segment.

Scope assumes that the company will continue to generate revenues at least at historical levels backed by a strong backlog of projects of HUF 68.4bn as of April 2022 (2.8x revenues for 2021). In addition, a higher expected contribution from fit-out activities will help protect revenues and profitability in the next few years. DVM’s pipeline of projects will also benefit from planned co-developments, including a 6,000 sq m office refurbishment and an 18,000 sq m logistics facility, which should benefit from robust tenant demand for industrial premises. Rising prices for raw materials are expected to put some pressure on profitability. This will be partially mitigated by the company’s strategy to: i) conduct frequent project budget reviews; ii) appoint subcontractors and construction material providers at engagement letter signing; and iii) sign construction projects under a fixed general contractor fee instead of contracting for overall projects (thus avoiding bearing all risks for material and subcontractor fees). Whilst the last of these should somewhat hedge the company against material cost inflation, it also implies longer negotiation periods before signing new contracts and could result in a weaker backlog of projects in the next few years. Scope’s forecast assumes that DVM will keep its Scope-adjusted EBITDA margin around 6% over the next 12-18 months. It will manage to offset rising costs through updated contract terms, although it does face some risk from projects signed before the pandemic (17% of current backlog).

DVM’s business risk profile continues to benefit from its good vertical integration. This includes a wide range of services in the different stages of the construction value chain (design, project management, contracting, base building, and fit-out services). DVM also has a good domestic network and long-standing relationships with its main clients. The rating remains constrained by the company’s small scale in both a European and Hungarian context. Weak diversification is a further constraint, namely: i) a lack of geographical diversification; ii) a high reliance on one segment (building activities); iii) a strong reliance on certain key customers; and iv) a concentrated backlog (with the top three and top 10 projects representing about 68% and 99% of the total respectively).

The company’s financial risk profile reflects robust debt protection, as indicated by a Scope-adjusted interest cover ratio of 7.7x and a Scope-adjusted debt (SaD)/Scope-adjusted EBITDA ratio of 4.3x as at December 2021 (based on preliminary financials). These metrics are in line with the rating category. Free operating cash flow has been volatile in the last few years. It was negative in 2020, driven primarily by the company’s investment activities, but turned slightly positive in 2021.

Scope foresees leverage as measured by SaD/Scope-adjusted EBITDA to slightly increase from 2022 on due to: i) weaker-than-expected cash flow generation; and ii) the increase in leverage to partially finance the industrial facilities (HUF 1.7bn in 2023) before stabilising at a level commensurate with the rating category once developments are complete and provide a boost to the top line. Scope anticipates debt protection to decline in the coming years due to higher balance sheet leverage. However, Scope-adjusted EBITDA interest cover is forecast to remain above 5.0x on average in the next few years.

Liquidity is adequate. It benefits from cash and cash equivalents of HUF 4.8bn as at December 2021 and a backloaded debt maturity profile comprising a HUF 8bn bond maturing in 2030 with a first instalment (HUF 2.4bn) due in 2026 and no significant amounts due in the coming years. Scope expects the company’s low short-term debt levels will be maintained going forward and be sufficiently covered by available financing sources.

Outlook and rating-change drivers

The Outlook remains Stable for DVM and incorporates Scope’s view that the company will continue to generate positive operating cash flows based on its current backlog. It also reflects Scope’s expectations of a successful execution of current co-development projects as well as the SaD/Scope-adjusted EBITDA ratio remaining below 6x and Scope-adjusted interest cover remaining around 5x. While Scope believes that credit metrics will remain consistent with the rating category, the company’s small size and low diversification significantly threaten cash flow stability. Hence, Scope expects a tangible improvement in cash flow diversification going forward, which could be driven by a higher share of EBITDA from the more granular fit-out business. Scope also highlights the potential for further cost inflation paired with a weaker economic outlook and greater uncertainty across Europe as a result of the military conflict in Ukraine.

A positive rating action could occur if Scope’s rating scenario materialised, including maintenance of a backlog-to-sales ratio above 2.5x combined with greater diversification (customers and projects) while improving the SaD/Scope-adjusted EBITDA ratio to below 4x on a sustained basis.

A negative rating action could occur if SaD/Scope-adjusted EBITDA increased to above 6x on a sustained basis or liquidity worsened due to, for example, delayed payments by customers, or delays or cost overruns in projects in the current pipeline.

Long-term and short-term debt ratings

The company issued a HUF 8bn senior unsecured corporate bond (ISIN HU0000359781) under the Hungarian National Bank’s Bond Funding for Growth Scheme in the second half of 2020. The bond has a 3% coupon and is amortising, starting in 2026, with a 10-year tenor.

Scope’s recovery analysis is based on a hypothetical default scenario occurring at year-end 2023. It assumed outstanding senior unsecured debt of HUF 8.0bn and additional secured bank debt of HUF 1.7bn to partially finance DVM’s co-development projects. The result was an ‘above average recovery’ for the company’s unsecured debt. Scope therefore affirms the B+ rating for this debt category (one notch above 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; Construction and Construction Materials Rating Methodology, 25 January 2022) 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 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: Rigel Scheller, Director
Person responsible for approval of the Credit Ratings: Philipp Wass, Executive Director
The Credit Ratings/Outlook were first released by Scope Ratings on 26 May 2020. The Credit Ratings/Outlook were last updated on 2 June 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
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