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Rating action

Scope Ratings GmbH (Scope) has affirmed the issuer rating of Hungary-based Progress Étteremhálózat Kft. at BB/Stable. The senior unsecured debt category has been affirmed in line with the issuer rating at BB.

The rating action reflects the strong organic growth coupled with new store openings and the modernisation of all existing restaurants while investment cost is fixed and margins are protected by robust treasury activity.

Rating rationale

The rating action is based on Progress’ strong market position in Hungary, its good margins and significant growth potential. The rating is constrained by the low diversification and increasing leverage due to the refurbishment of existing restaurants, new restaurants openings, and pressure on mid-term profitability following soaring input costs.

The business risk profile (rated BB) remains unchanged compared to last year. Progress closed a strong year in 2021, with revenue exceeding pre-pandemic levels and good profitability.

Progress has a good local market position in the informal eating out market as one of the largest restaurant operator in Hungary, operating the McDonald’s brand.

Revenues of HUF 41bn in 2019 (roughly EUR 120m), HUF 37.4bn in 2020 and HUF 51bn in 2021 (to above pre-Covid levels) make Progress a small- or medium- sized B2C company. In Hungary, McDonald's has over 100 restaurants with system-wide sales exceeding HUF 88bn in 2021 and HUF 68bn in 2020. Of these 102 local stores, 62 are operated and owned by Progress and 40 are operated via conventional licence partners in the country. Four new stores were opened in 2021 and more than twenty were modernised. Progress plans to expand its Hungarian restaurant network by a dozen stores in the coming three years.

Progress’ strategy of focusing on drive-through restaurants is positive, as this is the most stable format in the informal eating out market segment and the most resilient during the pandemic. The operating environment is currently challenging, and the company is planning to expand to exploit its comparative advantages. Home deliveries through delivery partners started during the pandemic. Progress’ revenue therefore rely more on volume than on margins. The primary risk for the business lies in a deterioration in its relationship with McDonald’s.

Progress’ activities are facilitated by the McDonald’s Corporation and its strong brand, which supports the company’s market leader position in the informal eating-out industry in Hungary and its good profitability, which in turn is supported by well-defined global marketing facilities and supply-side capacity.

Product diversification is above that of other McDonald’s licensees in other countries, but it remains mainly limited to fast food. A strong new offering in premium burgers and local tastes boosted the average order size and profitability. As the rise in the price of food, paper and utilities is expected to exceed 20% in 2022 and unemployment remains low, retaining volumes and economies of scale from 2022 onwards will put pressure on profitability to be able to keep growing sales and nominal EBITDA.

In 2022, Scope does not expect any one-off items as seen in previous years such as Covid-19-related wage subsidies or VAT reduction. Pre-election cash incentives to the population will however fuel consumption until YE 2022. Affordability and economies of scale remain key with the current soaring inflation environment.

The competitive position of Progress is constrained by its small size on a global level and its concentration on one geographical area and activity.

The financial risk profile (rated at BB) remains unchanged compared to last year. In 2020, Progress issued a senior unsecured HUF 33bn bond under the Bond Funding for Growth Scheme of the Hungarian National Bank (MNB). The bond has a fixed coupon of 3% and will start amortising in 2026 after the capex plan has been completed. The low fixed interest rate bond and the fixed investment costs provide a competitive advantage.

Scope assumes that significant capex for new restaurants and the redesign of current ones will be in line with management’s projections, with most construction costs being fixed. Furthermore, Scope assumes dividends will only be paid post 2025, after planned investments have been made.

As is the case for other franchise companies, real estate plays an essential role in the finances and the business case of Progress. Here, real estate is not only the ownership of certain properties and their subsequent sub-franchising to conventional franchise partners, but also long-term franchising entered into by Progress with consequent sub-franchising to these partners. Scope has adjusted EBITDA for these franchise payments.

The company’s debt includes a HUF 33bn senior unsecured bond with a 3% fixed coupon and HUF 2.4bn in bank guarantees at the end of 2021, with no major changes expected in the next three years.

Scope has excluded from cash netting the contracted capex amounts (HUF 4.3bn at the end of 2021) and HUF 500m in cashier money.

Despite the ongoing large capex plan and inflationary pressure, leverage remains manageable and well within the BB category. Even after the issuance of the HUF 33bn bond, Scope-adjusted debt (SaD)/EBITDA will stay around 3-3.5x.

Leverage depends heavily on the pace at which capex is deployed. Progress’ capex is phased and management has space to manoeuvre, which helps to keep leverage under control.

Funds from operations/SaD is very stable and strong, in the range of 25-35%, reflecting good funds from operations and a limited debt position. High inflation will put pressure on this metric in 2022-23.

Interest cover measured by Scope-adjusted EBITDA/interest expenses is robust. It was extremely high between 2016 and 2019, and Scope expects it to be above 10x in the next three years.

In 2020, Progress issued a senior unsecured HUF 33bn bond under the Bond Funding for Growth Scheme of the Hungarian National Bank (MNB). The bond has a fixed coupon of 3% and will start amortising in 2026 after the capex plan has been completed. The low fixed interest rate bond and fixed investment costs provide an advantage over most competitors.

Liquidity is adequate and benefits from the company’s conservative debt maturity profile, with no short-term debt either historically or planned in the coming years. Scope anticipates that low short-term debt levels will be maintained going forward and be sufficiently covered by available financing sources.

Financial policy supports the rating given the company target of net debt/ EBITDA of below 3.5x. Parent support is rather neutral as Scope does not expect support from the owner or the holding company. Scope assumes no dividend before the investment plan is executed, at least until 2025. The bond prospectus limits dividend up to 50% of previous year’s profit after tax, which is also favorable to debt protection. No notching was applied for supplementary rating drivers.

Progress is working on a dedicated ESG strategy and aims to be the most sustainable restaurant chain in 2030 in Hungary. The environmental footprint is going down thanks to the reduction of packaging in general, to the offer shifting away from beef products and to the modernisation of the infrastructure. A sustainability report is underway with set targets.

Outlook and rating-change drivers

The Outlook is Stable based on our expectation of expansion being executed as planned, which should result in revenue increasing as new restaurants open. Scope also assumes that the company will not pay dividends to the parent company before 2025.

A positive rating action is a remote scenario but could be warranted if the company strengthened free operating cash flow/SaD of at least 10% on a sustained basis.

A downgrade could be warranted in the event of an increase in SaD/Scope-adjusted EBITDA to above 4x as a result of: i) a deterioration in the franchise relationship (development licence) with McDonald’s; ii) a significant delay in or failure to successfully execute expansion plans; and/or iii) a renewed closure of restaurants due to another wave of Covid-19 and/or (iv) inflationary pressure.

Long-term and short-term debt ratings

Scope has affirmed the senior unsecured debt at BB, the same level as the issuer.

In Scope’s recovery assessment, the increase in assets compared to the YE 2021 level (investments under execution) is heavily discounted and, despite a strong unencumbered asset position, the significant intercompany loan limits the recovery for outstanding senior unsecured debt to ‘average’ (30%-50%) in a hypothetical default scenario based in 2024. For these reasons, there is no uplift to the rating for senior unsecured debt as a category. 

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://scoperatings.com/governance-and-policies/rating-governance/methodologies.
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: Barna Gáspár, 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 7 July 2020. The Credit Ratings/Outlook were last updated on 13 July 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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