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Rating action

Scope Ratings GmbH (Scope) has today downgraded the issuer rating of GVC George’s Venture Capital Zrt. (GVC) to BB-/Stable from BB/Stable. Scope has also downgraded the senior unsecured debt category to BB- from BB.

Rating rationale

The downgrade is driven by GVC’s constrained operating profitability, driven mainly by higher prices for raw materials and commodities, which represent a significant portion of the cost base. The company’s business model of long-term operating contracts with price adjustments at the beginning of each business year lags behind immediate increases in its cost base. While Scope believes GVC has purchasing power and an ability to renegotiate service prices with top customers to some extent, elevated production costs will still have a negative effect on profitability in the short-to-medium term. Furthermore, strained EBITDA generation will have a negative impact on the company’s financial profile.

GVC’s business risk profile (assessed at B+) benefits from its multi-year contract backlog with predictable top-line development. Although its business operations were partially interrupted by a lockdown in Q1 2021, it managed to maintain EBITDA of HUF 2.4bn and keep its EBITDA margin above 10% at YE 2021.

GVC’s operating profitability is expected to deteriorate, with EBITDA margins dropping below 10% as a result of a significantly increased cost base due to expected inflation. The macroeconomic context is unfavourable as Russia’s war in Ukraine has exacerbated inflation and supply chain disruptions, cutting short a robust post-Covid recovery. Supply bottlenecks and blockages from the war are squeezing profitability and cash flow. Suppliers of agricultural products are having to contend with soaring commodity prices while also having to hold more inventory amid product shortages and supply chain disruptions.

While dietary Kitchens is expected to generate revenue from the sale of diet meals for external markets only from FY 2023, Scope sees integration risk of loss making company. The one-year delay is due to a product development failure involving testing of non-allergenic raw materials in the food factory it acquired (Food Universum). Furthermore, due to increased prices, production of ready-to-eat meals is expected to become less profitable (energy-intensive cost base). Hence, the strategic priority of the food factory might need to be reconsidered.

GVC’s financial risk profile (assessed at BB) is expected to be constrained by elevated leverage as a consequence of lower EBITDA generation potential. Although indebtedness has remained flat at around HUF 8.0bn, the negative development of EBITDA (in absolute terms) is likely to put leverage at around 4.0x in the short term. Delayed operational integration of twin acquisitions Food Universum and PVK Horog Kft. is limiting EBITDA development. Scope expects leverage, as expressed by SaD/EBITDA, to decrease towards 3.5x in the medium term. Leverage is assessed without netting of cash due to the lowered rating in line with methodology and a high cash balance that Scope expects to be partly used in future instead of serving as a liquidity buffer.

Favourable collection of receivables continues to keep GVC’s working capital needs moderate despite expected supply chain bottlenecks.

After the company acquired 20% of Zág Körte in 2021 (the remaining 80% is owned by the Gyorgy family), it expected to use refinanced bank loans to pay back a HUF 4bn intercompany loan to finance the acquisition of the remaining entities in Zalai Group. Given an increasing interest rate environment, management decided to convert its short-term loan to a long-term investment and amortise it over the next 10 years. While the bond prospectus clearly defines the use of proceeds according to the initial plan (development of dietary kitchen R&D and construction, refinancing of existing loans) and the provided intercompany loan could signal a soft covenant breach, the financial statements of Zalai Group (standalone) including the market value of arable land suggest that management is correct in saying that the intercompany loan can be collected in a short period of time once needed.

Furthermore, Scope believes intercompany loans would have a limited positive impact on GVC’s financial risk profile. Although management communicated 3% interest on intercompany loans without the arm’s length principal, interest could be cumulative and have no cash effect in the short-to-medium term. As a result, Scope has left potential cash interest income out of its metrics calculation.

Outlook and rating-change drivers

The Stable Outlook incorporates Scope’s expectation that Scope-adjusted debt (SaD)/EBITDA will peak at 4.0x in 2022 and decrease again thereafter.

A positive rating action could follow an improvement in the business risk profile, driven by increasing operating profitability or revenue stream diversification with less exposure to public tenders. A positive rating action could also be warranted if leverage, as expressed by SaD/EBITDA, fell below 3.0x. In addition, stabilization and integration of the acquired companies is necessary.

A negative rating action could result from a deterioration in credit metrics as indicated by SaD/EBITDA of above 4.0x on a sustained basis. Weak financial performance could be triggered by an adverse change in regulations and/or macroeconomic conditions, further increasing input costs and putting operating profitability under pressure.

Long-term debt rating

Scope has downgraded its rating of GVC’s senior unsecured debt to BB-, in line with the issuer rating. This rating is based on a hypothetical liquidation scenario as of year-end 2024, in which Scope computed an ‘average’ recovery for holders of senior unsecured debt based on its assumptions of attainable liquidation values.

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, (General Corporate Rating Methodology, 15 July 2022), 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: Zurab Zedelashvili, Senior Analyst
Person responsible for approval of the Credit Ratings: Olaf Tölke, Managing Director
The Credit Ratings/Outlook were first released by Scope Ratings on 22 September 2020. The Credit Ratings/Outlook were last updated on 28 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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