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      Scope affirms B+ issuer rating of Bayer Construct Zrt. and revises Outlook to Negative

      THURSDAY, 04/08/2022 - Scope Ratings GmbH
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      Scope affirms B+ issuer rating of Bayer Construct Zrt. and revises Outlook to Negative

      The Outlook change is driven by the risk that leverage remains high amid impending headwinds including higher input prices, a lower order intake and an unsupportive macroeconomic outlook.

      The latest information on the rating, including rating reports and related methodologies, is available on this LINK.

      Rating action

      Scope Ratings GmbH (Scope) has today affirmed the B+ issuer rating of Bayer Construct Zrt. and revised the Outlook to Negative from Stable. Scope has also affirmed the B+ rating for senior unsecured debt.

      Rating rationale

      The Outlook change to Negative is driven by the risk of consolidated leverage remaining high (Scope-adjusted debt/EBITDA at 6.9x in 2021) amid impending headwinds including higher input prices, a lower order intake and an unsupportive macroeconomic outlook.

      The rating affirmation is driven by the issuer’s still solid competitive position supported by high vertical integration, which preserves its market share as well as profitability and results in a business risk profile assessed at B+. Bayer Construct is primarily active in construction, which accounts for 55% of its consolidated EBITDA as of 2021. This focus is not expected to shift, with around 50% targeted going forward despite the growing exposure to real estate development.

      Revenues were up 84% YoY in 2021 to HUF 74.7bn (around EUR 206m) as well as Scope-adjusted EBITDA (up 17% YoY to HUF 8.3bn; around EUR 23m). Revenue growth in 2022 will be constrained by impending headwinds, including higher input prices and a smaller order intake from third parties amid an unsupportive macroeconomic outlook. The company’s sole exposure to Hungary and small size also limits its ability to weather the downturn in Hungarian construction anticipated for 2022 with recent growth of the market considered unsustainable. From 2023, the top line is expected to stabilise, supported by increased real estate development activity, which will help to reduce the supply-demand uncertainty in construction and provide better economies of scale along the vertically integrated business.

      The expected slowdown in the construction industry in 2022 follows a dynamic 2021 during which contracted volume in increased by 13% YoY to HUF 5,389bn. The slowdown will be due to the effect of the Russia-Ukraine war, rising materials costs, labour and building materials shortages, and rising interest rates. However, the availability of raw and building materials has improved of late, with prices as of July 2022 already below January 2022 levels.

      Customer concentration is also high. On average, the top 10 contributed 92% of the backlog during 2017-21 (91% at end-March 2022; around 60% from contracts with affiliates). The development of the Zugló City Centre as well as the Aligaliget project pose high development risk and cluster risk for cash flow, accounting for 41% of outstanding work as at end-March 2022.

      Scope-adjusted EBITDA margin dropped to 11% in 2021 (down 8.3pp), largely due to increased materials and labour expenses and the upfront costs on the prefabricated structure division. Investments along the supply chain are improving economies of scale along the vertically integrated business, with investment focused on production facilities for raw materials, prefabricated modules and real estate developments. This should provide a cushion against volatility in both profitability and cash flow, with Scope-adjusted EBITDA margin forecasted above 10%.

      The financial risk profile (assessed at B) reflects the rising indebtedness to finance the significant investments being undertaken. A large share of debt is also floating rate and therefore exposed to rising interest rates that will follow central bank attempts to stem inflation.

      Scope-adjusted debt is forecasted to increase to around HUF 70bn by YE 2022 (YE 2021: HUF 57.1bn), driven by negative free operating cash flow due to the large investments. Thus, leverage as measured by Scope-adjusted debt/EBITDA will likely remain elevated (2021 6.9x; up 0.9x YoY driven by lower-than-expected EBITDA). This will narrow the issuer’s access to external financing, impairing its ability to offset i) cash flow volatility; ii) operational disruptions; and iii) pronounced real estate value drops. Scope expects leverage to be sustained at 5-7x due to the need to finance the negative free operating cash flow externally. However, pressure on leverage could ease from the lower capital expenditure from 2023, higher-than-anticipated customer prepayments and a significant reduction of working capital as anticipated by the issuer.

      Interest cover will be under severe pressure from the high share of floating-rate debt (43% indexed to BUBOR, which has risen drastically by around 750bp since YE 2021) and the strongly increased indebtedness. Scope-adjusted EBITDA interest cover is forecast to fall to 2-3x (YE 2021: 9.8x) but be sufficient to serve interest payments and provide headroom against cash flow volatility.

      Liquidity is adequate despite an anticipated shortfall against short-term debt of HUF 8bn for the 12 months to YE 2022. Scope’s view is based on the unencumbered assets (Aligaliget) to be used to source secured financing and the consistent record of rolling over or repaying debt.

      Outlook and rating-change drivers

      The Negative Outlook reflects the risk of consolidated leverage remaining high after a strong increase in 2021 and volatile due to a concentrated backlog and uneven project pipeline, with a Scope-adjusted debt/EBITDA of above 6x (2021: 6.9x) and Scope-adjusted funds from operations/debt of 10%-15% (12%). The Outlook also reflects the significant development risk and cluster risk for cash flow regarding the Zugló City Centre and Aligaliget (at lake Balaton) projects. The Zugló City Centre will be transferred to an affiliated company, making cash generation from construction work dependent on that company’s ability to finance the project, while the Aligaliget project is yet to receive building permits.

      A positive rating action (i.e. Outlook back to Stable) could be warranted if consolidated Scope-adjusted debt/EBITDA will decline to below 6x on a sustained basis. This could be due to higher customer-led prefinancing of developments or much lower working capital needs.

      Scope may downgrade the rating if Scope-adjusted debt/EBITDA were sustained above 6x or liquidity worsened. Liquidity could worsen through: i) significant delays in customer payments; ii) non-recoverable cost overruns and/or delays in projects; or iii) weaker access to external financing. Leverage might remain elevated if lower investor demand leads to delays on or cancellations of the company’s projects.

      Long-term debt ratings

      Bayer Construct issued a HUF 30.1bn senior unsecured corporate bond in 2021. Proceeds were used to refinance working capital loans with the Hungarian Development Bank and invest in production facilities and development projects. The bond’s tenor is 10 years. It will amortise in years 5-9 in equal instalments with a 50% balloon at maturity (21 October 2031). The coupon is fixed (3.7%) and payable yearly.

      Scope’s recovery analysis incorporates a default scenario in 2023 and is based on Bayer Construct’s liquidation value, with the company’s parts assumed at a higher value than the group as a whole. Scope’s view is driven by the high vertical integration among the group companies. Scope has determined an ‘average recovery’ for senior unsecured debt, resulting in a B+ rating for this debt class (in line with that of the issuer).

      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, (General Corporate Rating Methodology, 15 July 2022; Construction and Construction Materials Rating Methodology, 25 January 2022), are 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 Rated Entity and/or its Related Third Parties participated in the Credit Rating process.
      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: Philipp Wass, Executive Director
      Person responsible for approval of the Credit Ratings: Henrik Blymke, Managing Director
      The Credit Ratings/Outlook were first released by Scope Ratings on 31 August 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. 

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