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Rating action

Scope Ratings GmbH (Scope) has today affirmed the BB- rating of Bonafarm Zrt. and changed the Outlook to Stable from Positive. Senior unsecured debt has also been affirmed at BB-.

Rating rationale

The Outlook change is mainly driven by the group’s flexible financial and M&A policy despite improving credit metrics. Improvement in credit metrics is due to higher margins in 2022 from the low agricultural input prices of 2021 and high sales prices this year, and slow deployment of capex in the new brownfield processed meat plant.

The outlook reflects the already improved profitability challenged by inflation, which resulted in lower leverage in 2021 than previously anticipated. The lower leverage is also due to the delay in contracting the once-in-a-lifetime capex programme for Bonafarm Zrt’s wholly owned subsidiary Pick Szeged Zrt. With construction costs soaring of late, the final budget may change, though this is mitigated by the increased government subsidies.

The credit rating mainly reflects the leading positions in Hungary’s meat and milk processing industries of Bonafarm Zrt. and its consolidated subsidiaries (Bonafarm Group).

The strong business risk profile (rated BB+) is attributed to i) two of the group’s brands, Pick and Sole-Mizo, being among the most valued in Hungary; ii) its high vertical integration for its agriculture assets (crops, animal feed, livestock, wine); iii) solid profitability (EBITDA margin of 7.8% in 2021, up from 7.5% in 2020); and iv) continuously strong parent support. The rating is held back by delayed modernisation of acquired production plants across several locations. The low automation in the plants has not only resulted in headcount being double that of main competitors but also made operating expenses and EBITDA more vulnerable to market prices, especially the recently increasing animal feed price, the fluctuating ZMP index (German slaughter pigs index), the milk price and increasing labour costs. This vulnerability is compounded by the delayed execution of strategic investments. High production-related headcount compared to peers and rather low automation in the food processing segment, however, poses a risk on increasing wage costs and hence profitability.

Bonafarm’s main market is Hungary. The country’s economic growth after the pandemic is challenged by record high inflation (projected to reach up to 17% in 2022 while inflation in the food sector was in the range of 20%-35% in the first half year of 2022, one of the highest rates in the EU), weakening local currency, delay in receiving certain EU funds and labour shortages due to ageing workforce and wage pressure. The low input prices of 2021 and high sale prices of 2022 will have a positive impact on Bonafarm’s profitability in 2022. The weakening Hungarian Forint will help on the export margin. Most of investment subsidies have been secured or, in other cases, investments can be delayed or done with EU agricultural subsidies, hence Scope expects moderate effect on Bonafarm Group. Increasing wages, however, affect Bonafarm negatively, as it is one of the largest employers in the country and its level of automation is moderate.

Bonafarm Group’s industry rating remains at A-, with a portfolio consisting of one-third agribusiness and two-thirds non-durable consumer products. Bonafarm Group is the largest fresh food producer in Hungary and operates in a controlled vertical integration model, from crop production to a large-scale animal farming business. In the agricultural and food industries, its market leadership in meat and milk processing gives it pricing power in Hungary. However, Scope’s assessment of market share is held back by the group’s production output, which is much lower than European competitors’, although the medium-term target of expanding its regional presence may lead to an improvement.

Customer diversification is broad. Meat and milk products of the group are present in all Hungarian retail chains. In addition, export markets, mainly to Germany and Romania, made up more than 20% of group revenues (with HUF 59bn out of HUF 257bn) in 2021. Third-party suppliers are well diversified. Strategic partnerships are strong with the group owner’s other assets such as MCS Slaughterhouse, one of the largest such establishments in the region. However, the product offering, while improving, remains limited. Processed meats focus on salami (around 50% of Pick Szeged’s revenues), with a low share of high-protein products such as premium ham. The milk processing segment mainly relates to milk-fat-based products and lacks the protein-based (whey/added milk protein) and plant-based milk products offered by competitors.

The financial risk profile (rated B+) is based on the reasonable leverage metrics, with a Scope-adjusted debt (SaD)/EBITDA ratio projected below 3x despite the ongoing capex and potential for M&A. Scope has taken a more conservative view on the financial risk profile and hence has calculated with a higher base case leverage (up to 3x) instead of adjusting separately for financial policy.

The good projected leverage is supported by prior deleveraging to 2x as of 2021, by way of the 76% EBITDA increase since 2017 (to HUF 20bn from HUF 11.3bn) due to increases in sales by more than 25% and in the EBITDA margin to 7.8% from 5.7%. EBITDA/interest cover has always been strong at Bonafarm Group.

Bonafarm Group also receives interest from affiliates and related parties which Scope excludes from its forecast. The financing structure includes low amortisation and high balloon or bullet facilities, which allow a good debt service coverage ratio. The issued HUF 27bn bond is repayable only at maturity in 2029, which provides great cash flow headroom. Funds from operations/SaD have been well above 30% since 2019 due to the improving EBITDA margin and good working capital management.

The main rating constraint, however, is free operating cash flow/SaD, which has been negative in 2017, due to the acquisition of large production sites in need of modernisation and capacity expansion. Scope expects very negative values once the Pick Szeged brownfield investment kicks in.

Since the plans for the Pick Szeged facility were made and the related bond was issued in 2019, construction costs in Hungary have soared. The Hungarian Investment Promotion Agency recently granted a HUF 10.6bn non-refundable investment subsidy to the HUF 39bn investment budget; the previous plan calculated conservatively only a HUF 2bn subsidy, leaving room for cost overruns.

Liquidity coverage is rather low and is caused by capex-induced negative free operating cash flow, some of which can be delayed. The company has a HUF 7.3bn overdraft facility, which is currently mainly unused, and a small factoring facility at Sole-Mizo (fully consolidated subsidiary), also unused. However, due to the short tenor of these facilities, Scope has excluded them from the liquidity calculation. Taking these lines into account based on their historical prolongation track record results in adequate liquidity. Cash pooling is in place across Bonafarm and its subsidiaries. MCS Slaughterhouse (out of group entity) was granted limited access to the cash pool for in 2022.

The issuer rating also reflects a one-notch supplementary rating driver upgrade for parent support, reinforced by the recent equity increase for Pick Szeged’s capital expenditure and for investments in agriculture. Bonafarm Group is fully owned by renowned businessman and banker Dr Sándor Csányi through holding company Bonitás 2002 Zrt. Dr Csányi has supported the group significantly with equity and owner loans since its inception.

Outlook and rating-change drivers

The Outlook was changed to Stable from Positive reflecting the further delayed capex, the flexible financial and investment strategy of the Group and hence expected volatility in metrics. The Stable Outlook reflects Scope’s expectation that Bonafarm can tackle inflation and keep its margins, execute on its capex plans while keeping leverage below 3.5x.

A positive rating action is possible upon i) a free operating cash flow/SaD sustained at more than 5% as a result of the executed investment strategy and production ramp-up; and/or ii) keeping Pick Szeged’s investments within budget despite the increasing construction costs and/or (iii) tighter financial and investment policy.

A negative rating action could be warranted by i) a funds from operations/SaD sustained below 15%; and/or ii) a SaD/EBITDA sustained above 4x. The latter could be caused by more debt taken on due to i) higher construction costs; ii) a slow production ramp-up; iii) a significant change in market input prices; and/or iv) weaker pricing power in main segments due to further delays in modernisation that result in shrinking market shares and/or M&A.

Long-term debt ratings

Wholly owned subsidiary Pick Szeged Zrt. issued senior unsecured debt in 2019 of HUF 27bn. While the company has a strong asset position, Scope has not provided an uplift for any potential recovery.

Scope therefore affirms the BB- rating on senior unsecured debt issued by Pick Szeged, which is in line with the issuer rating. The debt category rating reflects the ranking of debt issued by Pick Szeged, which is below the HUF 32bn senior secured bank debt of Bonafarm Group. Scope expects an ‘average’ recovery for outstanding senior unsecured debt in a hypothetical default scenario in 2024.

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 Outlooks, (Corporate Rating Methodology, 15 July 2022; Rating Methodology: Consumer Products, 30 September 2021), 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 Outlooks and the principal grounds on which the Credit Ratings and/or Outlooks are based. Following that review, the Credit Ratings were not amended before being issued.

Regulatory disclosures
These Credit Ratings and/or Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and/or Outlooks are UK-endorsed.
Lead analyst: Barna Szabolcs Gáspár, Associate Director
Person responsible for approval of the Credit Ratings: Henrik Blymke, Managing Director
The Credit Ratings/Outlooks were first released by Scope Ratings on 6 September 2019. The Credit Ratings/Outlooks were last updated on 17 September 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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