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Rating action

Scope Ratings GmbH (Scope) has today affirmed its BB- issuer rating on Tegeta Motors LLC (Tegeta) and revised the Outlook to Negative from Stable. Scope has also affirmed its BB- rating on senior unsecured debt.

Rating rationale

The rating action reflects weakened credit metrics driven by partially debt-funded capital-intensive projects and stockpiling with less favourable repayment terms, which outweigh the positive impact on Tegeta's business risk profile from the significant growth being pursued. The delayed issuance of a bond with a bullet repayment structure illustrates the elevated refinancing risk of the mostly amortising financial debt portfolio of the company. Scope expects that negative free operating cash flows and insufficient funds to refinance short-term debt will remain in the short-to-medium term, mainly as a consequence of the fast-growing SME business model.

Tegeta Motors’ business risk profile (assessed BB-) benefits from a leading position in the Georgian auto retail market in terms of sales. After prudent supply chain management confirmed by the post-Covid pandemic business environment, Tegeta continues to serve clients without any major interruptions due to sufficient inventory and flexibility in terms of substituting suppliers when necessary. In a fragmented automotive sector, Tegeta has more financial flexibility than its competitors, giving it more favourable inventory delivery times.

Diversification remains one of the weak elements in the group’s business risk profile. There are limited sales outside of Georgia and distribution channels are not diversified. The product diversification of Tegeta, however, provides defensive features against the economic cycle compared to its local competitors, who remain solely focused on car sales. With strong spending on new cars, sales increased by 182% in FY 2021 (YoY), supported by the newly opened Toyota Batumi Centre together with the Volvo centre in Tbilisi and overall increased demand from the region.

Scope believes that Tegeta will be able to keep EBITDA margins at the 8-9% level going forward. These will be supported by: i) historically stable gross margins of circa 20% benefiting from a complementary product portfolio with advantageous commercial terms and limited switching costs; ii) The company’s growth strategy continuing to enhance the bargaining power of the company, potentially creating higher margins in different markets and generating synergies; iii) ability to pass inflationary costs to customers.

The adjusted EBITDA return on assets is gradually decreasing due to the stockpiling operational concept which gives a competitive advantage to Tegeta in terms of delivery times. We expect it to remain at around 20% going forward.

Tegeta’s financial risk profile (assessed B+) is weaker than its business risk profile. Scope expects a drop of EBITDA by around 10% in YE 2022 to GEL 82m from GEL 89m due to completing the bus tender deliveries in 2021. Lower EBITDA and additional external funding for working capital should lead to a deterioration in both leverage metrics: Scope-adjusted debt/EBITDA should peak at 4.2x at YE 2022 versus 3.1x at YE 2021 and Scope-adjusted funds from operations/debt are expected to drop to 15% versus 24% the year before. Our rating case incorporates leverage staying at around 4.0x (2022E: 4.2x, 2023E: 3.9x and 2024E: 3.6x).

The cash flow cover remains the weakest element of Tegeta Motor’s financial risk profile. Annual expected capex in the high double-digit million lari range limits the room for deleveraging. Scope highlights that capex programmes are mainly to open new points of service and/or showrooms and the company has the necessary flexibility to adjust. However, as the company sees the medium-term expansion plan as a strategic pillar to gain a competitive advantage in the operating region, that flexibility might not be used and Tegeta could decide to use all the headroom that covenants provide. Cash flow generation is further constrained by Tegeta’s high inventory, low delivery times business model.

Interest payments are set to rise significantly as the issuer raises more debt to finance its growth. Furthermore, to deal with inflationary pressures, the National Bank of Georgia continues to tighten monetary policy. The refinancing rate has risen by 2.0pp over the last 12 months to end-August 2022, to 11% from 9%, which will increase the cost of debt, putting additional pressure on EBITDA interest cover. The expected increase in EBITDA, thanks to expanded operational scale and the ramp-up of new products/brands, will help to partially mitigate the negative effect from the high interest rate environment. Scope expects the Scope-adjusted EBITDA interest cover to decrease to around 3.0x in 2022-2024 (3.9x YE 2021).

The current debt structure, with a large amount of short-term debt, significantly weakens Tegeta’s liquidity profile. Scope estimates that relatively low cash levels of around middle double-digit million lari will be insufficient to fully cover (re)financing needs from expected negative free operating cash flow in 2022-2024 and a short-term working capital loan of around GEL 70m. However, the issuance of a bond of 100 million lari with bullet repayment will mitigate the refinancing risk of the mostly amortising nature of the company’s current financial debt. Furthermore, liquidity is also supported by the substantial number of light vehicles inventories (around 30% at half-year 2022).

Outlook and rating-change drivers

The Outlook change to Negative from Stable reflects risk of deterioration in credit metrics as indicated by negative FOCF following substantial new capex plans and some uncertainty of refinancing. It also incorporates the expectation that it will continue growing sales at a low double-digit percentage without any major supply chain bottleneck.

A positive rating action (i.e. an Outlook change to Stable from Negative) could result from Scope-adjusted debt/EBITDA below 4x on a sustained basis and/or with a sustained improvement in liquidity. This could be achieved via deleveraging while maintaining relatively high EBITDA. A positive rating action could also be warranted if the company were to increase export sales significantly, leading to higher diversification.

A negative rating action could result from a deterioration in credit metrics as indicated by Scope-adjusted debt/EBITDA increasing above 4.0x on a sustained basis. Weak financial performance could be triggered by an adverse change in the operating environment with muted sales growth pressuring operating profitability. A negative rating action could also be warranted by inadequate liquidity, which could result from the unsuccessful placement of an additional bond.

Long-term debt rating

Scope has also affirmed the senior unsecured debt at BB- reflecting Scope’s expectations about average recovery for senior unsecured debt positions in the hypothetical event of a company default. The recovery analysis is based on a hypothetical default scenario in 2024, which assumes outstanding senior secured loans, payables and guarantees ranked prior to senior unsecured debt.

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; Retail and Wholesale Rating Methodology, 27 April 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: Zurab Zedelashvili, Associate Director
Person responsible for approval of the Credit Ratings: Henrik Blymke, Managing Director
The Credit Ratings/Outlook were first released by Scope Ratings on 22 March 2019. The Credit Ratings/Outlook were last updated on 4 November 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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