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Rating action

Scope Ratings GmbH (Scope) has affirmed the BB- issuer rating of Duna Aszfalt Zrt. and revised the Outlook to Stable from Positive. Scope has also affirmed the BB rating for the senior unsecured debt category.

Rating rationale

The risk of a slowdown in cash flow amid impending headwinds including higher input prices, a lower order backlog and an unsupportive macroeconomic environment drive the Outlook change.

Duna Aszfalt’s resilient performance in 2021, with a revenue of HUF 303bn and Scope-adjusted EBITDA of HUF 67bn (respectively 6% and 8% above Scope’s forecast), drive the rating affirmation. Duna Aszfalt’s profitability – as measured by its EBITDA margin – has remained over 20% in recent years (22% in 2021, adjusted for provisions and impairments) and continues to support the rating.

While Scope acknowledges that Duna Aszfalt has continued sourcing new projects, there is little visibility on the sustainability of the group’s profitability level and orders beyond the execution of the existent order backlog. Revenue visibility is held back by the potential shrinkage of public procurements in coming years. The group’s strong dependence on public (EU-funded) infrastructure projects could weaken operating cash flow, especially given growing uncertainty over Hungary’s access to EU funding. After years of fiscal stimulus boosting Duna’s niche market – linked to EU funding priorities and specific local governmental policies – tenders have become scarce, leading to a lower order backlog (HUF 424bn in September 2022, down from HUF 498bn a year earlier).

Duna Aszfalt’s business risk profile (assessed at B) continues to be held back by its relatively small scale in the European context, which weakens its ability to mitigate economic cycles. Weak diversification is a further constraint, as Duna Aszfalt is strongly focused on the construction sector in Hungary. Within the sector, the group has a high exposure to motorway construction, where it generated more than 68% of revenue in H1 2022 (71% in 2021). The group also remains largely dependent on governmental demand and strategy (more than 63% of Duna Aszfalt’s revenue in 2021 came from Hungarian state-owned companies).

Increasing prices of raw materials are expected to put pressure on profitability. Scope anticipates a decline in margins in FY 2022 and beyond due to rising construction materials prices and potential supply chain disruptions, leading to weaker profitability and a reduction in the buffer against cost overruns. Profitability will likely remain below 15% in the next few years.

Duna Aszfalt’s financial risk profile (assessed at BBB-) benefits from solid credit metrics. Scope-adjusted debt/EBITDA was 1x as of December 2021, slightly below Scope’s expectations. Scope-adjusted EBITDA and Scope-adjusted debt were respectively 8% higher and 25% lower than expected. Scope anticipates that Scope-adjusted debt/EBITDA will increase to above 2x in the next few years and remains cautious about the sustainability of current credit metrics. Firstly, credit metrics are heavily influenced by the profitability of contracts in Duna Aszfalt’s current order backlog. Secondly, in previous years Duna Aszfalt has reduced long-term financial assets and increased cash balances to prepare for large projects and acquisitions. The HUF 62bn cash position at end-2021 is therefore not permanent, in Scope’s view. Debt protection, as measured by Scope-adjusted EBITDA interest cover, remained strong in the last years. Financial costs increased following the HUF 30bn bond issued in H2 2019 (3% coupon). The group plans to add a HUF 15bn bank loan to finance part of the investment plan. Although this would significantly increase total financial expenses amid the current interest rate environment in Hungary, Scope expects debt protection to remain strong given the group’s remaining backlog and associated operating cash flow.

Liquidity is adequate and benefits from a backloaded debt maturity profile comprising a HUF 30bn bond with a bullet maturity in 2029 and no significant amount due in coming years. In line with Scope’s expectations, the group’s cash balances remained strong with HUF 62bn by end-2021. Marketable securities (such as real estate funds) and expected positive free operating cash flow for 2022 enhance the group’s liquidity. Given the long maturity of the bond, upcoming short-term maturities will be manageable. All in all, the group has a sufficient cash buffer to finance its investment programme (about HUF 85bn).

Scope deems regulatory and reputational risks to be a negative rating driver (ESG factor). Scope believes that Duna Aszfalt’s market position in recent years has been gained by winning state tenders, thanks to the group’s well-established credentials for projects with state owned companies. State tenders accounted for more than 63% of total revenues in 2021, which creates a high dependency.

One or more key drivers for the credit rating action are considered ESG factors.

Outlook and rating-change drivers

The Stable Outlook is based on continued operations backed by an existing order backlog amid weaker profitability due to rising construction materials prices. Scope’s base case foresees credit metrics to remain robust but factors in the lower visibility on business fundamentals, including a weaker economic environment and inflationary pressures, but also the expectation of a gradual recovery of public procurements.

A positive rating action is possible if the group’s backlog strengthens, providing greater visibility on future cash flow and lowering dependency on state orders, paired with an unchanged solid financial risk profile.

A negative rating action could result from an order backlog dropping below 1x. This could be triggered by a deterioration in market conditions and fewer projects being added to the backlog. A downgrade could be required if Duna Aszfalt’s leverage, as measured by Scope-adjusted debt/EBITDA, significatively deteriorated to above 3.5x on a sustained basis.

Long-term debt rating

The recovery calculation considers the HUF 30bn unsecured corporate bond issued under the Hungarian National Bank’s Bond Funding for Growth Scheme. Further, in line with the group’s plans, Scope assumes that the business plan will be executed with HUF 15bn additional bank debt and, in addition, for the calculation Scope assumes: i) payables have a higher seniority than the bond; and iii) advances received have the same seniority as the bond. This view is based on the legal opinion provided by the local legal counsel.

Scope’s recovery analysis is based on a liquidation value of HUF 119bn in a hypothetical default in 2023. This value is based on a haircut of around 60% on assets and reflects liquidation costs of 10% for the assets. Scope expects an above-average recovery for senior unsecured debt. Thus, Scope affirms the BB rating for the senior unsecured debt category, which is one notch above the issuer rating. The uplift is limited by the risk and possibility of senior secured debt potentially increasing in the path to default (volatility of capital structure and share of 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 this Credit Rating 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 Rating if the Credit Rating were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The Credit Rating was 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 Rating: 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 Rating 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 Rating and/or Outlook and the principal grounds on which the Credit Rating and/or Outlook are based. Following that review, the Credit Rating was not amended before being issued.

Regulatory disclosures
This Credit Rating and/or Outlook is issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Rating and/or Outlook is UK-endorsed.
Lead analyst: Rigel Scheller, Director
Person responsible for approval of the Credit Rating: Sebastian Zank, Managing Director
The Credit Rating/Outlook was first released by Scope Ratings on 6 September 2019. The Credit Rating/Outlook was last updated on 15 October 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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