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Rating action

Scope Ratings GmbH (Scope) has today affirmed the BB/Stable issuer rating of Hungarian tyre distributor Abroncs Kereskedőház Kft. (AKH) along with its BB long-term senior unsecured debt rating.

Rating rationale

The affirmation of the issuer rating is supported by the company’s strong results in 2021. Despite a weaker environment for the Hungarian tyre market, AKH increased its EBITDA from HUF 1.1bn to HUF 1.3bn in 2021 (excluding the impact from the acquisition of ARS) while maintaining its EBITDA margin of 4.8%. This is the result of discontinuing the low-profitability drop-shipping business without a decline in volume and replacing it with AKH’s own online platform. Additionally, the company has continued to develop its retail segment for passenger car sales. A shortage of tier 3 Chinese-brand tyres has enabled AKH to improve its revenue mix by selling additional exclusive tier 2 brands from Japan and Korea.

In October 2021, AKH announced a full acquisition of Slovakian dealer ARS from Bridgestone. ARS is a retail specialist in passenger car, truck and bus tyres. It operates seven outlets across the country. In truck and bus tyres, ARS has a market share of over 30%. The newly acquired company generates HUF 4bn-5bn in revenues and has 80 employees. The full consolidation was implemented as of 1 January 2022. Results for the first half of 2022 show a recovery at ARS, with an EBITDA margin above 5% after breaking even in 2021. This was driven by its ongoing offer diversification, in which ARS has extended its number of brands sold as well as its number of sales channels. Scope therefore does not expect ARS will impair AKH’s profitability going forward.

The issuer rating continues to reflect AKH’s leading position and high market share in tyre retailing and wholesaling, where it accounts for more than 30% of the Hungarian market. This is a consequence of the company’s strong presence in B2B and B2C distribution, supported by the extended brand portfolio and broad presence in Hungary. The partial integration of its model, brought by car services stores and an exclusive partnership with BP Lubricants (around 7% market share), has also enabled it to reduce its exposure to the seasonality inherent in the tyre market and diversify its offering beyond just one product type. In addition to lubricants, AKH can rely on strong relationships with its suppliers, exhibited by a balanced mix between exclusive and semi-exclusive products and other brands, including those of worldwide tyre makers (among them are Continental and Bridgestone). Despite its strong market share in Hungary, the company’s business risk profile is limited by its small size, strong competitors, little prospect of domestic growth and low potential for expansion.

In addition, the business risk profile (assessed at B+) is still constrained by weak geographical diversification (80% of revenues from Hungary) and the types of products sold. Although the acquisition of ARS expands the company’s geographical reach (expected to reduce the share of revenues from Hungary to below 70%) and types of products sold, it does not change the overall business risk profile assessment due to the company’s limited size. On the other hand, Scope views positively the diversified pool of customers (car leasing companies and retailers) and the diversified sales channels with an increasing share of B2C online sales. The latter have grown by 250% during the Covid crisis.. In addition to a better brand mix and controlled opex, profitability surged from 2.3% in 2019 to 4.8% in 2021. Nevertheless, the EBITDA margin driven by seasonality and the high share of B2B distribution in revenues, remains below average and continues to put pressure on the rating.

AKH will continue to face challenges in the supply chain. The ongoing impact of tyre producers’ price increases and the adverse HUF/EUR exchange rate (where AKH purchases in EUR and sells in HUF) are not expected to put pressure on company profitability as the increased costs will be passed on to end customers. Nevertheless, Scope foresees a decline in consumer demand coupled with rising staff costs for 2022. The company is expected to protect its EBITDA margin thanks to ARS’ recovery and the development of more value-added segments, such as lubricants and tyre shop services.

AKH’s financial risk profile (assessed at BBB-) is a clear support for the rating case thanks to its good credit metrics, including high interest cover and good leverage. With the acquisition of ARS, credit metrics such as the Scope-adjusted debt (SaD)/EBITDA ratio has remained under control at less than 3.0x. The leverage is assessed throughout the fiscal year because the working capital consumption is at the lowest at year end, giving a biased picture of the true company’s indebtedness. The working capital is highly seasonal and generally peaks twice a year in Q1 and Q3. Therefore, Scope adjusts part of the cash as restricted considering it is to be used yearly to fund AKH’s inventory. In 2021, SaD/EBITDA reached 2.9x. The acquisition of ARS (consolidated in 2022), the additional capex needed by this new company, and the deteriorating working capital are not expected to put leverage under pressure though at a manageable 2.2x in 2022. The negative driver of the financial risk profile is volatile free operating cash flow generation, driven by low capex (below 2% of sales) paired with highly volatile working capital. The consolidation of ARS should lead to higher working capital consumption and higher capex. This is expected to weigh on free operating cash flow.

Scope’s rating base case assumes ARS’ consolidation within AKH from 1 January 2022 (although ARS was acquired in the second half of 2021).

Despite low to negative free operating cash flow, liquidity remains adequate with no major short-term debt except for HUF 200m and HUF 350m bond amortisations in 2022 and 2023, fully covered by unrestricted cash balance and HUF 1.0bn of undrawn credit line.

Outlook and rating-change drivers

The Outlook is Stable and incorporates Scope’s expectation that the SaD/EBITDA ratio will remain below 3.0x throughout the year, including when working capital seasonality peaks. The Outlook also reflects Scope’s expectation of a stable EBITDA margin from the continued recovery of ARS, limited disruption in the supply chain and the capacity to pass on price increases to end customers.

A positive rating action could be warranted either by an improvement in AKH’s business risk profile, which could be achieved via better diversification, or by a material increase in operating margins.

A negative rating action could be taken if the SaD/EBITDA ratio increased towards 3.5x on a sustained basis or significant shareholder remuneration was undertaken contrary to Scope’s expectations. An increase in leverage could be triggered by a rise in net debt due to larger-than-anticipated capex and working capital consumption.

Long-term and short-term debt ratings

All senior unsecured debt is issued by Abroncs Kereskedőház Kft. We affirm a BB debt rating to the senior unsecured debt of AKH. This rating is based on a hypothetical liquidation scenario as of year-end 2024, in which we computed an ‘average’ recovery for holders of senior unsecured debt based on our 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 methodologies used for these Credit Ratings and/or Outlooks, (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 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 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: Thomas Langlet, Senior Analyst
Person responsible for approval of the Credit Ratings: Olaf Tölke, Managing Director
The Credit Ratings/Outlooks were first released by Scope Ratings on 20 November 2020. The Credit Ratings/Outlooks were last updated on 25 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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