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Rating action

Scope Ratings GmbH (Scope) has affirmed the BB-/Stable issuer rating of Hungarian construction company ÉPKAR Zrt. Scope has also affirmed the company’s BB senior unsecured debt rating.

Rating rationale

The credit rating is supported by ÉPKAR’s strong credit metrics, whose resilience during the Covid-19 pandemic was strengthened further by the acquisition in January 2022 of a performing office building in central Budapest. The acquisition also helped to diversify cash flows through rental income (invoiced in euro). New privately funded projects have also improved the diversification of cash flows away from government contracts, necessitated by the slowdown in public infrastructure contracts that can be alleviated only once Hungary resolves its dispute with the European Union. Scope’s backlog calculation therefore excludes any signed but unfunded government contracts, resulting in a lowered figure over the last 12 months of two years from 2.5 years. The roughly one year of revenue backlog excluded from Scope’s base case will be well placed once EU funding resumes. This is because it relates to hospital and school infrastructure projects, two areas in urgent need of attention. Spared from the suspension is HUF 700bn of funding, which benefit two of ÉPKAR’s projects (Nyíregyháza Stadium and ELTE Márton Áron Szakkollégium dormitory renovation).

The financial risk profile remains unchanged at BBB since the last yearly review, based on cash flows stabilised through a stronger-than-expected business environment and diversification into rental cash flows and privately funded projects.

In terms of leverage, the Scope-adjusted debt/EBITDA ratio peaked at 3.0x at year-end 2020 (adjusting for cash earmarked for property acquisitions). After the company used bond proceeds for the office acquisition and reaped the benefits at EBITDA level, Scope forecasts deleveraging to a 2.4x Scope-adjusted debt/EBITDA at YE 2022 and further to 1.8x in 2023. In 2024, Scope would have projected further deleveraging as performance is set to normalise; instead, leverage is expected to return to 2.7x, given the market uncertainty, the lack of EU funding and the inclusion of only contracted and funded projects in Scope’s base case. Leverage as measured by Scope-adjusted funds from operations/debt will remain comfortably above 30% during the forecast period, even with the cliff risk built into Scope’s base case in 2024.

Scope expects interest coverage to remain strong at above 10x, protected by only a fixed-rate exposure on interest-bearing liabilities (MNB bond) at a very favourable rate of 3%. Given the high cash cushion on the balance sheet, only part of which is used as working capital, ÉPKAR placed HUF 3bn on a time deposit yielding double-digit interest rates, improving interest cover significantly. Cash flow cover remains strong with positive free operating cash flow. However, the backlog remains concentrated, with the top three projects providing 47% of future revenues, posing a risk in the event of cost overruns or delays.

The rating is mainly constrained by the business risk profile (assessed at B). The company is small in a European construction context, which lessens its ability to mitigate economic downturns. Weak geographic diversification (predominantly active in Hungary), segment concentration and a dependency on government contracts, which only recently has been addressed, are further constraints. Scope also judges the issuer’s backlog as concentrated, though somewhat improved over the last 12 months through private projects and mitigated by the investment grade counterparties on the government side. The book-to-bill ratio is volatile at below 1x (excluding signed but unfunded projects).

The above-average profitability continues to be a strength for the business risk profile. With increased visibility through rental cash flows and a still decent backlog until mid-2024, Scope foresees profitability to remain above the peer average, at a 13%-15% Scope-adjusted EBITDA.

Liquidity remains adequate with very limited short-term debt (HUF 171m) against positive free operating cash flow and high unrestricted cash holdings.

Outlook and rating-change drivers

The Outlook is Stable and incorporates Scope’s view of healthy cash flow via the construction backlog in addition to rental income from the office property, which itself can cover the cost of debt by more than 2x. Scope foresees deleveraging in 2023 to a Scope-adjusted debt/EBITDA of around 1.8x based on cash flow visibility from the backlog and assuming rental cash flows remain at current levels. ÉPKAR’s backlog stretches into mid-2024, after which there are several large but unfunded government projects. Scope’s main concern is the dependency on government contracts ultimately tied to EU funding.

A positive rating action may be warranted by a much stronger business risk profile – evidenced by a higher market share, a larger, more diversified backlog, improved segment diversification, and a larger exposure to market-based projects – while Scope-adjusted debt/EBITDA is kept at around or below 2x.

A negative rating action could occur if Scope-adjusted debt/EBITDA reached above 3.5x on a sustained basis, or if the backlog decreased below one year because the public backlog contraction could not be offset by new market-based contracts. Increased leverage could be triggered by either i) an adverse operational development leading to reduced profitability and cash flows; or ii) additional debt-funded real estate acquisitions. Losing access to EU funding and jeopardising already signed contracts could also constitute a negative rating trigger into 2024.

Long-term and short-term debt ratings

Scope still expects an ‘above average’ recovery for the company’s unsecured debt and has affirmed the senior unsecured debt rating at BB (one notch above the issuer).

Scope’s recovery analysis is based on a hypothetical default scenario at year-end 2023, assuming outstanding senior unsecured debt of HUF 14.5bn (bond loan and payables) in addition to senior secured bank debt of HUF 2.7bn (loan facility, cash advances, guarantees).

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, (General Corporate Rating Methodology, 15 July 2022; Construction and Construction Materials Rating Methodology, 25 January 2022; European Real Estate 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 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, the Rated Entities' Related Third Parties 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 Faeh, Executive Director
Person responsible for approval of the Credit Ratings: Olaf Tölke, Managing Director
The Credit Ratings/Outlooks were first released by Scope Ratings on 28 February 2020. The Credit Ratings/Outlooks were last updated on 5 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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