Rating action

Scope Ratings GmbH (Scope) has today assigned a BB-/Stable first-time issuer rating on the Hungarian construction company KÉSZ Holding Zrt. Scope has also assigned a first-time rating of BB on the senior unsecured debt issued by KÉSZ Holding Zrt.

Rating rationale

KÉSZ’s issuer rating is supported by the group’s position as one of the leading construction companies in Hungary, with a robust construction backlog and activities in other segments (energy and business services) which partially limits cash flow volatility and leads to relatively stable profitability. The main constraint on the rating is the group’s exposure to the high cyclicality of the construction sector, combined with limited geographic diversification. Additionally, the expected increase in leverage to finance the group’s expansion, will put credit metrics under pressure in the short to medium-term.

KÉSZ’s business risk profile (assessed at B+) is mainly driven by its position as the third largest construction company in Hungary, with revenues of HUF 197bn and Scope-adjusted EBITDA of HUF 13bn in 2022 (based on preliminary figures). The group’s market position benefits from its vertical integration – and being a one-stop shop - as KESZ's subsidiaries can carry out the designing, manufacturing, and implementation of new construction projects, generating efficiencies in both the cost and duration of projects. Furthermore, KÉSZ’s limited dependency on external subcontractors supports its market position by maintaining consistent quality across all their products and services. While KÉSZ’s main activity is their general construction business (67% of revenue in FY 2022) followed by their steel manufacturing and implementation business (12% of revenue in FY 2022), the group has other business lines providing diversification and revenue streams that are not dependent on the construction cycle (asset management; energy; and services such as project management and IT infrastructure). This spread of activities partially limits cash flow volatility and leads to relatively stable profitability.

Profitability, as measured by the Scope-adjusted EBITDA margin, was relatively stable between 7%-8% during the past two years, supported by higher demand for projects and the company’s integrated business model. Scope expects profitability to remain stable around 6.5%-7.5%, as rising prices of raw materials together with inflation are expected to put pressure on margins (the European Commission forecasts Hungarian inflation at 16.4% in 2023). To mitigate this, the company plans to assess construction contracts based on i) pricing; ii) hard or soft terms in contracts; iii) the possibility to pass on price increases in contracts; iv) managing exchange rate volatility (only bidding with exchange rate clauses); and v) only committing to a certain level of raw material prices. Scope notes some downside risks of being a conglomerate, as this could result in limited room to maneuver the group’s cost structure, which could lead to a prolonged period of deprived profitability.

The group’s construction order backlog, as of March 2023, amounts to HUF 287bn (including ongoing and contracted projects) resulting in a healthy backlog of 1.7x (considering the average revenue over the past three years) and providing top line visibility until end-2024. The current order backlog includes projects with large multinational companies such as BMW, LEGO, and Mercedes-Benz. Hungary's automotive and battery industries have been growing rapidly in recent years, making the country increasingly important for these sectors in Europe. KÉSZ are benefitting from their existing relationships with these international clients through repeated business, as these clients continue to expand their operations in Hungary. These larger projects provide good visibility on KÉSZ’s cash flow over the next 18-24 months. The group’s top line will be supported by other segments generating recurring income, including their energy and services segments (projected at HUF 97bn over the next three years).

The main constraint on the rating is the group’s exposure to the high cyclicality of the construction sector, combined with limited geographic diversification, reflected in 93% revenue being generated in their domestic market, which weakens their ability to mitigate economic cycles. While KÉSZ have many industrial projects underway, the construction sector is experiencing a significant slowdown worldwide, particularly in Hungary, with output down almost 4% in 2022 YoY, caused by a spike in the cost of materials (24.5% higher YoY)¹. In addition, the volume of contracts awarded in the construction industry in Hungary in January 2023 was down 10.6% YoY. KÉSZ’s large exposure to Hungary – with only a marginal project-related side business outside of Hungary – poses a significant risk for the company. The group also has a weak customer diversification (top 10 >80%; top 3 >60%) though this is partially mitigated by the strong credit quality and long-standing relations with their key clients.

The financial risk profile (assessed at BB) is supported by the group’s credit metrics, including robust debt protection and adequate liquidity. KÉSZ’s main drivers of indebtedness are the corporate bonds (HUF 22bn and HUF 11bn) issued under the Hungarian Central Bank’s Bond Funding for Growth Scheme to partially finance their significant capex programme. Scope-adjusted debt/EBITDA stood at 3.0x as of December 2022, based on preliminary figures. However, Scope expects that Scope-adjusted debt/EBITDA will approach 4x following an anticipated increase in leverage to finance the group’s expansion plans, which involves increasing debt from HUF 48bn – which includes a HUF 5.7bn bond from their subsidiary Greenergy, and bank financing of c. HUF 9.3bn – to HUF 67bn by end-2023. Leverage, as measured by Scope-adjusted FFO/debt, is weak, and is expected to remain low around 12-14% by the end of 2024, when a number of large developments (with stronger margins) will be completed, further boosting the groups top line.

Debt protection, as measured by the Scope-adjusted EBITDA interest cover, has benefited from the low cost of debt in the past few years, and stood at 6.2x in 2022. However, financial costs are expected to increase with the anticipated KÉSZ bond issuance in Q2 2023 (at an average coupon of 6%, denominated in Euro) and an additional bank development facility of HUF 6.7bn (also denominated in Euro). Scope anticipates debt protection to decline over the next two years, caused by the increase in leverage. However, Scope forecasts that EBITDA interest cover will remain above 5.0x during this time. Currently, the group has 78% of its debt at a fixed-rate, with an average interest rate of 3.2%. However, the anticipated increase in debt in Q2 2023 – at a much higher fixed-rate than its existing facilities – will bring the fixed-rate debt to 85%, with a new average interest rate of 4.6%. The groups remaining debt – primarily made up of overdraft facilities which are subject to floating rate interest – expose the company to the potential risk of a significant rise in the 3-month BUBOR rate.

KÉSZ’s liquidity is adequate as the group benefits from a back-loaded debt maturity profile, with no significant amount due in the coming years. The group’s reported cash balances remained strong with HUF 23bn by end-2022 and given the long maturity of their bonds, upcoming short-term maturities will be manageable. However, free operating cash flow is expected to be highly negative in 2023, mainly driven by the group’s capex and increasing working capital requirements (inventory built up from real estate developments) and is expected to be partially financed by the upcoming bond issuance and bank facility. Free operating cashflow is expected to stabilise in 2024 upon the completion of a number of large projects.

Scope did not identify any ESG-related rating driver which would have a relevant impact on our overall assessment on credit risk (neither positively nor negatively). The KÉSZ Group plans to publish their first concise ESG report in 2023.

Outlook and rating-change drivers

The Outlook is Stable and incorporates Scope’s view that the company will continue to generate positive operating cash flow based on its current backlog. It also reflects Scope’s expectations of a successful execution of the group’s current construction projects, as well as Scope-adjusted debt/EBITDA remaining below 4x and Scope-adjusted interest cover remaining above 5x. Scope's outlook considers the group's commitment to a cautious financial approach, particularly regarding the distribution of dividends and investments for expansion.

A positive rating action is remote but may be warranted if the business risk profile improved, with size and diversification improving (by customer and project), combined with Scope-adjusted debt/EBITDA remaining below 3.0x on a sustained basis.

A downgrade could be required if KESZ’s leverage significatively deteriorated to above 4.0x on a sustained basis or if their order backlog dropped below 1x. This could be caused by a deterioration in market conditions and fewer projects being added to the backlog.

Long-term debt ratings

In June 2021, KÉSZ issued a HUF 22bn senior unsecured bond (ISIN: HU0000360466) through the Hungarian Central Bank’s Bond Funding for Growth Scheme. This was followed by a 2nd issuance of HUF 11bn senior unsecured bond (ISIN: HU0000360870) in November 2021 under the same scheme. The proceeds of the bonds were used to support the group’s working capital financing needs and to secure long-term funding for group-wide expansion plans. Both instruments have a tenor 10 years, with the HUF 22bn bond having a fixed coupon of 2.8% and the HUF 11bn bond having a fixed coupon of 4.1%. The repayments of both instruments are in five tranches starting from 2026, with 10% of the face value payable yearly, and 50% balloon payment at maturity.

Scope notes that KÉSZ’s senior unsecured bond issued under the Hungarian Central Bank’s bond scheme has an accelerated repayment clause. The clauses require KÉSZ to repay the nominal amount (HUF 22bn & HUF 11bn) in case of a rating deterioration (2-year cure period for a B/B- rating, repayment within 30 days after the bond rating falls below B-, which could have default implications). In addition to the rating deterioration covenant, other covenants include (i) change of control, (ii) maximum dividend 50% PBT, and (iii) consolidated net debt/EBITDA above 4x.

Scope’s recovery analysis is based on a hypothetical default in 2024, which assumes outstanding senior unsecured debt of HUF 49bn in addition to HUF 11bn in bank loans, payables of HUF 34bn and other financial obligations of HUF 3.5bn, assuming the group draws on available overdrafts. The recovery assessment results in an ‘above-average’ recovery for senior unsecured debt and therefore Scope assigns a BB debt for KÉSZ’s debt instruments in this category (one notch above the underlying issuer rating).

Rating driver references
1. EVOSZ

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 Outlooks, (General Corporate Rating Methodology, 15 July 2022; Construction and Construction Materials Rating Methodology, 25 January 2023), 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 Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and Outlooks are UK-endorsed.
Lead analyst: Rigel Scheller, Director
Person responsible for approval of the Credit Ratings: Thomas Faeh, Executive Director
The Credit Ratings/Outlooks were first released by Scope Ratings on 30 March 2023.

Potential conflicts
See www.scoperatings.com under Governance & Policies/Regulatory for a list of potential conflicts of interest related to the issuance of Credit Ratings.

Conditions of use/exclusion of liability
© 2023 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Ratings UK Limited, Scope Fund Analysis GmbH, Scope Investor Services GmbH, and Scope ESG Analysis GmbH (collectively, Scope). All rights reserved. The information and data supporting Scope’s ratings, rating reports, rating opinions and related research and credit opinions originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data. Scope’s ratings, rating reports, rating opinions, or related research and credit opinions are provided ‘as is’ without any representation or warranty of any kind. In no circumstance shall Scope or its directors, officers, employees and other representatives be liable to any party for any direct, indirect, incidental or other damages, expenses of any kind, or losses arising from any use of Scope’s ratings, rating reports, rating opinions, related research or credit opinions. Ratings and other related credit opinions issued by Scope are, and have to be viewed by any party as, opinions on relative credit risk and not a statement of fact or recommendation to purchase, hold or sell securities. Past performance does not necessarily predict future results. Any report issued by Scope is not a prospectus or similar document related to a debt security or issuing entity. Scope issues credit ratings and related research and opinions with the understanding and expectation that parties using them will assess independently the suitability of each security for investment or transaction purposes. Scope’s credit ratings address relative credit risk, they do not address other risks such as market, liquidity, legal, or volatility. The information and data included herein is protected by copyright and other laws. To reproduce, transmit, transfer, disseminate, translate, resell, or store for subsequent use for any such purpose the information and data contained herein, contact Scope Ratings GmbH at Lennéstraße 5 D-10785 Berlin.