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Rating action

Scope Ratings GmbH (Scope) has today upgraded the issuer rating on Appeninn Holding Nyrt. to B+/Stable from B under review for possible downgrade. Scope has also upgraded the senior unsecured debt rating to B+ from B-, and removed the under review for possible downgrade status.

Rating rationale

The rating action follows the previous monitoring announced and subsequently executed acquisitions of three real estate portfolios, which were conservatively financed by cash on the balance sheet and by transferring one bank loan from one of the sellers. Through these acquisitions, the company improved credit metrics sufficiently to lift Appeninn’s issuer and senior unsecured debt rating to B+ and thus avoiding the rating trigger built into the MNB bond documentation for the HUF 20bn bond issued in 2019 (ISIN: HU0000359344) that stipulated a potential acceleration of the full nominal bond amount in mid-April.

Within the last month, Appeninn closed three transactions for a total consideration of EUR 73m: i) the acquisition of two retail parks in mid-sized cities in Hungary (Székesfehérvár and Zalaegerszeg) including taking over an existing loan of EUR 18m from the seller; ii) the acquisition of a retail park in Nagykanizsa (near the Hungarian-Croatian and the Hungarian-Slovenian borders) financed by cash; and iii) the acquisition of an office park in Warsaw (near the airport) financed by cash. All three acquisition portfolios consist of performing assets with occupancies between 82-95% and WAULTs of 1.9 to 6.5 years, which are expected to contribute to Appeninn’s revenue and EBITDA from the day of ownership.

Appeninn’s business risk profile assessment remains unchanged at B. This is driven by: i) the company’s small size, resulting in cash flow volatility; ii) its limited geographic diversification, concentrated on Budapest, the Hungarian countryside and Warsaw; and iii) still high tenant concentration. While Scope-adjusted assets improved to EUR 211m from EUR 135m thanks to the acquisitions, bringing the company back to the same asset base pre-disposals, the bolt-on acquisitions were not in Appeninn’s core geographic areas or asset classes and thereby did not improve market positioning. Tenant concentration dropped to 30%/52% from 49%/69% for the Top3/10 but remains weak in Scope’s view.

Further drivers are Appeninn’s asset quality, with the exposure to the second-tier market of Budapest, enhanced by its new outreach to Warsaw, which is seen as stronger, but negatively impacted by its countryside retail exposure. The relatively low and declining weighted average unexpired lease term (WAULT) of the new combined portfolio remains unchanged at 3 years, with the previously moderate occupancy rate of 89% on its commercial real estate exposure, a result of the ageing assets in need of maintenance spending, declining to 87% (including acquisitions).

Profitability, as measured by the Scope-adjusted EBITDA margin, has been volatile, averaging 68% for the period 2016-2022, with a trough of 49% and peak in 2022 of 80% after development costs were discontinued and omitted from the income statement. Going forward, Scope expects operating profitability to remain around 50%, burdened by high maintenance expenses.

The financial risk profile (assessed at BB-) benefitted greatly from the acquisitions. The significant cash amount on the balance sheet at year-end 2022 was assessed as temporary in the last monitoring and therefore did not benefit Appeninn’s credit profile, so deploying those cash holdings into performing real estate thereby had a positive effect.

After the acquisition of three target property portfolios and increasing indebtedness by a modest additional EUR 18.0m in secured debt, Scope expects interest cover to improve to 2.2x in 2023, and 2.5x in 2024 (from 1.7x at YE 2022), thereby strengthening the credit assessment.

Leverage as measured by the Scope-adjusted loan/value stood at 58% at YE 2022 and is expected to decrease to levels just below 50%, significantly strengthening credit metrics. This factors in around 3-4% negative fair value adjustments per annum for 2023 and 2024, based on widening yields in the absence of changes to Appeninn’s portfolio structure. Scope-adjusted debt/EBITDA remains elevated but is reduced to 12-15x from 17-18x, thanks to predominantly using cash for its EBITDA accreditive acquisitions instead of debt.

Given the improvement in credit metrics allowing for a higher assessment of the financial risk profile and thereby opening up for a higher assessment of the overall issuer rating, Scope’s liquidity concerns stemming from the covenant-driven potential near-term acceleration of its bond repayment have eased.

On a normalised going concern basis, Appeninn’s liquidity is adequate as the company benefits from a back-loaded debt maturity profile, with no significant amount due in the coming years. Free operating cash flow is expected to be highly negative in 2023 due to the acquisitions but given the already happened implementation and achieved financing structure, this does not pose a risk. Free operating cash flow excluding acquisition capex is expected to stabilise in 2024 and become positive, which is estimated to comfortably cover amortisation of debt.

Appeninn has seen multiple changes of management and strategy over the last four years, driven by changes in dominant shareholders, which has led to reduced clarity and transparency towards stakeholders and the rating agency. Contracts were, and continue to be, awarded to closely related companies and transactions are undertaken with related parties, which Scope cannot verify to be at arm’s length. In the current corporate structure, all corporate functions apart from the CEO are outsourced to third parties, with key functions assigned to related parties. Recent property transactions were questioned about being at arm’s length by the agency, with valuation documentation lacking the standards Scope expects for such transactions. Such behaviour raises concerns on transparency and corporate governance (ESG factor: credit-negative).

One or more key drivers of the credit rating action are considered an ESG factor.

Outlook and rating-change drivers

The Outlook for Appeninn is Stable. This factors in the recent property acquisitions, predominantly financed by available cash and a EUR 18m bank loan taken over from the seller. Scope expects credit metrics to benefit from these acquisitions and has therefore upgraded the issuer rating to B+. The Outlook also incorporates the issuer having remedied the threat of the full repayment of its bond in April 2023. It also incorporates stable rental income from Appeninn’s commercial real estate portfolio translating into Scope-adjusted EBITDA/interest cover of about 2.2x and a Scope-adjusted loan/value ratio of below 50% in 2023.

A positive rating action is remote but could be warranted if Appeninn reduced interdependencies with the owners’ other holdings and significantly improved its business risk profile while keeping credit metrics in line with the rating scenario of a Scope-adjusted loan/value ratio of below 50% and Scope-adjusted EBITDA/interest cover of about 2.2x. An enhanced business risk profile could come from improved asset quality, broader diversification, or an increase in portfolio size that reduces the dependency on single tenants and thereby makes cash flow less volatile.

A negative rating action would be possible if credit metrics deteriorated below Scope’s base case with Scope-adjusted loan/value moving above 55% and a Scope-adjusted EBITDA/interest cover sustained below 1.7x, considering the high cash flow volatility driven by a short WAULT. Furthermore, a change of strategy or business plan in the near or medium term could lead to a multi-notch downgrade.

Long-term debt ratings

Senior unsecured debt is rated at the same level as the issuer rating based on Scope’s recovery analysis given a hypothetical default scenario at year-end 2023. Despite showing an above-average recovery, Scope caps the rating at the issuer’s level in light of limited creditor protection for senior unsecured bond holders and the assumption that the company would use available headroom on a secured basis to shore up as much liquidity as possible on the path to default. The uncertainty around achievable advance rates in case of distressed sales takes into account: i) the weak cash flow protection from a short WAULT; ii) the high economic age of the property portfolio; and iii) the link between operational performance of properties and their values, in addition to volatility in Appeninn’s capital structure and governance issues, representing additional reasons for Scope to keep the debt category rating in line with that of the issuer.

In November 2019, Appeninn Holding issued a HUF 20bn senior unsecured bond (ISIN: HU0000359344) through the Hungarian Central Bank’s Bond Funding for Growth Scheme. The proceeds of the bonds were intended to acquire performing commercial real estate. The bond has a tenor of 10 years, with a fixed coupon of 3.5%. The repayment of the instrument is in full at maturity.

Scope notes that Appeninn’s senior unsecured bond issued under the Hungarian Central Bank’s bond scheme has an accelerated repayment clause. The clauses require Appeninn to repay the nominal amount (HUF 20bn) in case of a rating deterioration (2-year cure period for a B/B- rating, repayment immediately after the bond rating falls below B-, which could have default implications).

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; European Real Estate 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 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 Outlooks and the principal grounds on which the Credit Ratings and 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/or Outlooks are UK-endorsed.
Lead analyst: Thomas Faeh, Executive Director
Person responsible for approval of the Credit Ratings: Philipp Wass, Executive Director
The Credit Ratings/Outlooks were first released by Scope Ratings on 1 October 2019. The Credit Ratings/Outlooks were last updated on 2 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
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