Scope affirms ITK’s issuer rating of BB-, Stable Outlook
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Scope Ratings GmbH (Scope) has affirmed the issuer rating and Outlook of BB-/Stable on Hungarian public transportation services provider and vehicle manufacturer ITK Holding Zrt. (ITK). Senior unsecured debt is also affirmed at BB-.
The BB- rating on ITK continues to incorporate a three-notch uplift reflecting strong support from majority shareholder MOL Group, which adds financial stability, risk management and professional backing to the company.
ITK’s business risk profile (assessed at B+) is underpinned by a stable public transportation services business. The company has six long-term contracts (five of which are 10 years or more from inception) for the provision of bus services in Hungary, with a high certainty of cost recovery over the term of the contracts. ITK also benefits from a relatively modern (aged 6.6 years on average) bus fleet comprising 528 vehicles at the end of 2022.
The company’s smaller business services operations have a long track record of stable margins. They performed particularly well in 2021, although 2022 reflected a drop in performance as certain profitable contracts were non-recurring. Risk has also risen in the more recently established vehicle manufacturing business, which started production in 2019. This business benefits from a collaboration with Daimler, whereby all vehicles produced by ITK (buses and vans built on Mercedes-Benz base vehicle/product) carry the Mercedes-Benz logo. Alongside its own Reform brand, ITK produces vehicles to order, most of which are lower value-added modifications to near-ready vehicles, although a growing share of production comprises ‘bodybuilding’ on Mercedes-Benz drivable chassis. The key to success will be ITK’s ability to ramp up production volume and increase the share of higher value-added units.
Profitability is strong and stable in business and transportation services. But vehicle manufacturing has been operating at a loss due to earlier startup costs, suboptimal production volumes, supply chain issues and then dampened demand in 2022. The company produced only 149 vehicles in 2021 and increased production to 258 in 2022, although both years were below expectations. The company expects a significant ramp-up in production over the coming three years to reach around 500 vehicles per annum. ITK needs a significant portion of these buses for additions to its own fleet, which ensures some demand.
Scope expects profitability to improve in 2023 as price increases are passed on to customers primarily through revised contracts in transportation services (Intertanker and Intertanker City). Scope also expects the overall group margin to show some dilution from the ramp-up of lower-margin vehicle manufacturing, sales and general distribution (ITE, ITE Bus and Truck). Supplier and customer concentration is high, but most are well-established industry players with a good credit standing.
ITK’s financial risk profile (assessed at B-) reflects very high leverage, measured by the Scope-adjusted debt/EBITDA ratio, which spiked to over 30x in 2022. Due to supply chain constraints, the company had to pay for new buses upfront in Q2 2022. But it was not able to realise revenue under the corresponding contract until September, resulting in disproportionately low profitability due to the timing mismatch. Even more impactful was the purchase of 100 buses for a contract with BKV where related cash flow commenced only in December 2022. Phasing-in of price increases that ITK negotiated last year did not come into effect to recover lost profitability early in the year either.
ITK ruled out a potential investment in a new HUF 20bn production plant at Debrecen due to economic and financial circumstances. However, the company recently closed on deals with Mercedes Benz to become its general distributor for trucks in Hungary starting in early to mid-2023. Leverage is expected to decline towards 10.5x in 2023E as the first full-year contribution from the expanded fleet and contracted price increases takes effect. Thereafter, leverage is expected to gradually fall to around 8.0x in 2025E.
Scope expects sizeable investments of around HUF 10bn, primarily in the bus services fleet for Intertanker and Intertanker City, to continue in 2023-25. With a ramp-up of vehicle production and growth in revenues from adjacent services operations (ITE/ITE Bus and Truck), Scope expects the company to reach free operating cash flow breakeven in 2025, a year later than previously forecasted due to 2022’s outlier financial results. Scope understands that shareholders prioritise growth and do not expect to extract dividends from the company in the short to medium term.
ITK had HUF 1.4bn of liquid assets and HUF 4.4bn of short-term debt at the end of 2022. In 2021, the company issued a HUF 20bn senior unsecured bond (ISIN: HU0000360631) with a fixed annual coupon under the Hungarian National Bank’s Bond Funding for Growth Scheme. The bond refinanced most existing debt and has a 10-year tenor, with amortisation of 10% per annum in 2027 and 2028, 20% per annum in 2029 and 2030 and a 40% bullet maturity in 2031. Though the company remains highly dependent on the availability of short-term external funding, Scope still considers ITK’s liquidity position to be adequate due the potential for financial support from MOL Group for planned projects and temporary liquidity needs.
Scope expects fleet growth to be financed primarily by new secured bank loans going forward and, to a lesser extent, by subordinated loans and equity from MOL Group. In addition to funding support, MOL Group also provides support in risk management and IT, resulting in a three-notch uplift to the ratings on ITK.
Outlook and rating-change drivers
The Stable Outlook reflects the stability of revenues and earnings from long-term public transportation contracts and the fact that financial support from MOL Group remains available if needed. Scope expects the company to gradually recover its profitability and move towards free operating cash flow neutrality over the next three years.
A negative rating action could occur if the company was unable to reduce leverage (as measured by the Scope-adjusted debt/EBITDA ratio) or bring free operating cash flow (FOCF) closer to breakeven (as measured by FOCF/Scope-adjusted debt). This could result from a failure to increase sales and production of higher value-added vehicles or from continued cost pressures not being passed on to customers. Deterioration in liquidity or MOL Group exiting the joint venture or not extending financial support when needed could also trigger a downgrade.
Scope also notes that ITK’s senior unsecured bond issued under the Hungarian Central Bank’s bond scheme has an accelerated repayment clause. The clauses require ITK 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).
Stronger-than-anticipated growth in sales and/or margins, resulting in leverage sustainably below 6x, could trigger an upgrade. Closer integration with MOL Group could also warrant a higher rating.
Long-term debt ratings
Scope rates senior unsecured debt in line with the issuer rating, based on pari passu ranking and a negative pledge provision in the bond documentation, limiting the extent of secured debt in the capital structure.
This results in a BB- debt rating of senior unsecured debt issued by ITK, including the HUF 20bn senior unsecured bond issued in 2021. The debt category rating reflects the ranking of the debt below more than HUF 20bn of secured loans and credit lines. Scope expects an ‘average’ recovery (30%-50%) for outstanding senior unsecured debt in a hypothetical default scenario based on the liquidation value approach.
Stress testing & cash flow analysis
No stress testing was performed. Scope Ratings performed its standard cash flow forecasting for the company.
The methodologies used for these Credit Ratings and Outlooks, (General Corporate Rating Methodology, 15 July 2022; European Automotive and Commercial Vehicle Manufacturers, 11 February 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 and the Rated Entity.
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.
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: Tiffany Ng, Director
Person responsible for approval of the Credit Ratings: Olaf Tölke, Managing Director
The Credit Ratings/Outlooks were first released by Scope Ratings on 14 April 2021.
See www.scoperatings.com under Governance & Policies/Regulatory for a list of potential conflicts of interest related to the issuance of Credit Ratings.
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