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Rating action

Scope Ratings GmbH (Scope) has today affirmed its B/Stable issuer rating on DVM Group Kft (DVM). Scope has also affirmed its B+ rating for the senior unsecured debt category.

Rating rationale

The rating affirmation is driven by DVM’s strong performance in 2022 as well as robust backlog that provides some cash flow visibility going forward. The company generated revenues of HUF 31.6bn based on preliminary figures (30% more revenue than in 2021 and 31% more than Scope’s forecast), mainly driven by fit-out construction works. While top-line figures have improved considerably, the crisis has impacted the company’s profitability, as measured by the Scope-adjusted EBITDA margin, which stood at 4.4% in 2022 based on preliminary figures (7.8% in 2021 and 1.2% below Scope’s forecast). This was mainly due to the energy crisis impacting construction material prices, with base-building projects subject to fixed contracts, and salary increases to retain high-quality staff.

DVM’s backlog of projects has weakened to HUF 52bn as of April 2023 (from HUF 68bn as of May 2022), equating to 1.9x the average revenue of the last three years (2.8x in 2022). The slowdown in DVM’s core market as evidenced by i) project developers postponing investment decisions; ii) access to financing sources becoming difficult; and iii) increased competition – as state developments are on hold – resulting in lower margins for projects and tenders that DVM participates in. To mitigate declining demand, DVM aims to benefit from planned co-developments, including an 18,000 sq m logistics facility and a residential project comprising 140 apartments. In addition, DVM has decided to enter the renewable energy sector by acquiring an 80% equity interest in a 20 MW photovoltaic project at the ready-to-build stage, to begin operation in 2025. Execution risk is partially mitigated by engaging an industry expert company on the project.

Scope assumes that DVM will continue to generate revenues at least at historical levels, backed by its robust backlog of projects. In addition, a higher expected contribution from fit-out activities will partially help protect revenues and profitability in the next few years. However, Scope expects high prices for raw materials will continue to put pressure on profitability. Scope’s forecast assumes DVM will keep its profit margin at around 5% over the next 12-18 months.

DVM’s business risk profile (assessed at B-) continues to benefit from its good vertical integration. This includes a wide range of services in the different stages of the construction value chain (design, project management, contracting, base-building, and fit-out services). DVM also has a good domestic network and longstanding relationships with its main clients. The rating remains constrained by the company’s small scale in both the European and Hungarian context. Weak diversification is a further constraint, namely: i) a lack of geographical diversification; ii) a high reliance on one segment (building activities); iii) a strong reliance on certain key customers; and iv) a concentrated backlog (with the top three and top 10 projects representing about 79% and 99% of the total respectively).

The company’s financial risk profile (assessed at B+) reflects robust debt protection, as indicated by a Scope-adjusted interest cover ratio of 5.3x in 2022 (based on preliminary financials). Scope anticipates interest cover will remain above 6x on average in the next few years, benefiting from a significant part (91% as at end-2022) of financial debt being subject to fixed interest rates. Leverage, as measured by the Scope-adjusted debt/EBITDA, stood at 6.3x as at December 2022. Scope-adjusted debt/EBITDA is expected to remain above 6x in 2023 due to: i) weaker-than-expected cash flow generation; and ii) an increase in indebtedness to partially finance the co-development of a logistics facility (HUF 1.7bn in 2024), before stabilising at a level commensurate with the rating category once developments are complete and provide a boost to the company’s top line. However, Scope acknowledges DVM’s unrestricted cash and cash equivalents (HUF 8.4bn as at end-2022) that almost exceed its limited financial debt (HUF 8.8bn as at end-2022) and that planned investments are of a discretionary nature.

Liquidity is adequate. It benefits from cash and cash equivalents of HUF 8.4bn as at end-2022 and a backloaded debt maturity profile comprising a HUF 8.0bn bond maturing in 2030 with the first instalment (HUF 2.4bn) due in 2026 and no significant amounts due in the coming years. Scope expects the company’s low short-term debt levels to be maintained going forward and sufficiently covered by available financing sources.

Outlook and rating-change drivers

The Outlook remains Stable and incorporates the risk that the Scope-adjusted debt/EBITDA ratio will remain above 6x amid pressure on the company’s profitability. However, this is mitigated by a strong cash cushion available to the company, which limits external financing needs and supports good liquidity over the next 12-18 months. The Outlook also reflects a recovery in the company’s Scope-adjusted EBITDA margin to above 5% (after it fell to a trough in 2022) and interest cover remaining firmly above 10x. While Scope expects credit metrics to be in line with the rating category, the company’s small size and low diversification pose a significant threat to cash flow stability. Hence, Scope expects a noticeable improvement in cash flow diversification going forward, which could be driven by a higher share of EBITDA from the more granular fit-out business.

A positive rating is currently considered remote. But it could materialise if the company demonstrated an ability to improve its backlog-to-sales ratio to above 2.5x, including highly profitable projects that ensure a recovery in the Scope-adjusted EBITDA margin to above 7% – in combination with greater diversification (customers and projects). At the same time, Scope expects the company to gradually deleverage after investments peak in 2024, bringing the Scope-adjusted debt/EBITDA ratio down below 6x on a sustained basis.

A negative rating action could occur if the Scope-adjusted debt/EBITDA ratio remained above 6x for a prolonged period (beyond 2024) while the company’s current strong cash position deteriorated significantly.

Long-term debt rating

In July 2020, DVM issued a HUF 8.0bn senior unsecured bond (ISIN: HU0000359781) through the Hungarian central bank’s Bond Funding for Growth Scheme. The bond proceeds were used for co-developments (HUF 0.8bn) and for working capital purposes (HUF 2.0bn), while the remainder is to be invested in planned co-development projects. The bond has a tenor of 10 years and a fixed coupon of 3%. Bond repayment is in three tranches starting from 2026, with HUF 2.4bn of the face value payable in 2026 and 2028 and the remaining portion payable as a balloon payment at maturity. Bond covenants include no dividend payments before 2022, plus change of control and LTV clauses regarding co-development financing (LTV greater than 50% for single co-development projects and greater than 30% for overall co-developed projects).

Scope’s recovery analysis is based on a hypothetical default scenario occurring at year-end 2024. It assumes outstanding senior unsecured debt of HUF 8.0bn and additional secured bank debt of HUF 1.7bn to partially finance DVM’s co-development projects. The result was an ‘above average’ recovery for the company’s unsecured debt. Scope therefore affirms the B+ rating for this debt category (one notch above the issuer rating).

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 Outlook, (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 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 Outlook and the principal grounds on which the Credit Ratings and/or Outlook are based. Following that review, the Credit Ratings were not amended before being issued.

Regulatory disclosures
These Credit Ratings and/or Outlook are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and/or Outlook are UK-endorsed.
Lead analyst: Rigel Scheller, Director
Person responsible for approval of the Credit Ratings: Philipp Wass, Executive Director
The Credit Ratings/Outlook were first released by Scope Ratings on 26 May 2020. The Credit Ratings/Outlook were last updated on 28 April 2022.

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

Conditions of use/exclusion of liability
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