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Rating action

Scope Ratings GmbH (Scope) has affirmed the BB+ issuer rating on Pannonia Bio Zrt. and changed the Outlook to Negative from Stable. Scope has also affirmed the BBB senior secured debt rating and the BB+ senior unsecured debt rating.

Rating rationale

The Outlook change to Negative is driven by the risk of weak ethanol margins and plant underutilisation for a prolonged period as well as adverse regulatory interventions in Hungary that are affecting the company’s business and financial risk profiles. These factors have more than offset the positive impact of recent investments in efficiency and the development of new products. The rating affirmation reflects the company’s still moderate business risk profile and good financial risk profile.

The increase in prices in 2021 for main commodities inputs (corn, natural gas and electricity) and outputs (ethanol and animal feed) was amplified in 2022 by the Russia-Ukraine war, reaching unprecedented levels. While the tight European bioethanol market supported crush margins for most of the year, high ethanol prices in Europe attracted record import volumes, primarily from the US and Brazil, where increases in input costs were less significant. Despite high import tariffs and shipping costs, net imports reached around 25% of total European (EU and UK) consumption. As a result, European ethanol prices fell sharply in Q4 2022, pushing crush margins into negative territory and indicating the weaker protective effect of tariffs. Some ethanol producers could still generate positive results and maintain output, supported by measures in several Western European countries to protect industries and households from the rocketing energy prices or by hedges concluded before the war in Ukraine. Other ethanol producers, however, primarily in Central and Eastern Europe, including Pannonia Bio, did not receive state support and were forced to reduce or halt production. The shortage of corn in Hungary and the region also resulted in the local corn price surpassing benchmarks, weakening Pannonia Bio’s profitability, which remained low into Q1 2023. The company stated that it has returned to full utilisation in Q2 2023 following some recovery in its margins.

Scope expects relatively stable bioethanol demand and production in Europe, implying that the significant import volumes will be sustained. Corn and energy prices have receded from their 2022 highs and supported the recent recovery in ethanol margins. Nevertheless, commodity prices remain volatile and Scope expects crush margins to gradually stabilise below multi-year averages.

Scope notes that the combination of much higher import volumes and state support for energy-intensive industries (including ethanol production) in several Western European countries has intensified competitive pressure on Pannonia Bio and hampered its profitability, offsetting the positive impact of recent investments. A persistent risk of weak margins and plant underutilisation could result in a lower business risk profile assessment (currently at BB-).

In 2022, the Hungarian government introduced measures aimed at tightening the fiscal balance, including windfall taxes on specific sectors such as energy and banks. In September 2022, Pannonia Bio paid the advance windfall tax of EUR 36m based on a preliminary calculation methodology and on estimated profits for 2022. Following clarifications by the tax authority and a significant worsening in Pannonia Bio's profitability in Q4 2022, the company revalued the amount of windfall tax due for 2022 and is now claiming back the majority of the advance tax payment. Discussions with the tax authority are ongoing. The limited policy predictability is supressing Pannonia Bio's risk appetite and the company is likely to significantly reduce capex going forward compared with the previously expected level of around EUR 100m a year. The company is also likely to focus on dividend distribution and consider the interests of senior lenders.

In May 2023, Pannonia Bio signed an agreement to dispose of its solar projects. The total consideration includes transferred shareholder loans, with a major part being due in 2025. The disposals are expected to be complete in June 2023.

Pannonia Bio’s business risk profile continues to reflect its highly efficient plant (ESG factor: credit-positive environmental risk factor), whose large scale and favourable location have led to competitive operating costs and solid overall profitability. Challenges include a strong exposure to very volatile commodities markets, very weak asset and product diversification, and the lack of exposure to low-cyclicality speciality products.

The company’s financial risk profile (assessed at BBB) reflects weaker but still solid credit metrics. Despite weak margins in Q4, Pannonia Bio generated a record Scope-adjusted EBITDA of EUR 144m in FY 2022. Nevertheless, credit metrics have weakened: leverage as measured by Scope-adjusted debt/EBITDA reached 2.1x and cash flow cover as measured by Scope-adjusted free operating cash flow/debt turned negative. This was mainly driven by large working capital outflows, investment spending and dividend distribution.

Scope-adjusted debt/EBITDA is forecast to increase above 3.0x in 2023 before recovering to 2.0x-3.0x in the next few years. Scope’s view is mainly driven by conservative commodity price assumptions, the downsized investment programme, the commissioning of new capacities, proceeds from the disposal of solar projects and dividend payments. Despite recent investments in efficiency and the development of new products, Scope expects EBITDA of around EUR 60m-90m annually in the next few years compared with well above EUR 100m annually in 2019-2022.

In August 2022 the company agreed additional financing facilities with existing lenders amounting to EUR 110m and utilised them by YE 2022. The EUR 45m working capital facility (upsized to EUR 60m in April 2023) was also utilised at YE 2022 and in Q1 2023. The additional debt and higher interest rates coupled with conservative EBITDA projections will lead to a lower but still strong Scope-adjusted EBITDA/interest cover of around 10x going forward.

In December 2022 the company signed a finance contract with the European Investment Bank for EUR 50m. The company is yet to use the facility and Scope’s rating case assumes no drawdowns given the likely downsizing of the company’s investment programme. The company is also likely to maximise dividend payments going forward, subject to operating performance, bank loan covenants (such as maximum leverage and surplus cash) and bank lender approval.

While Pannonia Bio’s liquidity remains adequate, Scope notes a reduced headroom as some available options (such as the working capital facility) have been utilised. For the next 12 months, Scope expects coverage of short-term financial debt at more than 1x, including from available cash and cash equivalents of EUR 41m as of 31 March 2023 and positive free operating cash flow.

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

Outlook and rating-change drivers

The Negative Outlook reflects the high likelihood that the continued pressure on ethanol margins will affect the company’s profitability and credit metrics, with Scope-adjusted debt/EBITDA exceeding 2.5x in the next 12-18 months. Scope’s rating case does not assume any prolonged interruptions of gas supplies.

A downgrade could be triggered by i) deteriorated credit metrics, e.g. if the Scope-adjusted debt/EBITDA increased above 2.5x for a prolonged period driven by low ethanol margins or excessive dividend payments; ii) weaker profitability, e.g. if the EBITDA margin fell below 15% for a prolonged period; iii) persistent risk of weak margins and plant underutilisation.

The Outlook could be revised back to Stable if the risk of weak margins and plant underutilisation was mitigated and the company could maintain solid credit metrics with a Scope-adjusted debt/EBITDA of below 2.5x. A further upside is unlikely under the current business setup but could be triggered by significant improvements in diversification, outreach and credit metrics.

Long-term debt ratings

Senior secured debt

Scope’s recovery analysis indicates an ‘excellent’ recovery for senior secured debt. These expectations translate into a BBB rating for this debt category. The recovery is based on an expected distressed enterprise value as a going concern in a hypothetical default scenario in 2025.

Senior unsecured debt

Scope’s recovery analysis indicates an ‘average’ recovery for senior unsecured debt, including the HUF 15bn bond (ISIN: HU0000359112) issued under the Hungarian National Bank’s Bond Funding for Growth Scheme. The recovery is based on an expected distressed enterprise value as a going concern in a hypothetical default scenario in 2025. These expectations translate into a BB+ rating for this debt category.

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; Chemicals Rating Methodology, 17 April 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 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: Marlen Shokhitbayev, Director
Person responsible for approval of the Credit Ratings: Olaf Tölke, Managing Director
The Credit Ratings/Outlooks were first released by Scope Ratings on 18 July 2019. The Credit Ratings/Outlooks were last updated on 27 May 2022.

Potential conflicts
See 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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