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Rating action

Scope Ratings GmbH (Scope) has affirmed the BB/Stable issuer rating of Progress Étteremhálózat Kft, the development licensee partner of McDonald’s in Hungary. The senior unsecured debt category has been upgraded to BB+ from BB.

Rating rationale

The affirmed issuer rating reflects the strong organic top-line growth (+43% YoY) while keeping solid credit metrics. This was due to the 22 store openings since 2019 (+25%), the modernisation of the majority of existing restaurants and the strong marketing activity while keeping a double-digit EBITDA margin, flat leverage and robust treasury activity. The rating is constrained by low diversification and the pressure on medium-term profitability from soaring input costs and the moderate decrease in purchasing power.

The upgrade of the senior unsecured debt rating reflects the significant expansion of the fixed asset base, which resulted in an above-average recovery assessment (as detailed under the long-term debt ratings).

The business risk profile (rated BB) remains unchanged compared to last year’s assessment. Progress had a resilient performance in 2022 despite the food consumer price index in Hungary soaring to 26%, with revenue at double the pre-pandemic level and profitability remaining moderate.

Progress along with its conventional licence partners is one of the largest restaurant operators in Hungary through its operation of the McDonald’s brand.

Hungary has over 110 McDonald's restaurants with system-wide sales (including by franchise partners) of HUF 114bn in 2022 (EUR 280m). 60% of the stores are operated and owned by Progress and the rest by local conventional licence partners. Progress opened 14 stores in 2022 and modernised more than 20, which means it operates the fastest-growing restaurant chain in Hungary. In an international context, however, the number of McDonald’s restaurants per capita in Hungary remains half of that in Germany, France or Austria, which can be linked somewhat to the less modern retail space, especially in highly frequented transport hubs, and to the lower purchasing power.

McDonald’s Corporation and its strong brand facilitate the company’s good market position in Hungary and provide additional support through well-defined global marketing tools, strong internal controls and supply-side capacity. The primary risk for Progress’ business lies in a deterioration in its relationship with McDonald’s. Progress is mitigating this risk through the timely execution of investments as undertaken in the development licence agreement.

The diversification assessment remains low due to the limitation of the development license agreement to Hungary and the concentration on a single business line. Product diversification is above that of other McDonald’s licensees in other countries but remains limited mainly to fast food.

Operating profitability is moderate with a Scope-adjusted EBITDA of HUF 10.6bn in 2022 (-3.9% YoY) and a decreasing but solid Scope-adjusted EBITDA margin of 14.4% (down from 21.4% YoY). The decrease is due to not only cost inflation but also the high number of own operated restaurants, which have lower margins than for franchising. Scope-adjusted EBITDA includes HUF 2.75bn of adjustments to the reported figure for real estate lease payments received.

The operating environment will remain challenging throughout 2023. The Hungarian National Bank forecasts inflation at 15%-20%, well above the EU average of 5.3% forecasted by the ECB. Affordability and economies of scale will therefore be key to remaining competitive. Certain input costs may decrease or at least stabilise compared to 2022 levels, but labour costs will continue to rise. Furthermore, the Hungarian forint has become volatile, which implies partners will apply higher headroom on input prices and hedging will become more expensive.

The financial risk profile (rated at BB) remains unchanged compared to last year. Leverage measured by Scope-adjusted debt/EBITDA stood at 3.2x (flat YoY). Scope expects gradual deleveraging to around 2.5x by YE 2025 through EBITDA growth due to inflation and organic growth and flat gross debt.

The company’s debt as at 2022 includes a HUF 33bn senior unsecured bond and HUF 2.45bn in bank guarantees. Scope expects no major changes in the next three years. Furthermore, Scope has excluded from cash netting the contracted capex and cashier money totalling HUF 3bn in 2023.

Interest cover measured by Scope-adjusted EBITDA/interest expense is very strong, at 13x at YE 2022, and may improve due to expected EBITDA growth and the bond’s low fixed coupon of 3% yearly.

Scope-adjusted funds from operations/debt is moderate at 28% at YE 2022 and indicates healthy cash flow. With inflation stabilising, cash flow generation is set to improve further.

Progress’ investment plan for 2019-2025 is roughly 80% completed, with store openings and modernisations progressing as scheduled. Medium-term growth will therefore be less aggressive and Scope forecasts the currently negative Scope-adjusted free operating cash flow/debt to turn positive by 2024. This will also result in no pressure to raise new debt in the current high interest rate environment, allowing cash to be accumulated for debt service and dividend payments.

Liquidity is adequate and benefits from the conservative debt maturity profile, with no short-term debt held historically or planned in the coming years.

No notching was applied for supplementary rating drivers. Financial policy supports the rating given the company target of a net debt/EBITDA of below 3.5x. Parent support is neutral as support is not expected from the holding company or the ultimate owner. No dividends were paid during the investment phase, and company guidance on dividends still allows for deleveraging. The bond prospectus limits dividends to 50% of the previous year’s profit after tax, which is protective for debtholders.

Outlook and rating-change drivers

The Outlook is Stable based on Scope’s expectation of expansion being executed as planned and input prices stabilising, resulting in improved cash flow and allowing gradual deleveraging.

A positive rating action could be warranted if the company strengthened Scope-adjusted free operating cash flow/debt to at least 10% on a sustained basis while growing in size.

A downgrade could be warranted if Scope-adjusted debt/EBITDA increased above 4x. This could be a result of a deterioration in the franchise relationship (developmental licencee) with McDonald’s and/or inflationary pressure leading to low cash flow.

Long-term debt ratings

In February 2021, Progress issued a HUF 33bn senior unsecured bond (ISIN: HU0000359906) through the Hungarian Central Bank’s Bond Funding for Growth Scheme. Proceeds were used for capex. The bond has a tenor of 10 years and a fixed coupon of 3.0%. Bond repayment is in four tranches starting from 2026, with 12.5% of the face value payable yearly and a 50% balloon payment at maturity. Scope notes that Progress’s senior unsecured bond issued under the Hungarian Central Bank’s bond scheme has several accelerated repayment clauses. The clauses require Progress to repay the nominal amount (HUF 33bn) in case of rating deterioration (2-year cure period for a B/B- rating, immediate repayment after the bond rating falls below B-, which could have default implications). In addition to the rating deterioration covenant, bond covenants include list of soft covenants among others (i) change of control unless approved by McDonald’s Corporation, (ii) net/Debt EBITDA up to 3.5x applicable only if breach is due to raising new debt, and (iii) dividend restriction up to 50% pay-out ratio.

Scope’s recovery assessment shows above-average recovery starting from 2023 due to the tripling of fixed assets to HUF 36.8bn at YE 2022 from HUF 13.8bn at YE 2020 as a result of the capex programme. The company has no senior secured debt and has no need to raise any. Therefore, Scope has upgraded the senior unsecured debt rating one notch above the issuer rating, to BB+ from BB.

Stress testing & cash flow analysis
No stress testing was performed. Scope Ratings performed its standard cash flow forecasting for the company.

Methodology
The methodology used for these Credit Ratings and/or Outlooks, (General Corporate Rating Methodology, 15 July 2022), is 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: Barna Szabolcs Gáspár, Director
Person responsible for approval of the Credit Ratings: Olaf Tölke, Managing Director
The Credit Ratings/Outlooks were first released by Scope Ratings on 7 July 2020. The Credit Ratings/Outlooks were last updated on 10 June 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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