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Rating action

Scope Ratings GmbH (Scope) has today affirmed its BB- issuer rating on Georgian Beer Company JSC (GBC) and revised the Outlook to Negative from Stable. Scope has also affirmed its BB- rating on senior unsecured debt.

Rating rationale

The changed Outlook to Negative from Stable reflects Scope’s expectation that leverage as measured by Scope-adjusted debt/EBITDA will exceed 4x in 2023 due to the additional financial guarantees needed to buy out minority shareholdings in H2 2023. Although Scope considers the setback in leverage as temporary, finding and integrating strategic shareholders willing to substantially preserve the financial policy and growth strategy could take time and hinder a timely recovery of credit metrics. However, the issuer rating continues to benefit from the company's careful management of indebtedness and the ongoing rise in absolute EBITDA resulting from organic expansion both domestically and abroad.

In August 2023, GBC's shareholder structure changed substantially. All minority shareholdings were bought out, including the 24.1% held by Georgian Industrial Group Holding LLC and the 12.4% by PSP Pharma LLC, using bank guarantees. Scope does not consider that these structural changes translate into a higher key person risk and anticipates that the company will identify strategic partners. This is further substantiated by the company's active pursuit of a potential purchaser for its minority shares. While this endeavour might extend beyond initial expectations and face obstacles, Scope's base case still assumes that the incoming shareholders will substantially preserve the company's capital structure and financial policy, for example, by maintaining the dividend payment policy.

GBC’s business risk profile (assessed at BB-) continues to benefit from its underlying industry of non-durable consumer products. Despite fierce competition in the saturated Georgian beer market, the company outperformed direct competitors in FY 2022, especially in the upper-mainstream market where its Bavaria beer brand remains a best seller. Scope expects this trend to continue in FY 2023, especially given H1 results. GBC’s strong competitive position will be reinforced by the ramp-up of international brand Miller and expected add-ons in the premium segment. In addition, nearly all GBC’s carbonated soft drink sales increased in 2022.

Sales rely on distribution company Zedazeni 2012, expected to account for 75% of total sales by end-2023, up from 68% in 2022. While having a single distribution channel is typical for Georgian beverage companies, Zedazeni 2012's credit quality, although improved, remains low, which could hamper operational sustainability and value chain management and lead to an impairment of receivables (ESG factor: credit negative).

GBC's balanced portfolio of beverage products further benefits from the ramp-up of new beer brands such as Ravi, Civ-Civ and Belgium Standard. However, geographical diversification remains a weak element of the business risk profile, exposing the company to Georgia’s macroeconomic risk. Moreover, exports to neighbouring countries constitute a negligible portion of overall sales, 13% FY2022.

Profitability remains comfortable thanks to GBC’s flexibility on retail prices. The heavy dependence on imported raw materials, typically without foreign exchange hedging, is expected to put further pressure GBC’s gross margins in the medium term. If GBC sells more to retail customers, sales costs will increase. Scope believes that GBC’s EBITDA margin (calculated based on gross sales) will remain above 15% as retail market consolidation and competition coupled with the group’s resumed marketing activities are likely to constrain profitability. Scope’s base case includes a stable gross margin without major supply chain disruptions. A sudden disruption of the supply chain could have a significant negative impact on operating performance.

GBC’s financial risk profile (assessed at B+) is constrained by its high leverage, including the financial guarantees issued for the share buyout. The sound leverage in 2022 with Scope-adjusted debt/EBITDA of 2.9x (down by 0.1x YoY) was the result of the higher-than-anticipated EBITDA due to the ramp-up phase of newly launched products; increased export sales; foreign exchange gains on non-lari liabilities; and the repayment of current debt despite the debt-funded acquisition at end-2022.

GBC acquired 26.67% of shares in Retail Group (RG) for around GEL 20m in December 2022, bringing its equity stake to 46.71%, accounted for as an investment in an associate. Even though GBC's parent company, Mixori, owns 9.9% of RG shares, Scope does not see the necessity of presenting consolidated accounts for Retail Group. This is due to GBC's minority stake in RG and minimal participation in managerial decision-making. While establishing de-facto control over an early-stage corporation committed to an aggressive growth strategy could potentially have negative impact on GBC's creditworthiness, there are no guarantees on debt issued by RG, and Scope considers the potential for exceptional support from GBC in times of need to be uncertain.

It is important to note that strong commercial relationship with rapidly growing retail chain bolstering GBC's sales and enhance negotiating leverage with other key clients.

Due to expected modest annual capital expenditures of GEL 8m-10m in 2023-2025, along with conservative working capital investments, Scope foresees a shift toward positive free operating cash flow.

Scope projects leverage as measured by Scope-adjusted debt/EBITDA to reduce to around a 3.5x in the medium term, driven by higher EBITDA through the expansion of the beer portfolio and increased exports. While the company believes that the financial guarantees may be resolved in the short term, the Scope-adjusted debt calculation conservatively includes these financial guarantees from 2023 to 2025. Scope expects that Scope-adjusted funds from operations to debt to exhibit a similar trend, improving toward 20% in the medium term.

Scope estimates that the low cash levels of around GEL 1.1m available at end-2022 will only partly cover financing and refinancing needs of the GEL 37.2m of current debt. The GEL 25m bond will mature at end-2023. Operating profits are unlikely to cover the full repayment and refinancing will require new bonds or a term loan. The ratio is still inadequate when accounting for undrawn committed lines of GEL 4.6m and expected free operating cash flow of GEL 7.1m. GBC therefore remains exposed to refinancing risks and a strong dependency on its banks.

In 2022, the company breached its covenant for debt service coverage ratio and leverage following investments in working capital and a debt-funded acquisition. Nevertheless, management secured letters from creditors before year-end to waive the right to accelerated repayment.

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

Outlook and rating-change drivers

The Negative Outlook reflects the expected deterioration in credit metrics in FY 2023 as indicated by a Scope-adjusted debt/EBITDA of above 4.0x following shareholder buyout, which also reduces clarity over the ability to deleverage over the next 12-18 months. The Outlook also accounts for the successful refinancing of senior unsecured debt due in December 2023.

A downgrade could occur if credit metrics deteriorated, and Scope-adjusted debt/EBITDA remained above 3.5x. Weak financial performance could be triggered by delays in executing minority share sales or from debt-financed investments in other expansion projects. It could also result from substantial and unexpected negative impact from changes in the retail market and heightened competition, which would place considerable pressure on operating profitability.

A positive rating action (i.e. a revision of the Outlook back to Stable) could result from Scope-adjusted debt/EBITDA at around 3.5x on a sustained basis and/or a sustained improvement in liquidity. This could be achieved via deleveraging through share disposals while maintaining high EBITDA. Further rating upside could evolve if Scope sees a strong improvement in credit metrics as indicated by Scope-adjusted debt/EBITDA falling below 3.0x possibly driven by the release of the minority buyout guarantee as early as 2024.

Long-term debt rating

Scope has affirmed senior unsecured debt at BB- including the GEL 25m bond (ISIN GE2700603725). This reflects Scope’s expectation of an average recovery for senior unsecured debt positions in the hypothetical event of a company default. The recovery analysis is based on a hypothetical default scenario in 2025, which assumes outstanding senior secured debt, payables, and fully drawn credit lines of GEL 41m. Significant haircuts were applied to the account receivables as a consequence of Zedazeni 2012’s low credit quality.

Scope expects, GBC will refinance its senior unsecured debt maturing in 2023 through the issuance of a new bond. The new issuance will be larger, at GEL 35m, have a three-year maturity, the same debt ranking level, and similar covenants as GBC’s existing debt.

While the recovery analysis points to an above-average recovery, Scope constrains the debt category rating to the same level as the issuer rating given emerging market risks and the risk that GBC could raise higher-ranking debt, which would dilute the recovery for senior unsecured debtholders.

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; Consumer Products Rating Methodology, 4 November 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 Rated Entity and/or its Related Third Parties participated in the Credit Rating process.
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: Zurab Zedelashvili, Associate Director
Person responsible for approval of the Credit Ratings: Olaf Tölke, Managing Director
The Credit Ratings/Outlook were first released by Scope Ratings on 30 March 2018. The Credit Ratings/Outlook were last updated on 6 October 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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