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Rating action

Scope Ratings GmbH (Scope) has today downgraded the issuer rating of Hungarian tyre distributor Abroncs Kereskedőház Kft. (AKH) to BB-/Stable from BB/Stable. Scope has also downgraded the senior unsecured debt rating to BB- from BB.

Rating rationale

The rating downgrade is driven by the weakening profitability, caused by a downturn in the tyre market in H1 2023, combined with the increased external financing, which has led to deteriorating credit metrics. Scope expects that the issuer will only partially recover its profitability in H2 2023, thus leading leverage to remain above or around 3.0x in the medium term. The market uncertainty and the historically volatile EBITDA as well as the high seasonality of AKH’s working capital, peaking twice during the year, put further pressure on leverage. The rating is supported by the issuer’s leading position in the Hungarian market and solid liquidity.

The business risk profile continues to be supported by AKH’s leading position in the Hungarian tyre market, thanks to a solid presence in both the retail and wholesale segment. The issuer has established strong brand recognition over many years based on a partially integrated business model with a car services store and an exclusive partnership with BP Lubricants. Furthermore, AKH benefits from strong supplier relationships, exhibited by a mix of exclusive and semi-exclusive partnerships as well as its status as a supplier of international brands, such as Continental and Bridgestone. Despite its strong competitive positioning in Hungary, the issuer’s small size (HUF 44bn of revenue in 2022) compared to international retailers constrains the business risk profile.

International expansion remains focused on neighbouring countries. However, the recent acquisition of ARS in Slovakia at year-end 2021 has reduced AKH’s dependency on Hungary as expected. Slovakian sales grew to 19% in 2022 from 5% of the issuer’s total sales in 2021, and the same year saw total non-domestic sales rise above 40% of total sales (vs around 22% in 2021). The type of product sold, which is considered cyclical, also limits the issuer diversification assessment. However, Scope views the issuer’s presence in both customer segments (retail and wholesale) and service integration positively. Moreover, in addition to typical tyre maintenance services such as changing between summer and winter tyres and wheels, tyre balancing and tyre hotels, AKH provides service and maintenance of brakes, wheel alignments, shock absorbers and small repairs that are considered less cyclical. The presence in the lubricants sector further reduces exposure to the high seasonality of tyre demand.

Profitability is the weakest element in the business risk profile. While the Scope-adjusted EBITDA margin remained above 5% from 2020 to 2022, this margin fell to 4.4% (from 5.6% at YE 2022) in H1 2023. The cause was weak demand (down 8% compared to H1 2022) driven by inflation and a lack of consumer confidence. For H2 2023, Scope expects a partial recovery in the market, while the margin is expected to remain around 4.4%. For 2024, the agency expects top line to grow by around 5%. Combined with AKH’s strategy to keep staff costs stable and transportation costs down while increasing efficiency with the introduction of a new packaging process in H2 2023, this should drive margins to increase to around 5%. Nevertheless, profitability margins remain weak compared to retail peers.

The assessment of the financial risk profile has been revised to BB from BBB-. While AKH benefitted from low leverage historically, a sharp increase is anticipated in 2023, to 3.6x from 2.1x in 2022, driven by lower EBITDA and the debt-financed purchase of real estate assets, as well as an increase in overdraft utilisation and off-balance sheet debt. Scope expects the ratio to return to below 3.0x by year end 2024 as EBITDA returns to growth and no new debt is anticipated. That said, Scope highlights the high volatility of the ratio throughout the year, driven both by EBITDA and net working capital needs during the peak seasons. Off-balance sheet operating leasing, which increased significantly in 2022 following the acquisition of ARS, represents most of the issuer’s debt (48% as at end-2022).

Interest cover has also fallen in 2023, driven by lower EBITDA and new debt combined with rising interest rates. Yet Scope expects interest cover to remain above 7x. Cash flow coverage is the weakest element in the financial risk profile. The ratio has been pressured by high capex, which increased from 2021 on driven by the incorporation of ARS’ capex. In 2023, further exceptional capex related to a real estate asset purchase will lead to negative free operating cash flow. In addition, highly volatile net working capital throughout the year weights negatively on the ratio assessment.

Despite low-to-negative free operating cash flow, liquidity remains adequate with short-term debt fully covered by unrestricted cash and a HUF 1,500m undrawn overdraft credit line.

Outlook and rating-change drivers

The Outlook is Stable and incorporates Scope’s expectation that credit metrics, weakened by low demand in H1 2023 that negatively impacted profitability, will be sustained at the current level in the medium term as no new debt is anticipated and EBITDA will slowly recover.

A negative rating action could occur if the Scope-adjusted debt/EBITDA ratio increased above 4x on a sustained basis. This could be driven by a continuation of the negative market trend combined with continued high inflation, resulting in profitability not recovering as expected.

A positive rating action could be triggered by the Scope-adjusted debt/EBITDA returning to around 2.5x on a sustained basis.

Long-term debt rating

Scope downgrades the rating of AKH’s senior unsecured debt to BB- from BB. Scope’s assessment considered the liquidation value based on a hypothetical default scenario in 2025, resulting in an above-average recovery. However, given high sensitivity to advance rates, Scope refrains from up notching the debt rating compared to the issuer rating.

AKH issued a HUF 3.5bn senior unsecured bond (ISIN: HU0000360177) in December 2020 through the Hungarian central bank’s Bond Funding for Growth Scheme. The bond proceeds were used for refinancing purposes. The bond has a tenor of 7 years and a fixed coupon of 2.8%. Bond repayment is in four tranches starting from 2021, with 5.7% of the face value payable yearly in 2021, 2022 and 2023, 10% of the face value payable in 2024, 10.7% of the face value payable in 2025, 12% of the face value payable in 2026, and a 50% balloon payment at maturity. Scope notes that AKH’s senior unsecured bond issued under the Hungarian central bank’s bond scheme has an accelerated repayment clause. The clause requires AKH to repay the nominal amount (HUF 3.5bn) in case of a rating deterioration (two-year cure period for a B/B- rating; repayment within 90 days after the bond rating falls below B-, which could have default implications). Other bond covenants in addition to the rating deterioration covenant include non-payment, insolvency proceedings, cross-default, pari passu, negative pledge, change in control and net debt/EBITDA covenants.

The rating was prepared with the application of Scope’s General Corporate Rating Methodology, 15 July 2022. The application of the General Corporate Rating Methodology, 16 October 2023, does not have an impact on the 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 Outlook, (General Corporate Rating Methodology, 16 October 2023; Retail and Wholesale Rating Methodology, 27 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 Outlook and the principal grounds on which the Credit Ratings and Outlook are based. Following that review, the Credit Ratings were not amended before being issued.

Regulatory disclosures
These Credit Ratings and Outlook are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and Outlook are UK-endorsed.
Lead analyst: Claudia Aquino, 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 20 November 2020. The Credit Ratings/Outlook were last updated on 18 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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