The latest information on the rating, including rating reports and related methodologies, is available on this LINK.

Rating action

Scope Ratings GmbH (Scope) has today affirmed the issuer rating of Hungary’s Wellis Magyarország Zrt. at B-/Negative. Scope has also affirmed the senior unsecured debt rating at B-.

Rating rationale

The affirmation is driven by the improving liquidity following the refinancing of bank loans in June 2023 and the addition of a new working capital credit line with a preferential interest rate. Cost cuts in the previous year have also resulted in a gradual recovery of the operating profitability margin since July 2023. Scope forecasts a Scope-adjusted EBITDA margin of close to 1% for YE 2023, which will weaken credit metrics for the year, followed by a likely improvement in 2024 and 2025 as macroeconomic conditions improve.

The business risk profile (assessed at B) is supported by the high diversification in terms of geographies, customers and suppliers. More than 80% of sales revenue is generated abroad, including a fast-growing share from the USA (26% of revenues in 2022). Only one supplier accounts for more than 10% of materials costs, while no customer accounted for more than 4% of revenues in 2022, demonstrating a high degree of diversification. Additionally, the business risk profile is supported by the issuer’s brand strength, benefitting from the international scope of branded sales as well as the solid quality of its products.

The major constraint on Wellis’ business risk profile remains its limited absolute size (2022 revenues of EUR 140m), which Scope expects to shrink by 43% in 2023 because lower demand will cause a sharp decrease in sales volumes.

Scope-adjusted EBITDA, after having been close to zero in 2022, is expected to improve to HUF 215m in 2023 (Scope-adjusted EBITDA margin of 1%). From 2024, the Scope-adjusted EBITDA margin is expected to remain close to 6%, benefitting from cost cuts (rationalisation of production with a lower headcount and a renegotiation of service costs) in addition to the positive macroeconomic developments of decreasing logistics and energy prices compared to 2022 levels. Scope notes that its profitability forecast incorporates substantial stresses to the levels in the company’s business plan.

The financial risk profile remains assessed at B-. Leverage measured by Scope-adjusted debt/EBITDA has remained high in 2023, due to weak operating profitability combined with a higher Scope-adjusted debt (including a new HUF 4bn loan). Scope expects the combined negative effect to continue to propel Scope-adjusted debt/EBITDA to unsustainable levels of above 100x, before gradually improving to around 11.0x in 2024 and 7x in 2025 in line with the forecasted improvement in operating profitability and the scheduled amortisation of debt.

The worsening profitability and increasing debt level are also unfavourable for debt protection, measured by Scope-adjusted EBITDA interest cover, which is expected to stay below 1.0x until YE 2023. Scope expects interest expense to increase by 89% between 2022 and 2023 to HUF 742m. The average interest rate is expected to stay between 3%-4%, benefitting from the fixed coupon of the bond (3%) and the lower interest rate on the euro-denominated loans compared with those in Hungarian forint. In 2024 and 2025, assuming no additional debt, Scope expects interest cover to improve above 2.0x.

Scope expects free operating cash flow to remain negative throughout 2023, mainly as a result of the low EBITDA and the HUF 1.9bn in capex forecasted for the year. Going forward, Scope-adjusted free operating cash flow/debt is expected to turn positive, thanks to a significant decrease in capex to only HUF 500m for maintenance and the cash inflow from working capital changes, especially through a reduction of inventory. However, Scope notes that shifts in working capital can be volatile, also depending on multiple external factors, and has applied a conservative approach in its cash flow cover assessment.

Liquidity is inadequate. Sources of liquidity, consisting of HUF 177m of available cash at YE 2022, do not cover the negative HUF 2.4bn of free operating cash flow and HUF 750m of short-term debt amortising in 2023.The company is therefore highly dependent on external funding. The rolling exposure to drawn credit facilities (HUF 5.6bn as of October 2023) has no definite maturity but is reviewed yearly by the financing banks and comes with the option to cease the annual extension. Scope expects the facilities to continue to be extended, based on the long term, well-established relationship between the issuer and its financing banks.

Scope notes that the HUF 10bn senior unsecured bond (ISIN: HU0000360250) constitutes a major source of funding for Wellis and that a negative rating action would accelerate its repayment and likely trigger a default as the bond agreement stipulates debt repayment acceleration at loss of a B- rating. This aspect is an additional weakness for the company’s liquidity. Wellis is already in a two-year grace period for its bond rating to recover to B+ starting in October 2022.

Outlook and rating-change drivers

The Negative Outlook reflects the uncertainty around the ability to generate revenue and improve operating profitability. Scope’s base case assumes that credit metrics will remain weak in 2023, factoring in that the discretionary nature of Wellis’ main products make them vulnerable to economic downturns and thus to the ongoing drop in demand. The base case also assumes a gradual recovery in the operating margin beyond 2023 because of tight cost controls and positive macroeconomic factors. Scope notes that the acceleration of bond repayment might have default implications for Wellis, with the two-year grace period for rating recovery ending in October 2024.

A downgrade could be triggered either by the further deterioration of liquidity, or interest cover staying below 1.0x. A downgrade could also be triggered by the adverse action from the financing banks, e.g. reduction of the credit lines in case of a covenant breach.

A positive rating action, along with the return to Stable Outlook, could be triggered if the EBITDA/interest cover improved sustainably above 1.0x, either as a result of interest expense or an improvement in operating profitability, while liqudity does not deteroriate below 100%. Further ratings upside is currently deemed remote.

Long-term debt rating

In February 2021, Wellis issued a HUF 9.9bn senior unsecured corporate bond under Hungary’s Bond Funding for Growth Scheme. The bond’s tenor is 10 years, with 10% of its face value amortising from 2026. The coupon is fixed at 3% and payable yearly.

Scope has rated the senior unsecured debt issued by Wellis at B-, the same level as the issuer rating. The recovery is ‘average’ for senior unsecured debt holders in a liquidation scenario.
 
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; 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 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: Istvan Braun, 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 22 January 2021. The Credit Ratings/Outlook were last updated on 20 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
© 2023 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Ratings UK Limited, Scope Fund Analysis GmbH, and Scope ESG Analysis GmbH (collectively, Scope). All rights reserved. The information and data supporting Scope’s ratings, rating reports, rating opinions and related research and credit opinions originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data. Scope’s ratings, rating reports, rating opinions, or related research and credit opinions are provided ‘as is’ without any representation or warranty of any kind. In no circumstance shall Scope or its directors, officers, employees and other representatives be liable to any party for any direct, indirect, incidental or other damages, expenses of any kind, or losses arising from any use of Scope’s ratings, rating reports, rating opinions, related research or credit opinions. Ratings and other related credit opinions issued by Scope are, and have to be viewed by any party as, opinions on relative credit risk and not a statement of fact or recommendation to purchase, hold or sell securities. Past performance does not necessarily predict future results. Any report issued by Scope is not a prospectus or similar document related to a debt security or issuing entity. Scope issues credit ratings and related research and opinions with the understanding and expectation that parties using them will assess independently the suitability of each security for investment or transaction purposes. Scope’s credit ratings address relative credit risk, they do not address other risks such as market, liquidity, legal, or volatility. The information and data included herein is protected by copyright and other laws. To reproduce, transmit, transfer, disseminate, translate, resell, or store for subsequent use for any such purpose the information and data contained herein, contact Scope Ratings GmbH at Lennéstraße 5 D-10785 Berlin.