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Rating action

Scope Ratings GmbH (Scope) has affirmed the BB-/Stable issuer rating of Hungarian construction company ÉPKAR Zrt. Scope has also affirmed the company’s BB senior unsecured debt rating.

Rating rationale

The affirmation is supported by ÉPKAR’s strong credit metrics, whose resilience during the Covid-19 pandemic was strengthened further by the acquisition of a performing office building in central Budapest in January 2022. The acquisition also helped diversify cash flows through rental income (invoiced in euros). New privately funded projects have further improved the diversification of cash flows away from government contracts, and the company’s backlog has improved to 2.3 years compared to last year’s 2.0 years. Nevertheless, the concentrated business risk profile continues to hold back the rating.

The rating is mainly constrained by the business risk profile (assessed at B). The company is small in the context of the European construction sector, and this reduces its ability to mitigate economic downturns. To somewhat mitigate this risk, ÉPKAR bought a centrally located commercial real estate building called R70, which generates recurring rental income. The building is currently underutilised with an occupancy rate of 62% after a large tenant moved out, but the company is in the final stages of discussions to let out significant parts again. Further constraints include weak geographic diversification (predominantly active in Hungary), segment concentration and dependence on government contracts, which has only recently been addressed. Scope considers the issuer’s backlog to be concentrated, although this has improved somewhat over the last 12 months by reducing the top three contracts to 32% of the backlog from 47%. Higher exposure to private projects has also helped, as have the investment-grade counterparties on the government side (Hungary: BBB/Stable). The book-to-bill ratio was volatile at 0.9x in 2022, but it is expected to rise above 1x in 2023 (excluding signed but unfunded projects).

ÉPKAR’s above-average profitability continues to be a strength for the business risk profile. Given increased visibility through rental cash flows and an improved backlog to late 2025, Scope expects profitability to remain above the peer average, with Scope-adjusted EBITDA at 13%-14%.

The financial risk profile remains unchanged at BBB since the last yearly review, based on cash flows having stabilised thanks to a stronger-than-expected business environment and diversification into rental cash flows and privately funded projects.

In terms of leverage, the Scope-adjusted debt/EBITDA ratio peaked at 3.0x at year-end 2020 (adjusting for cash earmarked for property acquisitions). After the company used bond proceeds for the office acquisition and reaped the benefits at EBITDA level, deleveraging brought the Scope-adjusted debt/EBITDA ratio to 1.2x at YE 2022 due to a strong operational year. Scope expects an increase in leverage of 2.0 at YE 2023E and projects deleveraging to 1.7x in 2024. It bases this expectation on strong labour cost inflation in 2023 with a related negative impact on expected FY EBITDA and advance payment guarantees that are nearly twice as high as in 2022 (which Scope uses as a proxy for restricted cash impacting Scope-adjusted debt negatively). Leverage as measured by Scope-adjusted funds from operations/debt will remain comfortably above 30% during the forecasted period.

Scope expects interest coverage to remain strong at significantly above 10x, protected by one fixed-rate exposure to interest-bearing liabilities (MNB bond) at a very favourable rate of 3%. Given the large cash cushion on the balance sheet, the funds have been placed in a term deposit where they earn significant amounts of interest, improving interest cover significantly. Cash flow cover remains strong with positive free operating cash flow. However, the backlog remains concentrated. Although it has improved, with the top three projects now providing 32% of future revenues (down from 47%), it still poses a risk in the event of cost overruns or delays.

Liquidity remains adequate, with very limited short-term debt (HUF 155m) historically and no short-term debt going forward. This is paired with positive free operating cash flow and high unrestricted cash holdings.

Outlook and rating-change drivers

The Outlook is Stable and incorporates Scope’s view of healthy cash flow via the construction backlog in addition to rental income from the office property, which can cover the cost of debt on its own. Scope foresees deleveraging in 2024 to a Scope-adjusted debt/EBITDA ratio of around 1.7x based on cash flow visibility from the backlog and assuming rental cash flows remain at current levels. ÉPKAR’s backlog stretches to late 2025, after which there are several large but unfunded projects in the pipeline. Scope’s main concern is dependence on government contracts.

A positive rating action could be warranted by a much stronger business risk profile – evidenced by a higher market share, a larger, more diversified backlog, improved segment diversification, and a larger exposure to market-based projects – while the Scope-adjusted debt/EBITDA ratio stays around or below 2x.

A negative rating action could occur if the Scope-adjusted debt/EBITDA ratio rose above 3.5x on a sustained basis, or if the backlog shrank to less than one year because a public backlog contraction could not be offset by new market-based contracts. Increased leverage could be triggered by either: i) an adverse operational development leading to reduced profitability and cash flows; or ii) additional debt-funded real estate acquisitions. Losing access to EU funding and jeopardising already signed contracts could also constitute a negative rating trigger into 2025.

Long-term and short-term debt ratings

Scope still expects an ‘above average’ recovery for the company’s unsecured debt and has affirmed the senior unsecured debt rating at BB (one notch above the issuer rating).

Scope’s recovery analysis is based on a hypothetical default scenario at year-end 2024, assuming outstanding senior unsecured debt of HUF 13.9bn (bond loan and payables) in addition to senior secured debt instruments of HUF 5.2bn (cash advances, guarantees).

Scope notes that ÉPKAR’s senior unsecured bond issued under the Hungarian central bank’s bond scheme has an accelerated repayment clause. The clause requires ÉPKAR to repay the nominal amount (HUF 11bn) within 90 days after the bond rating falls below B-, which could have default implications. Taking into consideration the BB rating of the bond rating, Scope considers this scenario to be remote at present.

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, (Construction and Construction Materials Rating Methodology, 25 January 2023; European Real Estate Rating Methodology, 25 January 2023; General Corporate Rating Methodology, 16 October 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 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, the Rated Entities' Related Third Parties 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: Thomas Faeh, Executive Director
Person responsible for approval of the Credit Ratings: Olaf Tölke, Managing Director
The Credit Ratings/Outlooks were first released by Scope Ratings on 28 February 2020. The Credit Ratings/Outlooks were last updated on 10 November 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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