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Rating action

Scope Ratings GmbH (Scope) has today affirmed Hungarian meat producer Baromfi-Coop Kft.’s issuer rating at BB-. The Outlook was changed to Positive from Stable. Scope has also affirmed the senior unsecured debt rating at BB-.

Rating rationale

The Outlook change to Positive is driven by the deleveraging observed following a heavy investment phase, largely executed in 2019-2021, that led to a significant increase in size. This was possible due to higher volumes as well as much higher prices in Hungary during 2022 as inflation caused food prices to increase up to 40% YoY. In the medium term, Scope expects credit quality to improve. The existing agricultural and slaughtering area has limited expansion potential and is becoming a cash cow, meaning moderate profitability can be generated from it on medium term without significant investments. At the same time significant investment in brands and processed-product production are needed to ramp up production in the processed products segment.

In 2022, sales were up 53% YoY to reach HUF 218bn and EBITDA was up 75% YoY to HUF 28bn. For 2023, Scope expects nominal revenues to grow due to organic expansion and inflation, while EBITDA develops more muted, in line with industry peers. This is because the year 2022 was characterised by the temporarily low input prices and high sales prices due to the inflation in winter 2022/23, with temporarily amplifying effects on EBITDA.

Like other Hungarian meat and processed meat producers such as Bonafarm Zrt. (BB/Stable) and Tranzit Food Kft. (BB-/Positive), Baromfi-Coop performed much better than expected in 2022. For Baromfi-Coop this was due to stable debt and much higher nominal EBITDA than projected. High energy prices were compensated, in the case of vertically integrated consumer product/agricultural entities such as Baromfi-Coop, by the very good agricultural year in 2022, supported by own energy production. On the other hand, the results of non-integrated, non-agricultural meat producers suffered in 2022, even showing negative margins in certain months, exacerbated by their general lack of energy hedging.

Baromfi-Coop is well placed coming into 2024, able to leverage on its dominant domestic position, strong export activity and vertical integration on cheaper forms of meat such as chicken, which customers also prefer above meats such as pork and beef due to environmental considerations and/or personal beliefs. In the next years, Scope therefore expects the group to grow, especially in processed products, produce stable operating profitability and reduce financial leverage while keeping investments moderate but below 2019-2021 levels.

The business risk profile (assessed at BB, unchanged) is driven by the leading position in Hungary, solid product quality and developing brand (leading to a moderate market share assessment) and double-digit profitability with low-to-medium volatility. Low diversification in terms of product categories and locations of production assets constrains the assessment.

The blended industry risk assessment has been revised to A- from BBB+, thanks to the issuer’s heavier exposure to consumer products by revenues and EBITDA.

Baromfi-Coop benefits of a moderate market share. It slaughters around half of all the chicken raised in Hungary, much from it produced in its own integration, and is one of the largest food producers in the country with revenues of EUR 0.6bn in 2022 (in comparison, Bonafarm had EUR 0.8bn which includes both processed meat brand Pick and processed milk brand Sole-Mizo and related agricultural activity). In Europe, Baromfi-Coop holds 1.5%-2.0% of the market, ranking it top 25 for chicken. Other large chicken producers, such as the French European leader LDC Group (majority owner of Tranzit Food Kft.), typically have farms and slaughterhouses in more regions and countries, benefiting their diversification and overall market size. A significant improvement in the issuer’s growth is limited by its single location in eastern Hungary. In addition, setting up a new location with a circular economy takes time, while growth investment is limited by the high interest rates and by internal management capacity constraints to execute plans of such scale.

Baromfi-Coop sells to all significant retailers in Hungary and has major international anchor buyers such as OSI Food (McDonald’s) and Iceland Foods. Exports are strong, accounting for 42% of revenues in 2022, mainly in the European hospitality and catering industries, which Scope expects to continue. Relationships with retailers are also strong, built on Baromfi-Coop’s resilience to epidemics due to their controlled vertically integrated production and thereby reliable, high-quality deliveries.

Baromfi-Coop shows good profitability in Hungary though below the European consumer products average. Double-digit profitability is achievable in Hungary only for vertically integrated consumer products, which includes agricultural activity as the issuer does. Positively, Scope-adjusted EBITDA margins range between 10%-13% from 2019 until the forecast horizon of YE 2025, which shows low volatility. Scope expects EBITDA to normalise in 2023-2024 from the exceptional HUF 28.3bn in 2022, to around HUF 24bn-25bn, still much above historical levels. This together with free operating cash flow turning positive will allow cash buildup and deleveraging.

Brand strength is moderate, and Scope’s assessment reflects emerging brand Master Good, now marketed heavily in Hungary and set to replace the SáGa brand. The brand strength assessment is constrained by the high share of non-branded or retailer/restaurant-branded chicken but supported by premium GMO-free labels.

The financial risk profile (assessed at BB-, unchanged) is driven by the moderate leverage, which improved significantly in 2022, and by the expectation that Scope-adjusted debt/EBITDA will stay below 3.0x (3.6x-3.9x in 2020-2021). Low cash flow cover constrains the rating, even though Scope expects it to turn slightly positive in 2023 while remaining volatile throughout the forecasted period (until YE 2025).

The group had HUF 80.9bn of gross debt at YE 2022 (+3.7% YoY), in the form of three senior unsecured bonds totalling HUF 51.5bn and HUF 29.4bn in senior secured bank loan facilities. The cash balance stayed high at HUF 15.0bn at YE 2022. The change on the debt side is marginal and relates to the rolling-over and refinancing of short-term loans with a medium-term government subsidised fixed-rate loan.

The deleveraging in 2022 to a Scope-adjusted debt/EBITDA of 2.3x from 3.9x in 2021 was driven by the strong increase of Scope-adjusted EBITDA to HUF 28.2bn (+75% YoY). This was due to higher capacity (14% more chicken slaughtered YoY), increased volumes across product categories and soaring inflation in Hungary benefitting the topline, while costs did not increase at the same speed.

The forecasted slight increase in Scope-adjusted debt/EBITDA to 2.7x in 2023 will be driven by the normalisation of Scope-adjusted EBITDA to around HUF 24bn-25bn. Further deleveraging to below 2.5x in 2024-2025 is expected, based on the reduced investment plan. However, stronger deleveraging is being hindered by expected negative working capital and uncertainty related to EU subsidies due to Hungary’s dispute on rule of law. Even so, the issuer plans to modernise its SáGa Foods production facilities in 2025-2026; the budget is yet to be released but Scope estimates up to HUF 15bn in gross investment with at least 25% subsidised.

Cash flow generation remains good, with Scope-adjusted funds from operations/debt well above 30%, helped by low interest rates (subsidised and largely fixed at well below 5% yearly) and low taxation (investment-related tax relief).

Scope-adjusted free operating cash flow/debt has been negative due to expansion to reach full vertical integration and a circular economy. These initiatives also required a significant expansion of working capital.

After at least five years of negative values, free operating cash flow may turn positive in 2023 because the investment phases launched parallel with the three large bond issuances have ended. Scope expects 2024 to be a consolidation year from an operational perspective and new investment to begin from 2025, mainly on processed products, which again may result in negative free operating cash flow. This metric therefore remains the weakest element of the financial risk profile.

Baromfi-Coop’s high share of fixed-rate debt offers significant debt protection. Scope-adjusted EBITDA/interest cover increased to 32x in 2022 from 16x in 2021, driven by the exceptionally strong EBITDA. After EBITDA normalises this year, Scope-adjusted EBITDA interest cover is forecast to exceed 18x in 2023 and decrease towards 10x afterwards due to decreasing interest received on time deposits and slight average interest rate increase, signalling the high but decreasing interest rate environment, which Scope expects until at least YE 2025.

Liquidity is adequate. Baromfi-Coop’s internal and external liquidity improved significantly in 2022 to close to 200%, from the negative values in 2021 due to the high investment and negative working capital. Scope expects the good liquidity metrics to stay at least until YE 2025 at 110%-190% due to improving free operating cash flow after the heavy investment phase.

No notching was given on supplementary rating drivers.

Baromfi-Coop contributes to the circular economy through its vertical integration with own agricultural activity, highly automated slaughterhouses and by-product facilities and solar energy production (ESG factor: positive factor for resource management and efficiencies in production). The company issued a green bond (Second Party Opinion available on its Green Bond Framework), underpinning the group’s commitment towards ESG principles.

Strategic owners (the Bárány family, via their family trust after the corporate structure reshuffling in H2 2023) have a hands-on management approach and reinvest most of the profits. Growing the group also means consolidating several small entities, though regulation has been slowing the process. Non-consolidation of all production assets, however, is a negative governance factor, though mitigated by consolidation efforts and the willingness of managing owners to simplify the structure over time (ESG factor: credit-negative governance factor).

Baromfi-Coop’s ESG strategy is credit-neutral. Scope nevertheless notes that the commitment to ESG principles is resulting in lower financing rates, while the risk on energy prices is being mitigated through own production, and high automation is making the labour scarcity manageable.

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

Outlook and rating-change drivers

The Outlook was changed to Positive from Stable, reflecting the expectation of Scope-adjusted debt/EBITDA reaching well below 3.0x in 2023 and decreasing afterwards to below 2.5x.

An upgrade could be warranted if 2023 financial results materialise in line with Scope’s expectations, exemplified by Scope-adjusted debt/EBITDA of below 3.0x while expected future leverage projections as measured by Scope-adjusted debt/EBITDA are sustained below 3.0x.

A return to Stable Outlook could be warranted in case leverage as measured by Scope-adjusted debt/EBITDA increased above 3.0x but remained below 3.5x, which could be a result of a new investment programme, working capital swings and/or lower-than-anticipated state subsidies.

A downgrade is remote but may be warranted if Scope-adjusted debt/EBITDA increased to 3.5x or above, which could also result in a covenant breach followed by debt acceleration if not waived upfront. Such debt acceleration is viewed as unlikely and mitigated by the generally higher than 3.5x net debt/EBITDA tolerated in Hungary by banks and their willingness to waive such covenant breaches without debtor repercussions.

Long-term debt rating

Scope has affirmed the BB- rating on Baromfi Coop’s senior unsecured debt.

Baromfi-Coop Kft. issued three series of senior unsecured bonds with total value of HUF 51.5bn during 2019-2021 (ISIN: HU0000359294, HU0000359302, HU0000360706) through the Hungarian Central Bank’s Bond Funding for Growth Scheme. The bonds are guaranteed by fully consolidated subsidiary Master Good Kft. The bond proceeds were used for capex to increase production capacity and deepen vertical integration.

The bonds have long tenors of 7.5-10 years and low fixed coupons of 2.7%-3.0%. The bonds have bullet repayment, with HUF 14bn repayable in November 2026, HUF 14.5bn in May 2028 and HUF 23bn in July 2031. Scope notes that Baromfi Coop Kft.’s senior unsecured bonds issued under the Hungarian Central Bank’s bond scheme have accelerated repayment clauses requiring repayment of the nominal amount (HUF 51.5bn) in case of rating deterioration (two-year cure period for a B/B- rating, repayment within 30 days after the bond rating falls below B-, which could have default implications). In addition to the rating deterioration covenant, bond covenants include a list of other covenants such as change of control.

The senior unsecured debt rating is based on a hypothetical default scenario at YE 2025 and resulted in an ‘average’ recovery expectation for this debt category, which remains unchanged from the previous rating action.

The recovery assessment assumes secured bank debt (2025: HUF 32bn vs HUF 40bn at last review) being ranked above senior unsecured, the full drawdown of HUF 4.0bn in unfunded senior secured loan commitments and 50% repayment for state and EU subsidies and grants (2025: HUF 15bn), which are all ranked above senior unsecured.

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, 16 October 2023; Consumer Products Rating Methodology, 3 November 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, 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 Outlook and the principal grounds on which the Credit Ratings and/or Outlook are based. Following that review, the Credit Rating and/or Outlook 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: Barna Szabolcs Gáspár, Director
Person responsible for approval of the Credit Ratings: Thomas Faeh, Executive Director
The Credit Ratings/Outlooks were first released by Scope Ratings on 19 September 2019. The Credit Ratings/Outlooks were last updated on 7 December 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.