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Rating action

Scope Ratings GmbH (Scope) has today downgraded the issuer rating of Pannonia Bio Zrt to BB from BB+ and maintained the Negative Outlook. The senior secured debt rating has also been downgraded to BBB- from BBB, while the senior unsecured debt has been downgraded to BB from BB+.

Rating rationale

The downgrade reflects Scope’s downward revision of Pannonia’s financial risk profile (assessed at BBB- from BBB) as a result of deteriorating operating performance - weaker than Scope expectation- negatively impacting credit metrics. The weak operating performance was driven by unfavourable market conditions and increased competitive pressure in 2023. The Negative Outlook reflects the persistence of some risk elements that could limit the recovery of ethanol margins for a prolonged period, and which could ultimately entail a weaker business risk profile (currently assessed at BB-).

Pannonia Bio’s business risk profile continues to benefit from its highly efficient plant (ESG factor: credit-positive environmental risk factor), whose large scale and favourable location have resulted in competitive operating costs and good overall profitability over time. Conversely, the business risk profile continues to be hampered by a strong exposure to highly volatile commodity markets, very weak asset and product diversification and a lack of exposure to low-cyclicality speciality products.

Over the cycle, Pannonia shows solid profitability with a Scope-adjusted EBITDA margin averaging 23% over the period 2015-2022. Based on interim reports and following discussions with management, Scope expects Scope-adjusted EBITDA to decline to around EUR 35m in 2023, with a Scope-adjusted EBITDA margin of around 7%, impacted by adverse market and macroeconomic conditions. High ethanol prices in Europe attracted record import volumes despite significant import tariffs and shipping costs, while European producers faced pressure from high energy and logistics costs, exacerbated by the war in Ukraine. As a result, net imports, mainly from the US and Brazil, reached a record high of 25%-29% of total European (EU and UK) consumption, causing European ethanol prices to fall, with crush margins reaching negative territory in Q4 2022 and remaining extremely low in Q1 2023. In addition, a significant increase in imports of allegedly fraudulent advanced biofuels from China caused prices to plummet, ultimately squeezing sustainability premiums in various markets. Further constrain came from high energy prices and unfavourable corn supply conditions. In Hungary, extreme drought led to a drastic reduction in the corn crop, with production unable to meet domestic demand. This resulted in local corn being priced at import parity with other countries, which impacted Pannonia Bio's profitability.

Scope expects profitability to start recovering from 2024, although remaining below historical levels, continuing the trend already observed in the last quarter of 2023, with some pressure elements such as maize supply conditions and lower energy costs easing. Some positive contribution is also expected from recent investments, such as the completion of the new barley plant. The agency expects the Scope-adjusted EBITDA margin to be around 14%-15%. Scope notes that some pressure from high import volumes from outside Europe will continue in the coming months; the risk of this situation persisting for an extended period could lead to a slow recovery in profitability and margins persistently below 15%, which could lead to a lower assessment of the company's business risk profile.

The revision of the financial risk profile to BBB- from BBB reflects weaker credit metrics, primarily leverage and debt protection. Scope expects leverage, as measured by Scope-adjusted debt/EBITDA, to increase to about 8.0x as of YE 2023, despite Scope-adjusted debt remaining broadly stable at EUR 296m. This is mainly driven by an unexpected sharp decrease in Scope-adjusted EBITDA to around EUR 35m, below Scope's projections in the previous rating case. In 2024-2025, Scope projects leverage to improve to a more sustainable level of around 2.5x-3.5x as a result of the downsized capex programme, a positive contribution from the commissioning of new capacity, proceeds from the sale of solar projects (assumed at around EUR 22m), despite conservative commodity price assumptions, and dividend payments in 2025 that were assumed to be around 50% of the previous year's net profit. Instead, no dividend payment is expected in 2024 due to covenant restrictions. Scope expects EBITDA of around EUR 60m-80m per annum in the next few years, compared to well over EUR 100m per annum in 2019-2022.

In December 2022, the company signed a EUR 50m loan agreement with the European Investment Bank, which management has decided to downsize to EUR 25m in 2023. The company has not yet drawn down the facility and Scope's rating case does not incorporate a drawdown given the likely reduction in the company's investment programme. Potential investments under evaluation are not included in Scope's base case, which in case would be supported by the EIB funds in this case.

Historically, Pannonia Bio has displayed a very strong debt protection, with Scope-adjusted EBITDA interest cover consistently above 10x between 2015 and 2022, despite increased financial debt to support capital expenditure and dividend payments. Scope expects Scope-adjusted EBITDA to fall below 10x between 2023 and 2025, reaching an all-time low of below 4x in 2023, before gradually recovering in the following years, as a result of increased interest expense due to the current interest rate environment and Scope-adjusted EBITDA remaining below historical levels.

While Pannonia Bio's liquidity remains adequate, Scope notes a reduced headroom as some available options (such as the working capital facility) have been largely utilised. Scope expects the upcoming debt maturities to be covered by available unrestricted cash and undrawn committed credit lines of EUR 40m as of September 2023. In 2023, the liquidity ratio is expected slightly below 100% due to the exceptionally weak profitability impacting FOCF generation, sustained capex levels and limited headroom from undrawn committed lines. This does not affect Pannonia's liquidity profile, given the company's track record and the fact that liquidity is expected to recover above 100% in the following years.

Scope reports that Pannonia has disclosed a breach of financial covenants (bank loans) in 2023 relating to cash flow cover, leverage and equity ratio, which has already been waived by the pool of lenders. The covenant will be re-tested in Q1 2024. Based on Scope's projections, cash flow cover and leverage will still breach the covenant thresholds at the retest date. However, following communications with management and Pannonia's history with the committed banks, Scope expects that another breach will most likely be waived. Therefore, no impact on the liquidity assessment has been assumed at this stage. Nevertheless, Scope will continue to monitor developments closely in the coming months. The arising of any potential risk of Pannonia not obtaining a waiver would result in a multi-notch downgrade of the issuer rating.

Pannonia Bio’s financial policy is neutral for the rating. The return on invested capital through capex and dividend payments is maximised while maintaining the sustainability of the company's business model. Significant cash outflows are further limited by covenants in the bank loan agreement, which require approval for temporary breaches of thresholds.

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

Outlook and rating-change drivers

The Negative Outlook reflects Scope's expectation that the ongoing pressure on ethanol prices will continue to impact Pannonia's profitability, putting pressure on its market positioning and ability to deleverage, with Scope-adjusted debt/EBITDA potentially exceeding 3.0x. The Scope-adjusted EBITDA margin is expected to remain below 15% over the next 12-18 months, implying a weaker business risk profile.

A downgrade could result from i) difficulties in deleveraging, e.g. if Scope-adjusted debt/EBITDA remains above 3.0x for a prolonged period due to low ethanol margins or high capex; or ii) no recovery in profitability, e.g. if the Scope-adjusted EBITDA margin remains below 15% for a prolonged period. In addition, a negative rating action, such as a multi-notch downgrade, could be warranted if the company fails to obtain a covenant waiver from the pool of lenders.

A positive rating action, such as a revision of the Outlook to Stable, could be warranted if Scope's expectations regarding Pannonia's weak credit metrics and profitability do not materialise on a sustained basis with leverage improving below 3.0x. Further upside is unlikely given the current business mix but could be triggered by significant improvements in diversification and credit metrics.

Long-term debt ratings

Scope’s recovery analysis indicates an ‘excellent’ recovery for senior secured debt. These expectations translate into a BBB- rating for this debt category, one notch lower than the previous rating following the issuer’s rating downgrade. The recovery is based on an expected liquidation value in a hypothetical default scenario in 2025.

Scope’s recovery analysis indicates an ‘average’ recovery for senior unsecured debt, including the HUF 15bn bond (ISIN: HU0000359112) issued under the Hungarian National Bank’s Bond Funding for Growth Scheme. The recovery is based on an expected liquidation value in a hypothetical default scenario in 2025. These expectations translate into a BB for this debt category, in line with the issuer 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/or Outlook, (General Corporate Rating Methodology, 16 October 2023; Chemicals Rating Methodology, 17 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 these 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 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: Eugenio Piliego, Director
Person responsible for approval of the Credit Ratings: Olaf Tölke, Managing Director
The Credit Ratings/Outlook were first released by Scope Ratings on 18 July 2019. The Credit Ratings/Outlook were last updated on 19 May 2023.
 
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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