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Rating action

Scope Ratings GmbH (Scope) has today affirmed the BB- issuer rating of Hungarian construction company KÉSZ Holding Zrt. and revised the Outlook to Negative from Stable. Concurrently, Scope has withdrawn the senior unsecured debt rating at its recent level of BB and assigned BB ratings to the senior unsecured guaranteed bonds issued by KÉSZ Holding Zrt. (ISIN: HU0000360466; ISIN: HU0000360870), both guaranteed by its subsidiaries KÉSZ Építő Zrt., KÉSZ Ipari Gyártó Kft. and Matech Magyar Technológiai Kft.

Rating rationale

The Outlook change is driven by the risk of a rise in leverage, caused by the potential deterioration in future revenues, given the lower order backlog in 2024 compared to 2023. The order backlog faces potential pressures, supporting top-line visibility for 2024 but providing limited visibility for 2025. The Negative Outlook also reflects the risk of persistent deterioration in the operating performance — weaker than expected Scope-adjusted EBITDA and EBITDA margin —which could ultimately entail a weaker financial risk profile (currently assessed at BB-).

KÉSZ achieved a milestone in 2023, marking it as a record year with revenues climbing to HUF 232bn (based on preliminary figures), thereby exceeding the previously forecasted HUF 220bn. The reported EBITDA for KÉSZ was HUF 10bn, showing a decline from the previous year's HUF 13.2bn. This was partly due to a HUF 2.8bn provision made for one of KÉSZ’s developments, the residential development Duna Terasz Grande, in which KÉSZ served as the general contractor. This provision, which represents 10% of the total contract value, has been allocated for a dispute with the client that is currently ongoing. KÉSZ has assured Scope that this provision fully encompasses the associated financial risk. However, the current dispute could potentially impact KÉSZ's reputation in the Hungarian construction market, underlining the importance of a prompt and positive resolution. Scope will closely monitor the development of the ongoing dispute and will assess any potential impact on KÉSZ's standing in the construction industry.

The business risk profile (assessed at B+) remains driven by the group's market position that benefits from its vertical integration — being a one-stop shop — since KÉSZ's subsidiaries can design, manufacture, and implement new construction projects, generating efficiencies in both the cost and duration of projects.

Diversification is set to improve in 2024 as KÉSZ expands its operations in Romania and Ukraine (35% of the order backlog as of March 2024), marking a strategic shift from its previously Hungary-centric focus. The Romanian and Ukrainian projects, include a significant contract with STIHL and two projects in Ukraine amidst challenging conditions. Alongside this, the group has also begun to expand its footprint in the US, with some minor projects, which underscore a deliberate effort towards geographical and operational diversification. This strategic shift is critical, especially as Hungarian sales volumes are expected to decline in 2024. In Ukraine, the most immediate risks include project delays or cancellations, due to the ongoing war with Russia, highlighting the need for robust contingency planning. Moreover, venturing into the US market carries its own set of execution challenges, including navigating new regulatory landscapes and logistical hurdles. However, Scope assesses these risks as manageable, especially when considering the scale of the US project relative to the total order backlog. The anticipated recovery in the macroeconomic conditions in Hungary in the second half of 2024 could herald new business opportunities. This expected upturn, if realised, may stabilise the company, enhancing revenue and pipeline visibility. Yet, geographical diversification remains a concern, with approximately 90% of 2023's revenue and 65% of the order backlog related to projects in Hungary.

Profitability, as measured by the Scope-adjusted EBITDA margin, declined to 5.5%, impacted by inflation and high raw material costs. However, with raw material prices stabilising and inflation in Hungary showing signs of abating, profitability is expected to stabilise around 6% for 2024 and 2025. This improvement is anticipated due to a more predictable cost environment, which is likely to reduce the incidence of loss-making projects. Additionally, there is a focus on higher-margin segments, such as steel structures manufacturing, technological and electrical implementation, and building structure solutions, which represented 16% of the backlog in 2024, up from 12% in 2023.

KÉSZ’s backlog of projects, which excludes energy revenues, has weakened, equating to 1.3x the average revenue of the last three years (1.7x in 2023) and evidencing a reduction in the volume of projects commencing in 2024. There is good visibility on the top line for 2024, but the group could face potential pressure on revenue and cash flow generation in 2025, due to the lower order backlog. Despite a notable reduction in the order intake and energy revenue (reflecting a downward adjustment in energy prices) the group remains buoyed by its ability to win new projects currently out for tender, based on its existing relationship with certain clients and its strong foothold in its domestic market. In addition, the current backlog is now more evenly distributed among the top 10 projects (represented 52% of the backlog as of March 2024), which ensures a healthier diversification of risk and opportunity. The composition of KÉSZ's order backlog has evolved, becoming more diversified as larger projects like BMW, LEGO, and Mercedes-Benz approach completion.

The revision of the financial risk profile to BB- from BB reflects the expected weaker credit metrics, primarily leverage. KÉSZ’s main drivers of indebtedness are the corporate bonds (HUF 22bn and HUF 11bn as well as the HUF 5.7bn issued by Greenergy, a majority-owned subsidiary) issued under the Hungarian Central Bank’s Bond Funding for Growth Scheme to partially finance their significant capex programme.

Scope-adjusted debt/EBITDA stood at 2.9x as at YE 2023, based on preliminary figures. Interest-bearing debt increased to HUF 57.5bn as at YE 2023 (up HUF 8.5bn YoY), lower than the HUF 67bn originally forecasted. Debt levels are expected to remain stable in the short to medium term, as the group has limited financing needs. The first bond repayments do not start until 2026. However, while the backlog offers good visibility on the 2024 revenue stream, Scope has limited visibility for 2025, with only 25% of the issuer’s planned revenue for 2025 contracted to date. The issuer was in a much stronger position in March 2023, with almost 73% contracted for the following year. As such, the Scope-adjusted debt/EBITDA could deteriorate significantly in the next 12 to 18 months, to above 4x, if the issuer is not able to convert its project pipeline into contracted projects.

Scope-adjusted EBITDA interest cover stood at 5.9x in 2023, a decrease from the previous year's 24x. Debt protection metrics were impacted by lower-than-expected EBITDA and higher net interest payments in 2023. This was partly offset by interest income. Scope expects debt protection will remain at this level in 2024. Similarly, without further visibility on 2025 revenue, the interest cover could begin to weaken. The group benefitted from the low-interest rate environment prior to the Ukraine/Russia war. As such, for YE 2023, the group had HUF 38.7bn in bonds’ fixed at an average rate of 3.2%, and an average maturity of 7.6 years. The group has HUF 18.8bn in bank debt, 90% from it subject to variable interest rates, introducing interest variation risk. KÉSZ intends to increase the share of contracted fixed-rate debt in the short-to-medium term. The bank debt includes HUF 10.9bn denominated in euros, adding FX risk and further interest rate variability. However, Scope believes it is unlikely that interest rates will rise further in 2024, with indications that central banks are expected to begin cutting rates in 2024. Additionally, the FX risk is partially offset, as 77.2% of the order backlog is in euros.

KÉSZ faces limited financing needs, with the exception of working capital, but changes in the tendering model in Hungary have seen larger clients provide 'advance payments' (interest-free) in the region of 10 – 20% of the contract value, in order to ensure the contractors are fully resourced and to prevent project delays. Furthermore, KÉSZ has HUF 3.8bn in unused credit facilities committed for more than one year (YE 2023), spread across a number of banks. FOCF will remain negative throughout 2024 and 2025, due to capex in KÉSZ’s Real Estate and Energy divisions, before recovering to a more normalised level in 2026 with the release of cash from the sale of the ambitious developments in Romania. Consequently, Scope forecasts cash flow cover to remain negative in the medium term.

Liquidity is adequate, as sources (HUF 38.5bn of cash and HUF 3.8bn in undrawn credit lines available as at YE 2023) cover uses (HUF 7.6bn in short-term debt as at YE 2023 and negative FOCF of HUF 15.9bn forecasted for 2024). Aside from the repayment of short-term debt, Scope anticipates positive FOCF from 2026 onward, once investment projects have been completed and sold, and a number of larger ticket projects have also been completed, primarily the developments in Romania, which will further support liquidity.

Scope highlights that Kész’s guaranteed senior unsecured bonds issued under the Hungarian National Bank’s Bond Funding for Growth Scheme have a covenant requiring the accelerated repayment of the outstanding nominal debt amount (HUF 33bn) if the debt rating of the bonds stays below B+ for more than two years (grace period) or drops below B- (accelerated repayment within 30 days). Such a development could adversely affect the group’s liquidity profile. The rating headroom to entering the grace period is two notches. Scope therefore sees no significant risk of the rating-related covenant being triggered. In addition to the rating deterioration covenant, other covenants include (i) change of control, (ii) maximum dividend 50% of the profit before taxes, and (iii) consolidated net debt/EBITDA above 4x in the last three years of the bond tenor.

Scope did not identify any ESG-related rating driver which would have a relevant impact on its assessment on credit risk (neither positively nor negatively). The KÉSZ Group published its first concise ESG report in 2023.

Outlook and rating-change drivers

The Negative Outlook is driven by the risk of a rise in leverage, caused by the potential deterioration in future revenues, given the lower order backlog in 2024 compared to 2023. The order backlog faces potential pressures, with visibility on the top line for 2024 but limited visibility for 2025. The Negative Outlook also reflects the risk of persistent deterioration in the operating performance – weaker than expected Scope-adjusted EBITDA and EBITDA margin – which could ultimately entail a weaker financial risk profile. The Negative Outlook also considers the possible reputational damage on KÉSZ's standing in the Hungarian construction industry. However, Scope views this as limited for the time being. The Outlook considers the group's commitment to a cautious financial approach, particularly regarding the distribution of dividends, investments for expansion, and continued access to performance guarantees.

A positive rating action, such as a revision of the Outlook back to Stable, may be warranted if the group can enhance visibility on sales beyond 2024 through successful tenders for new mandates, ensuring the backlog consistently remains above 1x. Furthermore, this is contingent upon the non-materialisation of Scope's concerns regarding KÉSZ's weak credit metrics, with leverage as measured by the group’s Scope-adjusted debt/EBITDA (including netting of cash seen permanent) staying below 4.0x on a sustained basis.

A downgrade could be required if KÉSZ’s leverage significantly deteriorated to above 4.0x on a sustained basis or if KÉSZ’s order backlog dropped below 1x. Such a scenario could be caused by a deterioration in market conditions, leading to fewer projects being added to the backlog, or if the company is impacted by the ongoing dispute, Duna Terasz Grande, which would affect its ability to secure new projects.

Long-term debt rating

In June 2021, KÉSZ issued a HUF 22bn senior unsecured bond (ISIN: HU0000360466) through the Hungarian Central Bank’s Bond Funding for Growth Scheme. This was followed by a second issuance of HUF 11bn senior unsecured bond (ISIN: HU0000360870) in November 2021 under the same scheme. Both are guaranteed by KÉSZ Építő Zrt., KÉSZ Ipari Gyártó Kft. and Matech Magyar Technológiai Kft., all subsidiaries of the issuer. The proceeds of the bonds were used to support the group’s working capital financing needs and to secure long-term funding for group-wide expansion plans. Both instruments have a tenor of 10 years, with the HUF 22bn bond having a fixed coupon of 2.8% and the HUF 11bn bond having a fixed coupon of 4.1%. The repayments of both instruments are structured in five tranches starting from 2026, with 10% of the face value payable yearly, and 50% balloon payment at maturity.

Scope’s recovery analysis is based on a hypothetical default in 2025, which assumes outstanding senior unsecured debt of HUF 33bn in addition to HUF 22bn in bank loans, payables of HUF 29bn and other financial obligations of HUF 6.9bn, assuming the group draws on available overdrafts. The recovery assessment results in an ‘above-average’ recovery for senior unsecured guaranteed bonds (ISIN: HU0000360466, ISIN: HU0000360870), which translate into a BB rating one notch above the underlying issuer rating. Any potential additional uplift is constrained by the risk and the possibility that senior secured debt will increase in the path to default.

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, (Construction and Construction Materials Rating Methodology, 25 January 2024; 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 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: Rigel Scheller, Director
Person responsible for approval of the Credit Ratings: Philipp Wass, Managing Director
The Credit Ratings/Outlook were first released by Scope Ratings on 30 March 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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