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Rating action

Scope Ratings GmbH (Scope) has today affirmed its B/Stable issuer rating on DVM Group Kft (DVM). Scope has also affirmed its B+ rating for the senior unsecured debt category.

Rating rationale

The rating affirmation is driven by DVM's robust backlog of HUF 88bn as of April 2024, which provides some visibility on revenue over the next few years. Although the backlog has improved significantly, it remains highly concentrated, with the top three projects accounting for 78% of future contracted revenues. Such concentration carries the risk of significant cash flow volatility, particularly if projects are delayed or cancelled.

Operationally, the company's top line was affected by a challenging market environment. Market uncertainty, high inflation, and changes in end-user demand led to the postponement of some contracted work, resulting in lower-than-expected earnings. In 2023, DVM revenues amounted to HUF 22.6bn down by 28% (preliminary figures) compared to 2022. Scope-adjusted EBITDA also fell to HUF 800m, 30% below Scope's expectations. Lower revenues and higher fixed costs, including higher salary cost, have also impacted the company's profitability, as measured by the Scope-adjusted EBITDA margin, which stood at 3.6% in 2023 based on preliminary figures (below Scope's forecast of 5.1%).

DVM's orderbook benefited significantly from a major residential project signed in December 2023. The project involves the construction of more than 600 apartments and will support the company's cash flow in the coming years. The project backlog reached HUF 88bn as of April 2024, which is 3.4x the average sales of the last three years (1.9x as of April 2023). Although positive, the orderbook is subject to high cluster risk, as 39% of the company's current orderbook is dependent on a single project and client, and the top three projects account for 78%. The second largest project in the pipeline, an office development by DVM's partner Horizon Development, is also subject to the demand for office space, which creates some uncertainty in the project timing.

In order to diversify its business, DVM has started co-development activities, including an 18,000 sq m logistics facility and a 140-apartment residential project. In addition, DVM has entered the renewable energy sector by acquiring an 80% stake in two ready-to-build photovoltaic projects, which are expected to be operational in Q1 2025. The execution risk is partially mitigated by the involvement of an industry expert in the project. Furthermore, the company has launched a JV in 2023 to enter the industrial and logistics development segment, having signed two projects worth around HUF 6.9bn.

Scope expects DVM to continue to generate revenues at least at historical levels, supported by its robust backlog. Additionally, DVM's management has adjusted the organisation to provide some flexibility in variable and fixed personnel costs. It also expects higher margins on some residential projects due to strong demand, which will partially help to protect revenues and profitability in the next few years. However, Scope expects that high raw material prices will continue to put pressure on profitability. Scope's forecast assumes that DVM's profit margin will remain at 2023 levels in 2024 and improve slightly towards 5% over the next 12-18 months as some of the projects begin to bear fruit.

DVM’s business risk profile (assessed at B-) continues to benefit from its good vertical integration. This integration spans a wide range of services across different stages of the construction value chain, including design, project management, contracting, base-building, and fit-out services. DVM also maintains a good domestic network and longstanding relationships with its main clients. However, the rating remains constrained by the company’s small scale withing both the European and Hungarian contexts. Weak diversification further constraint the rating, namely: i) a lack of geographical diversification; ii) a high reliance on the building activities segment; iii) a strong reliance on a few customers; and iv) a concentrated backlog, with the top three projects representing about 78% of the total.

The company’s financial risk profile (assessed at B+) reflects a robust debt protection, with a positive net interest in 2023, supported by interest income and low debt expense, as the HUF 8bn bond carries a fixed interest rate of 3%. Scope anticipates that the interest cover to remain strong over the next few years, as the company’s high cash balances and related interest income will partially offset the expected higher interest expense due to increased leverage. The interest cover is expected to weaken in 2025 due to of the planned increase in bank loans to finance further co-developments.

Leverage, as measured by the Scope-adjusted debt/EBITDA, stood at 10.8x as at December 2023, impacted by very low Scope-adjusted EBITDA. Scope-adjusted debt/EBITDA is expected to remain high in 2024 due to: i) weaker-than-expected cash flow generation; and ii) an increase in indebtedness to partially finance the co-development of a logistics facility (HUF 1.8bn in 2025), before stabilising at a level commensurate with the rating category once developments are complete and provide a boost to the company’s EBITDA. However, Scope acknowledges DVM’s unrestricted cash and cash equivalents (HUF 7.3bn as at end-2023) which is slightly below its financial debt (HUF 8.8bn as at end-2023) and notes that planned investments are of a discretionary nature.

Liquidity is adequate. It benefits from cash and cash equivalents of HUF 7.3bn as at end-2023, resources that limit external financing needs, and a backloaded debt maturity profile. The profile includes a HUF 8.0bn bond maturing in 2030, with the first instalment of HUF 2.4bn due in 2026.

Outlook and rating-change drivers

The Outlook remains Stable and incorporates heightened leverage with Scope-adjusted debt/EBITDA ratio above 6x amid pressure on the company’s profitability. However, the associated risk is largely mitigated by the company’s strong cash cushion, which limits external financing needs and supports good liquidity over the next 12-18 months. The Outlook also reflects the high top-line visibility associated with the record high order backlog of HUF 88bn, which is expected to be realised by 2026. While Scope expects credit metrics to be in line with the rating category, the company’s small size and low diversification continue to pose a significant threat to cash flow stability.

A positive rating is currently considered remote. However, it could materialise if the company is able to demonstrate its ability to maintain its backlog-to-sales ratio to above 2.5x, including highly profitable projects that ensure a recovery of the Scope-adjusted EBITDA margin to above 7%, combined with greater diversification (customers and projects). At the same time, Scope expects the company to gradually deleverage after the peak of investments in 2025, bringing the Scope-adjusted debt/EBITDA ratio down below 6x on a sustained basis.

A negative rating action could occur if the Scope-adjusted debt/EBITDA ratio remains above 6x for a prolonged period (beyond 2025), while the company’s current strong cash position deteriorates significantly.

Long-term debt ratings

In July 2020, DVM issued a HUF 8.0bn senior unsecured bond (ISIN: HU0000359781) through the Hungarian central bank’s Bond Funding for Growth Scheme. The bond has a tenor of 10 years and a fixed coupon of 3%. Bond repayment is in three tranches starting from 2026, with HUF 2.4bn of the face value payable in 2026 and 2028 and the remaining portion payable as a balloon payment at maturity. Bond covenants include no dividend payments before 2022, plus change of control and LTV clauses regarding co-development financing (LTV greater than 50% for single co-development projects and greater than 30% for overall co-developed projects).

Scope’s recovery analysis is based on a hypothetical default scenario occurring at year-end 2025. It assumes outstanding senior unsecured debt of HUF 8.0bn and additional secured bank debt of HUF 1.8bn to partially finance DVM’s co-development projects. The result was an ‘above average’ recovery for the company’s unsecured debt. Scope therefore affirms the B+ rating for this debt category (one notch above 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; Construction and Construction Materials Rating Methodology, 25 January 2024), 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/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 26 May 2020. The Credit Ratings/Outlook were last updated on 4 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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