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Rating action

Scope Ratings GmbH (Scope) has today placed Hungarian discretionary goods manufacturer Wellis Magyarország Zrt.’s B- issuer rating and B- senior unsecured debt rating under review for a possible downgrade.

Rating rationale

The under-review placement for a possible downgrade primarily reflects the pending risks about covenant compliance pertaining to a minimum rating level of B+ for the HUF 9.9bn bond that has been placed under the Hungarian National Bank’s Bond Funding for Growth Scheme. Non-compliance to the rating-related covenant beyond the two-year grace period, which expires in October 2024, could trigger the acceleration of the bond repayment which might have default implications for Wellis. Scope sees the recovery of the debt rating to the minimum threshold of B+ currently remote. After the expiry of the grace period, the issuer could face severe liquidity constraints unless it obtains refinancing that covers the early repayment of the outstanding bond amount, or it proactively obtains an investor waiver related to the accelerated repayment.

The business risk profile (assessed at B) remains supported by the high diversification in terms of geographies, customers and suppliers. Additionally, the business risk profile is supported by the issuer’s brand strength, benefitting from the international scope of branded sales as well as the solid quality of its products.

Prior to 2020, the global spa market was driven by an increase in disposable income, rising health awareness and technological advancements, which made home wellness products more affordable. The impact of the COVID-19 pandemic was positive overall, as customers became more conscious of their wellbeing, especially during the lockdown periods. However, starting in 2022, rising material, logistics and energy prices, high inflation and an economic downturn combined to result in a decline in demand and significantly decreased sales volumes in the segment. In 2023 sales revenues of Wellis fell by 42%, stemming from the softening demand conditions and the contraction of the market.

While the first quarter of 2023 was characterised by a high loss on the EBITDA level (EBITDA margin: -14%), there is evidence of a rebound starting from Q3 2023, which is expected to continue in 2024. While the EBITDA margin based on the preliminary 2023 accounts remained below 1%, Scope’s financial forecast includes an estimated EBITDA margin of approximately 7% for 2024. This is expected to increase close to 9% in 2025.

The improvement can be attributed to three key factors:

1. improving demand conditions, with a successful 5% price increase implemented in 2024
    
2. better gross margin, mainly related to a change of suppliers
    
3. significant cost cutting, reorganisation and reduction of operating costs

The financial risk profile continues to be assessed at B-, and remains the main constraint to the issuer rating. In a manner comparable to 2022, the leverage, measured by Scope-adjusted debt/EBITDA, reached levels that are unsustainable over the medium term. In accordance with the projected gradual recovery of the EBITDA margin, and due to the annual HUF 4bn debt amortisation, leverage is forecasted to gradually improve towards 5x until 2025, well below the leverage metrics recorded in 2022 and 2023.

The weak profitability and increasing debt level in 2023 have also had a negative effect on debt protection, as measured by Scope-adjusted EBITDA interest cover, which remained below 1.0x in 2023. Scope anticipates that interest payments will increase by 26% in 2024 compared to 2023, reaching almost HUF 1bn. The average interest rate is expected to remain between 3%-5%, benefitting from the fixed coupon of the bond (3%) and the lower interest rate on the euro-denominated loans compared with those in Hungarian forint. In 2024 and 2025, assuming no additional debt will be sourced, Scope expects interest cover to improve to above 2.0x.

Free operating cash flow (FOCF) remained negative in 2023, primarily due to the insufficient EBITDA, and the HUF 2bn CAPEX incurred during the year. Going forward, FOCF/ Scope-adjusted debt is expected to return to the positive territory, supported by reduced CAPEX needs (only HUF 400m maintenance CAPEX, according to the management forecast) and positive cash flow from the changes in the working capital (especially the reduction of inventory).

Liquidity remains inadequate. While the available cash at year-end 2023 (HUF 458m) and the forecasted free operating cash flow for 2024 (HUF 4bn) cover the scheduled debt amortisation of HUF 4bn, Scope considers the liquidity headroom to be limited and debt service to be highly dependent on the issuer’s ability to reduce the cash absorbed by working capital, particularly inventory. Scope notes that the issuer lacks the financial resources to repay the bond in full in the event of an accelerated repayment by creditors. This would result in a distressed liquidity situation and a potential multi-notch downgrade.

Under review for possible downgrade

The ratings of Wellis Magyarország Zrt. have been placed under review for possible downgrade. Scope intends to resolve the under-review status as soon as possible.

A downgrade, not limited to one notch, would occur in case the issuer is unable to obtain a waiver from the bondholders well before the expiry of the grace period on 20 Oct 2024. This would require Wellis to repay the nominal amount (HUF 9.9bn) within 30 days, which would likely lead to a further deterioration of the company’s liquidity profile and could have default implications.

The rating could be affirmed if Wellis is able to obtain a waiver from bondholders before the end of the grace period.

A positive rating action could be conducted if i) Wellis obtained a waiver from creditors on the covenant breach well ahead of the end of the grace period, ii) sustainably improved its operating margin and credit metrics and iii) improved further its access to external funding such as working capital facilities.

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, (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.

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 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: 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 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 the principal grounds on which the Credit Ratings are based. Following that review, the Credit Ratings were not amended before being issued.

Regulatory disclosures
These Credit Ratings are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings are UK-endorsed.
Lead analyst: Istvan Braun, Associate Director
Person responsible for approval of the Credit Ratings: Sebastian Zank, Managing Director
The Credit Ratings/Outlook were first released by Scope Ratings on 22 January 2021. The Credit Ratings/Outlook were last updated on 20 October 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
© 2024 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.