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Rating action

Scope Ratings GmbH (Scope) has today affirmed the B issuer rating on Hungarian gear manufacturer Szabó Fogaskerékgyártó Kft. (hereafter ‘Szabó) and changed the Outlook to Negative from Stable. Scope has also affirmed the B+ rating for the senior unsecured debt category, one notch above the issuer rating.

The Negative Outlook reflects the significant business slowdown in 2024 and unclear recovery potential in 2025.

The full list of rating actions and rated entities is at the end of this rating action release.

Key rating drivers

Business risk profile: B- (unchanged). The company’s business risk profile continues to be constrained by its size, low product diversification and high customer concentration. Despite a significant decrease expected for 2024, profitability (as measured by the Scope-adjusted EBITDA* margin in the context of the peer group) remains the major support for Szabó’s business risk profile.

After two years of declines, the EBITDA margin improved to 32.0% in 2023 from 21.7% in 2022. EBITDA was up to HUF 860m in 2023 from HUF 527m in 2022, driven by higher profitability and revenue growth of 11% YoY to HUF 2.7bn.

The business environment has deteriorated sharply in 2024. Revenue decreased by 58% YoY to HUF 577m in H1 2024 from HUF 1.4bn in H1 2023, reflecting a sudden drop in volumes from the company’s two largest customers. In this context, Szabó has assured Scope that there are no outstanding issues between the company and its main customers. It has also referred to its order backlog for 2025, for which both customers have already placed orders. As a relatively small supplier, Szabó is generally severely affected by even small reductions in demand from its often much larger customers. For the full year 2024, Scope has factored in revenue of around HUF 1.2bn (down 54% YoY).

The reported EBITDA margin decreased to 21.3% in H1 2024 from 35.5% in H1 2023 but remained strongly positive. Scope attributes this relative robustness in an extreme stress scenario to the low fixed cost base and the company’s operational flexibility. Based on the H1 2024 results, Scope expects the EBITDA margin to decline to around 22% in 2024. Together with the agency’s revenue forecast, this translates into a downward revision of EBITDA to around HUF 275m.

In view of the fragile global economic environment, revenue visibility for 2025 is rather low. There is uncertainty as to whether and to what extent the volumes from the largest customers will return in 2025. Scope has assumed that Szabó will maintain the relatively low level of revenue in 2025 and has factored in revenue of HUF 1.4bn. This is based on the current order backlog for 2025 of HUF 794m and the assumption that 20% of the potential sales opportunities amounting to HUF 2.95bn will be converted into sales in 2025. With an EBITDA margin of around 23% in 2025, Scope expects Szabó's profitability to remain broadly unchanged compared to 2024. A significant improvement is likely to be prevented by the still low volumes expected in 2025 and some additional costs for the relocation of production capacity from the old plant to the new one. By contrast, the gradual headcount reduction in 2024 will take full effect in 2025 and have a positive impact on profitability. Scope assumes that EBITDA will increase to HUF 325m in 2025 due to the somewhat higher revenue.

Financial risk profile: B+ (revised from BB+). The revised financial risk profile reflects Scope’s changed expectation for EBITDA in 2024-25, now with weaker credit metrics in these years.

Leverage as measured by debt/EBITDA improved to 2.6x in 2023 from 4.7x in 2022, largely driven by the increase in EBITDA. Scope foresees debt/EBITDA rising to around 7.7x in 2024, based on its revised EBITDA expectations for 2024. As the agency does not expect EBITDA to recover significantly before 2026, it anticipates that debt/EBITDA will still be relatively high at 5.8x in 2025. Assuming that volumes return in 2026, e.g. through the acquisition of new customers, and lead to a material recovery in EBITDA, Scope expects a stronger improvement in debt/EBITDA to around 3.7x in 2026.

The interest result was positive in 2022-23, supported by interest income on the high cash reserves in those years and the fact that the payment of interest on the bond started in 2023. As indicated by the 9M 2024 results, Scope expects Szabó to generate interest income again in 2024. The agency expects the interest result to turn negative in 2025, as the company’s cash reserve decreases in 2024 due to negative free operating cash flow (FOCF). Overall, Scope foresees good interest cover of around 4.7x in 2025 and about 5.9x in 2026, signaling the company’s ability to sustain its debt position.

After two previous years of negative FOCF, as a result of an investment programme in production capacities initiated in 2021, FOCF turned positive in 2023 at HUF 276m. This was the effect of higher EBITDA as well as lower capex, which largely reflects the delayed completion of the investment programme due to the postponed property development. Scope expects capex to peak at around HUF 2.3bn in 2024 and weigh heavily on cash flow. The agency expects negative FOCF of HUF -2.0bn in 2024. Scope assumes that Szabó will significantly reduce its capex after 2024 when the investment programme ends. Nevertheless, the agency forecasts slightly negative FOCF of around HUF -40m. This essentially reflects its expectation that EBITDA will remain relatively low in 2025 and that the net interest result will be negative in contrast to the last three years.

Cash flow cover improved to 12% in 2023, after being negative for two years. Scope expects cash flow cover to turn negative in 2024, considering the record capex. Based on its expectation for FOCF, Scope sees cash flow cover of around 0% in 2025-26.

Liquidity: adequate. Scope considers liquidity and financial flexibility to be adequate, as available cash sources cover short-term debt by well over 150% over the next two years. The agency notes positively the company's well stretched debt maturity structure, with no major repayments in 2025-26, and the available new five-year loan of HUF 180m signed with ERSTE Bank in October 2024, in addition to the cash on the balance sheet. Scope's liquidity assessment also reflects the significantly lower FOCF pressure expected in 2025, as capex is cut back following the completion of the investment programme.

Szabó’s HUF 1.5bn senior unsecured bond issued under the Hungarian Central Bank’s bond scheme in February 2022 has an accelerated repayment clause. The clause requires the repayment of the nominal amount (HUF 1.5bn) within 10 business days after the bond rating falls below B-. There is a two-year grace period for a B/B- bond rating, which means that to avoid the accelerated repayment the company must ensure the debt rating returns to B+ before the grace period ends. Such a development could adversely affect the company’s liquidity profile. The rating headroom to entering the grace period is zero notches. Given the limited rating headroom and the Negative Outlook, Szabó must at least maintain its current credit profile to avoid triggering the rating-related covenant.

The HUF 1.0bn subsidy is in principle non-refundable, but linked to the fulfilment of milestones, which relate to the growth rate of gross value added compared to GDP growth. Testing for repayment of subsidies starts in 2026. Failure to meet the milestones will result in a pro-rata repayment of the subsidy rather than full repayment. Scope expects Szabó to either meet the milestones or find a way to avoid repayments, as seen in other cases.

Supplementary rating drivers: credit-neutral. The rating does not incorporate any adjustments related to financial policy, peer group considerations, parent support or governance and structure.

Outlook and rating sensitivities

The revised Outlook to Negative from Stable reflects the expected significant deterioration in credit metrics in 2024. This is a result of the anticipated decline in revenue as indicated by the H1 2024 figures. It also reflects the general deterioration in the business environment, which makes the development of sales volumes beyond 2024 quite uncertain. Given Szabó's vulnerable business model with high customer and product concentration, Scope sees an increased risk that the assumed recovery in EBITDA and credit metrics in 2025/2026 may not materialise.

The upside scenarios for the ratings and Outlook are (individually):

1. EBITDA and leverage to recover in 2025/2026 based on improved business environment, e.g. leverage not settling well above 4.0x.
    
2. Greater size and improved diversification (deemed remote).

The downside scenarios for the ratings and Outlook are (individually):

1. Assumed recovery in EBITDA and credit metrics in 2025/2026 does not materialise and debt/EBITDA remains well above 4x on a sustained basis.
    
2. Loss of a major customer.
    
3. Deterioration in liquidity.

Debt rating

Scope has affirmed the senior unsecured debt rating at B+, one notch above the issuer rating.

In February 2022, Szabó issued a HUF 1.5bn senior unsecured bond (ISIN: HU0000361480) through the Hungarian central bank’s Bond Funding for Growth Scheme. The bond’s tenor is 10 years, with a fixed coupon rate of 5.5% and repayment in six tranches of 10% in 2027, 2028, 2029, 2030 and 2031 and of 50% in 2032.

Scope’s recovery analysis indicates an above average recovery for senior unsecured debt at the level of Szabó, translating into a rating one notch above the issuer rating of B. The recovery analysis uses a liquidation value of HUF 2.6bn for a hypothetical default scenario in 2025. This value is based on a haircut on the assets and reflects liquidation costs of 10% for the assets. The relatively high assumed liquidation value reflects the large amount of PPE as a result of the ongoing investment programme, which started in 2021 and ends in 2024.

Environmental, social and governance (ESG) factors

Overall, ESG factors have no immediate impact on this credit rating action.

From a governance perspective, Scope still sees high risk around key personnel. The company is entirely managed by CEO Ferenc Szabo, the sole owner of Szabó Fogaskerékgyártó Kft., and his son Krisztian Szabo, the executive vice president. Consequently, the company could prove vulnerable to structural changes in management.

All rating actions and rated entities

Szabó Fogaskerékgyártó Kft.

Issuer rating: B/Negative, Outlook change

Senior unsecured debt rating: B+, affirmation

*All credit metrics refer to Scope-adjusted figures.

Stress testing & cash flow analysis
No stress testing was performed. Scope Ratings performed its standard cash flow forecasting for the company.

Methodology
The methodology used for these Credit Ratings and/or Outlook, (General Corporate Rating Methodology, 16 October 2023), is 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 did participate 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: Gennadij Kremer, Director
Person responsible for approval of the Credit Ratings: Sebastian Zank, Managing Director
The Credit Ratings/Outlook were first released by Scope Ratings on 31 January 2022. The Credit Ratings/Outlook were last updated on 22 December 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, as well as a list of Ancillary Services and certain non-Credit Rating Agency services provided to Rated Entities and/or Related Third Parties.

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, Scope Innovation Lab 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.