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Rating action

Scope Ratings GmbH (Scope) has today affirmed its BB-/Stable issuer rating on Hungarian baked goods producer Zalaco Sütőipari Zrt. (Zalaco). Scope has also affirmed its senior unsecured debt rating at BB.

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). Zalaco continues to benefit from steady demand in the non-discretionary consumer goods sector, particularly in food production, which exhibits low volatility, moderate barriers to entry, and low substitution risk.

Zalaco's 2024 performance surpassed expectations, with impressive growth in both revenue (up 10% year-on-year) and EBITDA (up 8% year-on-year). This strong performance was primarily driven by a 16% increase in frozen product sales (compared to 14% in 2023). Additionally, Zalaco's gradual expansion into export sales, particularly through international retail chains, further contributed to the company's growth. However, this growth in frozen products was partially offset by declines in other segments: i) fresh product sales fell by 10.75% (compared to 18% growth in 2023); and ii) retail product sales declined by 1% (compared to 20% growth in 2023).

Zalaco's profitability continues to be a core strength, demonstrated by its relatively high and stable EBITDA margins compared to local competitors. The notable EBITDA growth in 2023 was primarily driven by early-year price increases – a short-term effect anticipated to normalise by year-end. However, 2024 EBITDA reached HUF 5.1bn, surpassing the HUF 4.7bn recorded in 2023. This growth was mainly thanks to greater demand for high-margin frozen products from retail chains, leading to a nearly 20% rise in frozen product sales volumes.

Nevertheless, Scope anticipates a decline in EBITDA margins over the medium term. This is largely on account of the expansion strategy, which is likely to exert pressure on profitability due to increased logistics costs and the introduction of new product portfolio trials. Additionally, inventory shrinkage and obsolescence costs remain steady at approximately 2% of sales, reducing gross margins by 200 basis points (ESG factor: credit negative).

The company's sales are heavily reliant on the international retail chain Lidl, which contributed approximately 55% of total sales in FY 2024, up from 50% in FY 2023. This share is expected to grow further in the medium term, as Lidl remains the primary customer and partner for frozen product sales. However, the risk associated with this high sales concentration is partially offset by Zalaco's ability, as a small-cap company, to consistently deliver quality-focused products and sustain its business operations effectively. Zalaco's business risk profile remains primarily constrained by its small scale and lack of geographic diversification, as slightly delayed export sales of its frozen products limits exposure to a specific region.

Financial risk profile: BBB- (unchanged). Zalaco's financial risk profile is stronger than its business risk profile. The company’s sound growth improved credit metrics in 2024. Leverage, as measured by Scope-adjusted debt/EBITDA*, decreased towards 1.3x (from 1.5x in 2023) and funds from operations/debt exceeded 70% due to solid EBITDA growth in absolute terms while indebtedness remained moderate.

Zalaco's M&A strategy, initially delayed due to the Covid pandemic and high inflation, has gained momentum with its first activity materialising in 2024. The company initiated the acquisition of its direct market competitor. This acquisition is expected to enhance Zalaco's production network and extend its regional coverage.

Scope anticipates that leverage will move to around 2.5x in medium term as a result of the expansion strategy. Zalaco is planning greenfield investments and is currently conducting due diligence for a new hybrid factory. Discussions are underway with the local city municipality regarding a seven hectare plot of land for a project valued at HUF 10.0bn. While management anticipates a government subsidy for this development, Scope assumes that the project will be internally funded. This initiative is expected to strengthen the company’s connection with Budapest and expand its regional coverage.

Scope’s leverage assessment does not include the netting of cash, as the high cash balance is expected to be partly utilised rather than serving solely as a liquidity buffer.

Liquidity: adequate (unchanged). Zalaco’s liquidity remains adequate. This is mainly driven by a limited short-term debt position and sound EBITDA cash conversion. While an expected increase in maintenance and development capex in upcoming years will push free operating cash flow close to nil in 2025, the company’s significant cash buffer should be sufficient to fully cover financing and refinancing needs.

Scope notes that Zalaco’s senior unsecured bond issued under the Hungarian National Bank’s Bond Funding for Growth Scheme has a covenant requiring the accelerated repayment of the outstanding nominal debt amount (HUF 4.4bn) if the debt rating of the bond 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 company’s liquidity profile. The rating headroom to entering the grace period is three notches. Scope therefore sees no significant risk of the rating-related covenant being triggered.

Supplementary rating drivers: no rating impact (unchanged): Supplementary rating drivers have no impact on the issuer rating.

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

Outlook and rating sensitivities

The Stable Outlook reflects Scope’s expectation that Zalaco will maintain organic growth, while profitability margins will be maintained at least at 15%, resulting in a debt/EBITDA ratio of around 2.5x. In addition, the Outlook is based on the assumption that Zalaco will not engage in any increased shareholder-oriented financial policies, such as significant dividend payments or additional third-party guarantees.

The upside scenario (deemed remote for the time being given the company’s limited size and geographical reach) for the ratings and Outlook would require:

• Improved business risk, particularly with regard to size and/or geographical diversification, while maintaining the current financial risk profile

The downside scenario for the ratings and Outlook would require:

• Debt/EBITDA at around 3.5x on a sustained basis

Debt ratings

Scope has affirmed the senior unsecured debt rating at BB, which is also applicable to the HUF 4.4bn (ISIN HU0000359765) bond. The rating is based on a hypothetical liquidation scenario as of end-2026, in which Scope computed an ‘excellent’ recovery for holders of senior unsecured debt based on its assumptions of attainable liquidation values. Although the recovery analysis indicates a relatively high recovery rate for senior unsecured debt, Scope has limited the uplift for the instrument to one notch due to i) the unsecured nature of the debt, ii) Zalaco’s small scale and the uncertainties around the setup of the company at the time of a default, and iii) the risk that the company could raise higher-ranking debt, which would dilute the recovery for senior unsecured debt holders.

Environmental, social and governance (ESG) factors

ESG factors have impacted this credit rating action. Despite a slight improvement in FY 2024, Scope remains concerned about inventory shrinkage and obsolescence costs, which still equate to 1.5% of sales and decrease gross margins. Although this credit-negative factor did not result in a rating adjustment under supplementary rating drivers, it impacts the rating somewhat negatively via Scope’s assessment of the company’s operating profitability and its overall blending in Zalaco’s competitive positioning.

All rating actions and rated entities

Zalaco Sütőipari Zrt.

Issuer rating: BB-/Stable, affirmation

Senior unsecured debt rating: BB, 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 methodologies used for these Credit Ratings and/or Outlook, (General Corporate Rating Methodology, 16 October 2023; Consumer Products Rating Methodology, 31 October 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, 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/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: Zurab Zedelashvili, Senior Director
Person responsible for approval of the Credit Ratings: Sebastian Zank, Managing Director
The Credit Ratings/Outlook were first released by Scope Ratings on 24 April 2020. The Credit Ratings/Outlook were last updated on 1 March 2024.

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
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