{"id":772,"date":"2023-04-02T18:49:34","date_gmt":"2023-04-02T16:49:34","guid":{"rendered":"https:\/\/creditanalyst.eu\/?p=772"},"modified":"2023-04-02T18:49:36","modified_gmt":"2023-04-02T16:49:36","slug":"koncar-group-the-risks-of-high-growth","status":"publish","type":"post","link":"https:\/\/kurtovicfinancial.com\/en\/koncar-group-the-risks-of-high-growth\/","title":{"rendered":"Kon\u010dar Group – the risks of high growth"},"content":{"rendered":"\n

Preliminary FY2022 accounts of the Kon\u010dar Group (hereinafter: \u201cKon\u010dar\u201d or \u201ethe Group\u201d)<\/strong> show a significant sales growth of 51,6%<\/strong> (+17% in 2021), driven by: (i) organic growth<\/strong> across all business segments, (ii) acquisition growth<\/strong> due to the completed takeover of Dalekovod, and (iii) inflationary environment.<\/strong> The growth would have been even higher, however Dalekovod\u2019s results had been consolidated only as of April.<\/p>\n\n\n\n

The Group\u2019s CAeu-adjusted EBITDA (only partially adjusted due to limited information available) followed the sales trend and ended at around HRK 525m, with the margin of approx. 10%. However, if Dalekovod had been consolidated from the beginning of the year, both the absolute EBITDA and the EBITDA margin would have been lower due to Dalekovod\u2019s negative EBITDA in the first quarter of 2022.<\/p>\n\n\n\n

While the developments within the income statement have been positive, the Group\u2019s cash flow<\/strong>, on the other hand, shows significantly different pattern<\/strong>.<\/p>\n\n\n\n

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Kon\u010dar Grupa – key FY2022 figures (preliminary)<\/em><\/figcaption><\/figure>\n\n\n\n

High cash burn to support growth<\/strong><\/p>\n\n\n\n

The Group\u2019s 2-year (2021-2022) cumulative FCF stood at HRK -729m<\/strong>, meaning that almost twice the amount of total FFO of HRK 746m achieved during the same period has been utilized to support growth. The largest outflow was recorded within working capital<\/strong>, in which investments amounted to HRK 1,16bn. The investments of that magnitude lead to negative operating cash flow<\/strong> and were largely driven by increase in activity (62% came from volume, price, mix and the acquisition of Dalekovod, while 16% came from changes in the working capital cycle). Kon\u010dar\u2019s operating cycle has always been long<\/strong> (on average 150 days), now further extended due to the integration of Dalekovod, which has historically had financial and operational issues leading to a pre-bankruptcy proceedings. CAeu estimates that the integration will take some time to show positive results,<\/strong> both in margins and working capital movements.<\/p>\n\n\n\n

Capex and dividends rebounded in 2022, leading to a record negative FCF. Negative cash flow has been further exacerbated by the outflows for the acquisition of Dalekovod<\/strong> and a couple of bolt-on acquisitions in total amount of HRK 386m.<\/p>\n\n\n\n

In order to finance the cash flow gap described above, the Group used mainly two sources. The largest source was new debt in an amount of HRK 637m, followed by internal cash reserves of HRK 575m<\/strong> (deposits and cash accounts are included in this figure).<\/p>\n\n\n\n

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Kon\u010dar\u2019s cumulative cash flow waterfall for the 2021-2022 period (all amounts in HRKm)<\/em><\/figcaption><\/figure>\n\n\n\n

As shown above, the Group\u2019s cash flow over the last two years follows completely different pattern compared to the key figures in the income statement. This underpins the importance of analysing cash flow, as in the Kon\u010dar case it had a significant effect on its leverage and liquidity levels. Furthermore,<\/strong> high growth over the last two years masked one fundamental issue in Kon\u010dar\u2019s business \u2013 below-average profitability<\/strong>.<\/p>\n\n\n\n

Weak profitability has been Kon\u010dar\u2019s underlying issue for years<\/strong><\/p>\n\n\n\n

Kon\u010dar had a negative FCF in five out of last six years<\/strong>. While the negative 2021-2022 FCF was largely driven by high growth, FCF over the 2017-2020 period was also cumulatively negative at HRK -8m. Although the deficit is relatively low, it shows there were some fundamental issues in the cash flow generation. Given that the 2017-2020 period was not a period of high investments, whether working capital or Capex (Capex-to-Depreciation and Amortization ratio stood at 1,07x only), it is clear that one of the main Kon\u010dar\u2019s weaknesses was low profitability compared to industry standards and its large global peers<\/strong>. The manufacturers\u2019 average EBITDA margin is normally between 11% and 18%, while Kon\u010dar has historically delivered the margin of 7-8%. The new management has managed to improve the EBITDA margin<\/strong> bringing it to the 9-9,5% level largely on the back of increased scale, and despite the negative influence of the margin-dilutive acquisition of Dalekovod and the inflationary environment which had a negative effect on raw material prices.<\/p>\n\n\n\n

CAeu estimates that there is still a long way to go for Kon\u010dar to sustainably bring the EBITDA margin up above 10%,<\/strong> more closely to the industry average and large global peers. For example, Siemens and ABB regularly post EBITDA margin in the 13-15% range, which is only one but important reason why Kon\u010dar\u2019s valuation hovers around 5,0-5,5x EBITDA, while Siemens and ABB are valued at 13-20x EBITDA.<\/p>\n\n\n\n

Can Kon\u010dar sustain additional growth amid increasing leverage and deteriorating liquidity?<\/strong><\/p>\n\n\n\n

Kon\u010dar\u2019s orderbook has been solid<\/strong> with a backlog of projects worth HRK 7,3bn and a Book-to-Bill ratio of 1,2x. Operationally, there is certainly space for growth<\/strong> also taking into account Kon\u010dar\u2019s relatively small size in the global market. Financially, the manoeuvre space is more limited, however still large enough, though not without risks.<\/strong><\/p>\n\n\n\n

The Group\u2019s leverage measured by Net Debt \/ FFO stood at 0,7x at the 2022YE, however based on the pro-forma consolidation with the Dalekovod\u2019s Q1 2022 figures, CAeu estimates the Net Debt \/ FFO ratio at 0,9x. In order to maintain solid credit profile, Kon\u010dar could further lever its business up to Net Debt \/ FFO of 3,0-3,3x, which would allow them to take HRK 1,0-1,1bn more debt.<\/strong> Important prerequisite would however be the gradual stabilization of working capital and maintenance of the FFO margin at the level of 9-10%. Margin improvement could open more space for new debt,<\/strong> as 1 p.p. more on the FFO margin level opens up space for additional HRK 160-170m od debt at this level of activity (HRK 5,3bn). On the other hand, obtaining new secured debt in the amounts quoted above could prove to be challenging<\/strong> despite relatively low LTV ratio of 48% at 2022YE, as additional debt of HRK 1,0-1,1bn would likely require tangible collateral taking into account Kon\u010dar\u2019s current financing structure. The banks\u2019 risk appetite for unsecured lending amid increasing interest rates and rising uncertainties might be limited<\/strong> in this case.<\/p>\n\n\n\n

CAeu estimates that the Group will increase its leverage going forward taking into account the management\u2019s growth strategy but will remain below Net Debt \/ FFO of 3,0x in the base case scenario.<\/strong><\/p>\n\n\n\n

Another relevant aspect to watch over the coming years is Kon\u010dar\u2019s liquidity. Historically, Kon\u010dar had been lead quite conservatively, and had maintained net cash position and high liquidity reserves. With the changes in the ownership and management structure, the Group has taken more proactive approach towards growth, both operationally and financially.<\/strong> Liquidity metrics have been deteriorating over the last couple of years but are still at an adequate level. Available cash (cash on accounts, short-term deposits, and available credit lines) comfortably covers the short-term debt maturities<\/strong>, however high growth could deplete at least a portion of reserves, leading to a higher liquidity risk.<\/p>\n\n\n\n

What has growth brought to Kon\u010dar\u2019s investors and creditors so far? What are the key risks going forward?<\/strong><\/p>\n\n\n\n

Kon\u010dar\u2019s growth has been strong over the last two years, but it came at a cost.<\/strong> Firstly,<\/strong> cash flow metrics have been highly negative<\/strong> due to rising raw material prices and effects of acquisition of Dalekovod. Secondly,<\/strong> the leverage has gone up<\/strong> from traditional net cash position to a still modest level, yet increasing. The management has not yet deviated from its moderate dividend policy (payout ratio of approx. 25%) which is a positive sign for creditors. Finally, liquidity has been on a downward trend<\/strong> as cash reserves are gradually disappearing but are still at a comfortable level.<\/p>\n\n\n\n

Creditors are facing higher risk going forward<\/strong> because the change in the Group\u2019s financial strategy will have impact on all relevant metrics. Kon\u010dar\u2019s credit rating will feel a downward pressure<\/strong> which will impact pricing.<\/strong> This, together with an increase in base rates could impede Kon\u010dar\u2019s growth.<\/strong><\/p>\n\n\n\n

CAeu expects that Kon\u010dar\u2019s credit profile will remain solid, absent any major negative events.<\/strong><\/p>\n\n\n\n

Investors have seen an increase in share price over the last two years, from around EUR 100 per share to around EUR 130 per share. However, given the rather low share turnover due to specifics of the Croatian capital market and the Group\u2019s ownership structure, the increase in share price might not truly reflect all benefits and risks associated with the high growth. Dividends remained flat, with a question mark on the dividend policy going forward.<\/p>\n\n\n\n

Here are the key risks to watch going forward:<\/strong><\/p>\n\n\n\n