Uzbek Passenger Vehicles Manufacturer UzAuto Motors Rated ‘B+/B’; Outlook Stable
Tashkent, Uzbekistan (UzDaily.com) -- S&P Global Ratings assigned ‘B+/B’ long- and short-term issuer credit ratings to UzAuto Motors.
The stable outlook reflects expectation of S&P Global Ratings that the company will secure financing for its capital expenditure (capex) project in first-half 2021, recover its car sales in 2021 as the pandemic eases, and maintain moderate leverage, with funds from operations (FF0) to debt of 40%-60%.
UzAuto Motors’ geographic concentration, dependence on favorable market regulation, and alliance agreement with General Motors (GM) are key rating constraints.
UzAuto Motors is a relatively small passenger vehicles producer, with manufacturing facilities in Uzbekistan, a country with relatively low GDP per capita compared with the Commonwealth of Independent States (CIS) average of about US$5,000 as of end-2019. This is partially offset by the country’s relatively old car fleet, increasing automobilization, and a sizable (about 50%) population of people under the retirement age, as of October 2020. In 2019, the company sold about 280,000 light vehicles, of which 95% were sold domestically. Compared with other international original equipment manufacturers (OEMS) we rate, which are typically much more geographically diversified in terms of sales or have much larger domestic home markets, UzAuto Motors is significantly exposed to the volatility of the Uzbek economy. Although not in base case of S&P Global Ratings, since the agency forecasts Uzbekistan’s economy will have expanded by 0.5% in 2020, despite COVID-19-related setbacks, and 5.0%-5.5% annually in 2021-2023, any local economic breakdown would meaningfully impair UzAuto Motors’ volumes sold and therefore its EBITDA. The company’s performance is further limited by its exposure mostly to the lower-priced market segment, compared with more premium-focused producers, meaning UzAuto Motors depends more on customers’ ability to pay for vehicles. We note the Uzbek manufacturer’s strategy to continue expanding export volumes to CIS countries, although domestic sales are likely to continue contributing up to 80% of total sales in the midterm.
UzAuto Motors relies on an alliance agreement with GM to manufacture and distribute cars under the Chevrolet brand, and we expect the agreement will be extended before it matures. However, any potential revision of terms resulting in lower profitability or significantly higher research and development (R&D) costs that alter credit metrics could lead us to reassess its business position.
UzAuto Motors enjoys its position as the largest national vehicle manufacturer in Uzbekistan.
The company benefits from government market-protection measures. These include high import tariffs and production localization requirements. UzAuto Motors’ monopolistic position secured it a market share of 96% in Uzbekistan’s passenger vehicles segment in 2019. However, we note the government’s plans to gradually build a more competitive environment. For example, in 2019 Uzbek auto producers’ exemptions on all taxes were cancelled. We understand the government will continue to prioritize national car manufacturers, but changes in taxes, tariffs, or regulations could hurt the company’s business prospects.
Although generating domestic revenue in local currency, UzAuto Motors pays for imported materials and components in U.S. dollars, exposing the company to FX risk.
The company’s bargaining power is quite limited because 70% of overseas components are provided by GM. Moreover, some local components are subject to FX risk since raw materials are imported. This should somewhat improve with the production and launch of new models, with the share of local currency-linked costs increasing to 45%-50% in the medium term from 35% in 2019, and the company switching to direct contracts for imported components. That said, the company does not mitigate FX risk with derivative instruments, and significant local currency devaluations would impede EBITDA generation.
UzAuto Motors’ key strengths include stable volumes and pricing power, ensured by high import tariffs, favorable margins given limited R&D spending, strong capacity utilization, and the ability to pass on costs.
As Uzbekistan’s largest national passenger vehicles manufacturer, UzAuto Motors enjoys certain pricing power, which allowed it to increase prices by about 10% on average in local terms in mid-2020 and partially mitigate Uzbek sum devaluation. Moreover, government-facilitated car loans issued during the pandemic, combined with the company’s decision to allow one-off sales in installments, secured volume growth of 3%-4% in 2020 despite the COVID-19 fallout. Although competition is increasing in more premium segments, in our base-case scenario, we assume no changes in local regulation, assuring the company’s status in the domestic market. The company’s flexibility to charge higher domestic prices, compared with export operations, supports strong margins generation. As per the alliance agreement with GM, UzAuto Motors gets access to GM technologies in exchange for royalties, which significantly limits R&D spending. This, combined with its ability to mitigate costs growth through optimization or direct costs pass-throughs, results in our expectation of EBITDA margins recovering up to 10% in 2021, following a drop in 2020 to 8%. We expect new model production will yield lower margins of 8%-9%. Minimal 5%-6% fixed costs ensure additional flexibility to adjust volumes produced with limited effects on profitability. This is because the company has a relatively affordable and stable workforce and operates its two production facilities at high utilization (75% in 2019, with combined full capacity of 360,000 vehicles per year).
UzAuto Motors will use the Eurobond issue and the forthcoming ECA funding to cover investments related to producing new models and refinance its bridge loan, while the local bank loan should be covered by repayment in installments.
New models will be launched under the GEM project, which assumes equipment renewal to retire old models and production of GM models specifically designed for emerging markets. Ramp-up of the GEM project will require about US$500 million in investments 2020-2022, financed partially through the Eurobond issue and ECA funds. We understand part of these investments were already incurred in 2020 and backed with a short-term bridge loan from Credit Suisse, which will be refinanced with a Eurobond or another type of long-term financing in 2021. Despite the sizable investments, we assume modest negative free operating cash flow (FOCF) in 2021 on the back of recovering EBITDA. We also understand a short-term loan of about US$110 million provided by a local bank to finance sales in installments will be closed in 2021 with repayments by customers.
S&P Global Ratings projects FFO to debt of 40%-60% in 2020-2022 in our base case, but also incorporate into our financial risk assessment the possibility of meaningful volatility in credit metrics.
The agency expects EBITDA will have contracted to about US$200 million in 2020 from a strong US$402 million in 2019, reflecting the impact of the pandemic, currency devalution, and increased costs due to cancellation of tax exemptions. Moreover, UzAuto Motors had to offer 12- and 24-month installments to customers to support sales, hampering cash flow. This created a meaningful cash outflow of US$250 million, which we expect will reverse in 2021 and 2022. We assume EBITDA will partially recover to about US$300 million in 2021, as UzAuto Motors restores sales and adjusts prices. However, there is downside risk to our forecast if the pandemic has a more pronounced impact on the Uzbek economy.
The company has modest debt, resulting in strong credit metrics, with FFO to debt of more than 60% despite the pandemic. But because of the anticipated increase in debt required to fund the investments, FFO to debt will likely decrease to 40%-50% in 2021-2022 before recovering.
S&P Global Ratings expects limited effect of group uphold from government-owned parent UzAuto Sanoat, which accounts for potential extraordinary government support.
The agency assesses the group credit profile of UzAuto Sanoat at ‘b+’, since we believe the group’s stand-alone credit profile is similar to UzAuto Motors’, given that UzAuto Motors generates 75%-80% of group EBITDA. S&P Global Ratings expects the holding company will benefit from its quasi-regulation function and diversification into other segments such as buses, heavy and light trucks, or engines and components production. However, these potential benefits will be offset by additional debt of US$230 million-US$240 million, resulting from subsidiaries attracting financing to fund their capex programs. In our opinion, the parent faces similar risks with regard to capital structure and capital markets access. We further note that group transparency is lower than that of UzAuto Motors because the holding company does not report under International Financial Reporting Standards.
S&P Global Ratings assesses UzAuto Sanoat as having a high likelihood of extraordinary support from the government of Uzbekistan, its 100% owner, although there is no rating uplift from this support for the current rating level. In our view, UzAuto Sanoat has a very strong link with, and plays an important role for Uzbekistan. In our base case, we don’t forecast a reduction in the government’s stake in UzAuto Motors through UzAuto Sanoat and expect the government will continue to fully control the company’s strategy through its representation on the board of directors. UzAuto Sanoat controls the automobile manufacturing, automobile localization, and auto components enterprises in Uzbekistan, and accounts for roughly one-quarter of industrial production in the country. We expect UzAuto Motors will benefit from extraordinary support from government through its holding company.
The outlook is stable and reflects our view that UzAuto Motors will generate modest revenue growth in U.S. dollar terms, keep EBITDA above US$250 million, successfully attract new financing in the first half of 2021, and ramp up new model production, without any material delay in 2022-2023, leading to limited negative free cash flow in 2021 and positive FOCF already in 2022.
S&P Global Ratings could lower the rating on UzAuto Motors if:
• UzAuto Motors’ fails to attract long-term financing to secure its capex project and refinance its bridge loan in the next six months;
• The company generates much weaker operating cash flow than we expect. This could happen if EBITDA does not recover to at least US$250 million-US$300 million in 2021 due to an inability to offset FX changes through local price increase, or if working capital outlays continue.
S&P Global Ratings could consider raising the rating if the company secures the full long-term financing for the capex projects and refinancing of the bridge loan, generates EBITDA of above US$300 million, and maintains adjusted FFO to debt consistently above 45%, alongside cumulative FOCF of about US$100 million in 2021-2022.
The credit quality of the parent, UzAutoSanoat, would also need to develop in line with that of UzAutoMotors, to support a potential upgrade. Notably, the agency expects the credit metrics of the parent to develop in line with those of UzAutoMotors, implying limited additional debt (other than assumed in our base case) and no material negative cash burn at other subsidiaries.