Tashkent, Uzbekistan (UzDaily.com) -- Fitch Ratings has upgraded JSC UzAuto Motors’ (UAM) Long-Term Issuer Default Rating (IDR) and senior unsecured rating to ‘BB-’ from ‘B+’. The Outlook on the Long-Term IDR is Stable. The Recovery Rating remains at ‘RR4’.

The upgrade follows the revision of socio-political and financial implications of a UAM default to ‘Strong’ from ‘Moderate’. We have therefore equalised its rating with that of sovereign in line with Fitch’s ‘Government-Related Entities Rating Criteria’(GRE). Fitch continues to assess UAM’s Standalone Credit Profile (SCP) at ‘b’.

Strong Socio-Political Impact: Our revision of socio-political implications of a UAM default to ‘Strong’ reflects our view of a material negative socio-political impact given UAM’s large revenue and contribution to Uzbekistan’s economy. In addition, UAM, together with related parties, has a rather large workforce in the country of about 28,000 staff, which in case of default will increase the unemployment rate in the country.

Strong Financial Implication: Our revision of financial implication of default to ‘Strong’ reflects the proven record of the company’s access to international capital markets. We expect that a UAM default would adversely affect the reputation of Uzbekistan, as it is a state-owned company and one of the largest corporate companies in the country. In terms of revenue size it is similar to such companies like JSC Almalyk Mining and Metallurgical Complex (BB-/Stable) and JSC Uzbekneftegas (BB-/Stable). UAM is one of few entities in Uzbekistan that placed a Eurobond, leading us to believe that this company could be treated as proxy for government bonds.

Strong Links with State: Fitch views the status, ownership and control linkage of UAM with the state as ‘Strong’ due to full state ownership and operational control by the parent over the company’s capex and operational strategy. We assess the support track record as ‘Strong’ due to historical state support in different forms, including shareholder loans on favorable terms; the absence of large dividends paid to the parent, which we expect to continue at least until the end of the large capex programme; and a favourable regulatory environment supported previously by high import duties for cars, protecting UAM’s dominant position in its domestic market.

Car Sales Disruption: UAM has a long-term license agreement with General Motors Company (GM; BBB-/Positive), and while there may be alternative offers from foreign competitors, a default of UAM would cause temporary disruption to the delivery of new cars. While the regulatory environment has softened over the last two years with falling import duties, demand for UAM’s cars is still strong and it remains the dominant seller in Uzbekistan. UAM supplies the most affordable cars in the local market and we believe that it would be hard to substitute UAM’s cars with other foreign brands in the medium term.

Constrained SCP: UAM’s ‘b’ SCP reflects a weaker business profile than that of other Fitch-rated carmakers, with limited scale, a narrow product range and sales concentration in Uzbekistan. This could be mitigated by its entry into new markets in the CIS region. Its business profile is also constrained by the absence of a strong brand, limiting the company’s competitive position in relation to global auto manufacturers’. UAM’s operating activity is fully dependent on its existing long-term license agreement with GM, which provides access to the latter’s technological knowledge.

Inherent Cash Flow Volatility: UAM’s cash flow generation has been highly volatile since 2016 and is one of the key rating constraints. Its funds from operations (FFO) and free cash flow (FCF) margins were deeply negative in 2020 before returning to strongly positive territory in 2021, mainly driven by extreme year-on-year working capital development and expansionary capex. Although its main capex project is set to complete by 2023, Fitch expects such volatility to remain in the near term on the back of raw-material price inflation and lingering supply-chain issues in the auto industry.

Temporary Profitability Erosion: EBITDA profit margin in 2022 has been affected by inflation and industry-wide chip shortage, which led to inefficiencies of fixed-cost absorption in 1H22. This is partially offset by price increases on average of about 10% and some production catch-up in 2H22. We expect EBITDA and EBIT margins to slightly decline to 8.9% and 7.4%, respectively, in 2022, before trending toward 11% and 8% by 2025. This is due to a change in the portfolio mix, with UAM’s legacy models being phased out by 2023 and sales of the new and relaunched models growing.

Dominant Position: UAM is the main producer of passenger cars in Uzbekistan and has a dominant position in Uzbekistan. This, combined with high capex in production facilities and favourable regulation, acts as significant barriers to entry and supports the company’s local market share. Nevertheless, ongoing liberalisation of Uzbekistan’s economy could increase competition from foreign competitors and erode UAM’s sales and profitability.

UAM’s business profile is weaker than that of global automotive manufacturers including GM (BBB-/Positive), Ford Motor Company (BB+/Positive), and Renault SA (BB/Stable). The company is not fully comparable to Fitch-rated peers as it does not own the brand of the models it manufactures and the associated technological knowledge. Moreover, despite its dominant position in its domestic market UAM’s scale is much smaller than peers’. The company’s product and geographical diversification is also significantly lower than global automotive manufacturers’.

Though UAM’s EBITDA and EBIT margins are commensurate with Fitch’s expectation for the investment- grade category, its cash flow generation has been erratic. We forecast that UAM’s FFO margin will be in the range of 6%-9% in 2022-2025, in line with GM’s and Ford’s, but lower than Stellantis N.V.’s (BBB/Stable). The historical FCF margin volatility stems from large annual working-capital swings and growth capex.

UAM’s gross leverage profile is comparable with Ford’s and GM’s. We expect UAM to reach net cash position by 2025.