Fitch Ratings has revised the Rating Outlook on Mexican auto parts manufacturer Nemak, S.A.B. de C.V.'s to Negative, from Stable.

Fitch has affirmed Nemak, S.A.B. de C.V.'s Long-Term Foreign- and Local Currency Issuer Default Ratings (IDRs) and senior unsecured notes at 'BBB-'. Fitch has also affirmed Nemak's National Long-Term Rating at 'AA(mex)'.

The Negative Outlook reflects Fitch's expectation that leverage will remain above the downgrade sensitivities over the medium term. The de-leveraging process may take longer to materialize as a result of moderating growth in the electric vehicle (EV)/structure and chassis (SC) business segment, which has been the focus of the company's major investments. Fitch expects to resolve the Outlook depending on whether or not the company is able to reach leverage metrics that are more consistent with its current rating.

Nemak's ratings reflect its strong competitive position in its main products of cylinder heads and engine blocks, particularly in North America and Europe. The ratings also incorporate increasing product diversification efforts and investments in aluminum cast components for EV and SC applications.

Fitch considers the company well-positioned to navigate the challenges faced by the automotive industry stemming from continued inflationary pressures, the transition into EVs, and production constraints from a recovering supply chain.

Key Rating Drivers

Strong Global Business Position: Nemak's status in Europe and the Americas is complemented by its presence in faster -growth regions such as Asia, and its high percentage of installed capacity in low-cost countries. The business profile benefits from its long-term customer relationships, use of aluminum price pass-through contracts that reduce raw material volatility, its position as an essential supplier for Detroit's OEMs, and its participation in several of the largest global engine platforms.

Leverage to Remain High: Fitch expects net leverage at above 2x through 2026, after reaching 2.7x in 2023 - up from 2.2x in 2022. This metric should trend downwards gradually over the ratings horizon. Fitch expects EBITDA to approach USD600 million by 2025. EBITDA could benefit from higher volumes, subsiding inflationary pressures, and improved cost-sharing agreements with original equipment manufacturers (OEMs), which could help accelerate the de-levering process. We expect EBITDA margins to improve to 12% by 2025.

EV Transition at Slower Pace: Fitch believes de-leveraging will extend beyond that previously anticipated. Recent market developments point to a significant slowdown in the growth of EV sales. Consequently, we expect Nemak's recent investments and growth perspectives in this segment to decelerate. Awarded business to date in its EV/SC applications segment grew more slowly in 2023, going from USD1.6 billion in expected annual sales in 2022 to approximately USD1.75 billion.

Nemak is targeting USD2.0 billion in annual sales in this segment by 2025. Fitch estimates total capex of around $1.4 billion between 2022 and 2024. A significant portion of these investments is allocated to EV/SC strategic projects, including the construction of three new plants located in Mexico, Germany and the Czech Republic.

FCF Turning Positive: Fitch expects FCF to be slightly negative to flat in 2024, and to turn positive in 2025 as the company reduces capex. Nemak has a flexible dividend policy that accommodates cash flow generation for the purposes of maintaining healthy liquidity and improving leverage metrics.

Comfortable Debt Maturity Profile: Nemak has approximately USD1.76 billion in debt, of which USD1.2 billion is due in 2028 and beyond. Just over USD1 billion is in two sustainability-linked bonds due in 2028 and 2031. This comfortable debt maturity profile provides significant financial flexibility to address a potentially challenging macro environment and higher investment requirements.

Derivation Summary

The complexity and technological innovation of Nemak's aluminum castings give it a strong competitive position, allowing it to operate as a sole supplier to OEMs in 90% of its products. Nemak's business profile compares well with Metalsa S.A.P.I. de C.V. (BBB-/Stable), as Metalsa has a less dominant position in its core businesses, and with Tupy S.A. (BB+/Stable).

Metalsa is focused on light truck and commercial vehicle frames that represent close to 80% of its sales, and is regionally concentrated in the North American market where it obtains over 80% of its revenue.

Tupy is a niche producer of iron engine blocks and heads used predominantly in commercial off-road vehicles, with less geographical diversification.

Nemak's business profile is similar to those of U.S. peers BorgWarner, Inc. (BBB+/Stable) and Dana Incorporated (BB+/Negative) in terms of competitive position, although both have larger scale than Nemak, with EBITDA of about 4.3x and 1.3x, respectively. Similar to Nemak, BorgWarner focuses on making vehicles more fuel efficient. Dana maintains a strong competitive position, focusing primarily on driveline systems for light commercial and off-road vehicles, with a customer base including virtually every major vehicle and engine manufacturer for light vehicle, commercial vehicle and off-highway global markets.

Nemak's strong competitive position and its core focus on light vehicles - demand for which is considered more stable than the heavily cyclical commercial and off-road vehicle segments - mitigate its relatively lower geographical, customer and product diversification compared with Dana.

Nemak's profitability sits between that of BorgWarner and Dana. Fitch estimates Nemak's EBITDA margin in 2024 will be about 11%, while that of Dana will likely be under 8.0% and BorgWarner around 15.0%. Nemak is should maintain gross EBITDA leverage of around 3.0x in 2024 and to trend toward 2.5x within the ratings horizon. Dana's gross leverage is above 3.0x, while BorgWarner is below 2.5x.

Key Assumptions

Fitch's Key Assumptions Within Our Rating Case for the Issuer Include:

Consolidated equivalent unit volumes to grow by at least 3% in 2024 and 1.8% in 2025;

EBITDA surpasses USD600 million by 2025;

Capex remains at or below USD400 million in 2024 and USD350 million in 2025;

FCF improves to neutral or slightly negative in 2024, then becomes positive beyond that;

Dividend policy accommodates deleveraging;

The company continues to partially roll over short-term maturities;

Mexican peso exchange rates versus the US dollar between 18-18.5.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade

A rating upgrade in the near term is unlikely, considering Nemak's business and financial profiles;

Gains in product, customer or geographical diversification;

Sustained net debt/EBITDA solidly below 1.5x;

Sustained gross EBITDA leverage solidly below 2.0x.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

A rapid transition of the industry to EVs, and growing capex without a commensurate increase in Nemak's electric housings and structural components contracts;

A loss of competitiveness in the supply of precision cast aluminum parts;

Sustained net debt/EBITDA above 2.0x;

Sustained gross EBITDA leverage above 2.5x

Liquidity and Debt Structure

Sound Liquidity: Nemak's cash position of around USD323 million at YE 2023 adequately covered its roughly USD293 million in short-term debt obligations. The company has a total of USD420 million available under committed credit facilities that can be used as additional liquidity if necessary.

Nemak has a flexible dividend policy that is sensitive to positive cash flow generation. It paid no dividends in 2023, and does not plan any in 2024. Nemak maintains access to bank lending, with an additional USD422 million available in uncommitted credit lines.

The company has a comfortable debt maturity profile, with USD $1.2 billion of its USD1.7 billion due beyond 2028 and held primarily in two sustainability-linked senior unsecured bonds, a USD500 million note due in 2031, and a EUR500 million note maturing in 2028.

Issuer Profile

Nemak is the largest global supplier of cylinder heads and engine blocks for automobiles and light trucks. Its product portfolio also comprises battery and electric-motor housings used in hybrid and fully electric vehicles.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.

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