Fitch Ratings has affirmed Uzbekistan-based Artel Electronics LLC's (AE) Long-Term Issuer Default Rating (IDR) at 'B'.

The Outlook is Stable.

The rating reflects the group's small scale, limited geographical diversification, improved, albeit still high, foreign-currency (FX) risk, and delayed deleveraging in comparison to our previous forecast. Negative free cash flow (FCF) generation and exposure to Uzbekistan's operating-environment risks additionally constrain the rating.

Rating strengths are its leading market position, which provides sustained revenue visibility, and should support AE's moderate funds flow from operations (FFO) generation.

Key Rating Drivers

Moderate Cash Generation: AE's Fitch-defined EBITDA margin decreased to 10.4% in 2021 from 14.7% in 2020, slightly worse than our forecast, on intensified supply-chain disruption in 2H21. Rising inflation is likely to constrain a rise in EBITDA margin to 11% in 2022, mainly on export sales. Our base case foresees a gradual rise of EBITDA margin to 13% by 2025. Nevertheless, AE's forecast operating profitability compares well with that of peers in the appliances and consumer electronics segments.

Rising Leverage: AE's gross debt-to-EBITDA rose to 3.6x, exceeding our forecast of 3.1x, reflecting weaker profitability and delaying cashflow deleveraging. Fitch expects the ratio to fall to 3.2x in 2022 on revenue growth and slight improvement in profitability, and to below 2.0x after 2024. Profitability improvement will be key to its deleveraging capacity, which if not achieved, could put pressure on leverage metrics and result in a negative rating action.

FCF Under Pressure: Historically, AE's FCF generation has been negative, due to high capex and sustained dividends payments. In 2021, FCF was materially eroded with large working-capital (WC) outflows due to repayment of trade payables following the issue of a new US dollar-denominated loan. Fitch expects WC flows to normalise in the next three years but ongoing capex and dividends payments, together with constrained profitability, will weigh on FCF generation. We expect FCF to return to marginally positive territory from 2023.

Limited Business Profile: AE's rating is constrained by its small scale versus large international peers' and limited geographic diversification with Uzbekistan being its focus. Its share of export revenue has risen steadily to 23% in 2021 from 14% in 2019, which AE aims to increase to 29% in 2022. However, it will mainly be to developing CIS countries and remain concentrated compared with that of higher-rated peers, such as Arcelik and Whirlpool, which have a global presence. AE's business profile is also characterised by a poorly-diversified customer base: most of the sales are arranged via few commissioners.

Leading Market Position: AE is the leading household appliances producer in Uzbekistan with a domestic market share of over 30%-50%, depending on the product type. Its strong market position, successful long-term co-operation with other brands like Samsung and Shivaki and established production and logistical network all act as barriers to entry.

High FX Exposure: While AE has increased its export sales and successfully managed to improve its cost structure linked to foreign currencies, its overall FX exposure is still high. About 77% of revenue and about 45% of costs in 2021 were in local currency, while almost all its debt was linked to US dollars. AE does not use any hedging instruments and depreciation of the Uzbekistani so'm against other hard currencies could therefore materially affect AE's leverage metrics.

Related-Parties Transactions Decrease: AE's corporate governance has seen material improvement as loans to related parties and shareholders in 2021 fell to about 10% of Fitch-defined EBITDA from about 70% in 2020. Management aim to further reduce such loans in the next two years. Nevertheless, the risk of further cash leakage via related-party transactions could constrain AE's deleveraging capacity. Financial transparency remains weak versus international peers', constraining our assessment of AE's corporate governance factor.

Derivation Summary

AE is much smaller than its direct peers such as Arcelik A.S. (BB/Negative), Whirlpool Corp. (BBB/Positive) and Panasonic Corporation (BBB-/Stable). AE's business profile is limited by its poorly diversified geographical presence (being exposed mostly to Uzbekistan), compared with Arcelik's, which derives 65% sales outside its domestic market of Turkey. We view material exposure to emerging markets as a rating constraint due to vulnerability of cash flow generation to macro-economic, political and FX risks.

AE's EBITDA margin of 10%-15% and FFO margin of 8%-13% during 2021-2025 are broadly in line with that of Arcelik and Whirlpool and slightly better than Panasonic's. Similar to AE, Ammega Group B.V. (B-/Stable), Arcelik and Panasonic all have volatile FCF margins, which is however mitigated by their stronger business profile due to better geographical and end-market diversification.

AE's current total debt/EBITDA of 3.6x is higher than that of Whirlpool and Panasonic and compares well with Arcelik's (3.6x as at end-2021) and ams-OSRAM AG's (3.5x). We expect AE's leverage to improve towards 3.0x by end-2022 and to below 2.0x from 2024. AE's leverage profile is better than Ammega's leverage of above 6.0x at end-2021.

Key Assumptions

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

- Average revenue growth of 17% during 2022-2026

EBITDA margin of 10.8% in 2022, rising towards 13% by 2026

Capex at 3.5%-4.5% of sales over 2022-2026

Sustained dividends payments of UZS139 billion in 2022 and over UZS170 billion from 2023

No M&A to 2026

RATING SENSITIVITIES

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

Evidence of improved corporate governance practice, including better financial transparency

Improved geographical diversification, with materially lower reliance on the domestic market

FCF margin above 3% on a sustained basis

Total debt/EBITDA below 2x on a sustained basis and improved liquidity

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

Total debt/EBITDA above 3x on a sustained basis

FCF margin below 1%

FFO margin below 10%

Deterioration in liquidity position resulting in inability to refinance short-term debt

Best/Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and Debt Structure

Tight Liquidity: At end-2021 AE's Fitch-defined readily available cash was UZS14 billion, adjusted for about UZS42 billion to cover potential WC swings. In 1H22 AE successfully refinanced and extended its US dollar-denominated bank loan. It also issued local bonds of UZS30,000 million due July 2023 and January 2024. All this has helped improve its debt repayment schedule. Nevertheless, expected negative FCF in 2022 weighs on AE's liquidity and we expect further refinancing on an annual basis.

AE has no available committed credit facilities but has a record of good long-term relationships with local banks that helps it refinance its short-term debt regularly.

ESG CONSIDERATION

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This 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. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg

Issuer Profile

AE is based in Uzbekistan (BB-/Stable) and its leading domestic producer of household appliances and electronics.

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.

RATING ACTIONS

Entity / Debt

Rating

Prior

Artel Electronics LLC

LT IDR

B

Affirmed

B

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