Tashkent, Uzbekistan (UzDaily.com) -- 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.

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.

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.