Fitch Ratings has assigned the benchmark-size senior unsecured notes due 2032 co-issued by Garrett Motion Holdings Inc. and Garrett LX I S.a.r.l, guaranteed by Garrett Motion Inc. (Garrett) an unsecured debt rating of 'BB-' with a Recovery Rating of 'RR4'.

Proceeds from the issue are expected to be used to refinance its existing secured debt.

The unsecured debt rating is equalized with Garrett's Long-Term Issuer Default Rating (IDR) of 'BB-' - which has a Stable Outlook - reflecting its unsecured ranking and Fitch's expectations for average recovery prospects of the notes. The issue is expected to be leverage-neutral.

The ratings reflect Garrett's business profile as a niche, medium-sized auto supplier, designing and manufacturing turbochargers, a core component of engines that help reduce carbon dioxide (CO2) emissions. Garrett's product portfolio is more focused than higher-rated peers', and more exposed to electrification transition, with over 65% of component sales derived from internal combustion engine (ICE) cars.

Rating strengths are Garrett's robust profitability, and strong free cash flow (FCF) supported by the elimination of preferred shares, which provides sufficient internal funds for deleveraging and portfolio transition towards electrification. Nevertheless, a faster-than-expected battery electric vehicle (BEV) transition by original equipment manufacturers (OEM) could significantly affect our volume and profitability assumptions.

Key Rating Drivers

Strong Profitability: Fitch forecasts Garrett's EBITDA margin at 15%-16% for 2023-2026, driven by slightly increasing volumes in all segments, including commercial vehicles and passenger cars. This is despite our expectations of continued consumer weakness coupled with inflationary, non-raw material related cost pressures, including wages and logistics.

The company's fairly low and flexible cost structure, along with pass-through clauses in its contracts, continues to underpin margins that are among the highest across auto suppliers. This contributes to Garrett's consistently positive annual adjusted FCF and provides it with significant financial flexibility.

Cash Flow Generation Improves Sharply: Fitch expects Garrett to generate strong FCF margins of around 4% to 2028, which is higher than its investment-grade-rated peers', and the 'a' rating median of 3% for auto suppliers. This is in line with Garrett's historical adjusted 4%-8% in previous cycles. Non-adjusted FCF has been sharply lower due to Chapter 11 expenses and former liabilities paid to Honeywell under its indemnification agreement. Once these costs are settled, and without USD100 million payments made to preferred A shareholders, which we have treated as operational cash outflows, Garrett has sufficient operational cash for rapid debt repayment.

Deleveraging Capacity: Since emerging from voluntary bankruptcy in 2021, Garrett has significantly improved its leverage profile. All of the company's outstanding debt under its credit facilities has been cancelled and replaced with a less-expensive capital structure, which has been simplified with the cancellation of preferred shares. Following the conversion of preferred A shares to common stock, and the signing of a new term loan B (TLB), Fitch calculates that Garrett's EBITDA net leverage will be around 3.5x, which we expect to ease to 2.5x at end-2025, broadly in line with our 'bb' rating median of 2x.

Combustion Engine Concentration Risks: The loss of revenue and earnings stemming from faster- than-expected growth of BEVs is a risk for Garrett's financial performance. Garrett is expecting to increase its zero emission revenues to USD1 billion by 2030, providing fuel cell, E-powertrain and E-cooling solutions to OEMs. Sales to hybrid technologies and the different electrification ramp-up speed in emerging geographies will provide some buffer, but transition risk and portfolio exposure are major rating constraints. However, Fitch believes that this will not dampen Garrett's ability to pay down debt, given visibility over orders for different engine types in the medium term.

Conservative Capital Allocation Policy: In line with management's guidance, Fitch expects operational cash generation to be diverted into deleveraging and additional organic investments into operational needs. Fitch's forecasts do not have shareholder returns beyond the approved USD350 million buyback programme for 2024, under management's planned capital structure. We believe the risk of excessive shareholder returns will decrease as major shareholders holdings and board representation are reduced with the preferred shares conversion. Nevertheless, it remains a risk as some shareholding concentration remains. Shareholder-friendly policies that lead to a deviation from our forecast deleveraging could drive a negative rating action.

Leading Market Position: Garett is a global leader in the USD10 billion turbocharger industry with an estimated market share of 30%. With a new business win rate of greater than 50%, Garrett is the number one or number two across all of its core businesses. Fitch expects Garett's differentiated technology in the core light and commercial vehicles to drive robust sales growth of around 4% in the medium term, as it increases penetration with its hybrid electrical vehicle programmes and its global light vehicle production ramps up.

Diversified Business: As a core component manufacturer for engines, Garrett is well-positioned in the auto value chain, and has good long-term relationships with most global OEMs with no major concentration on a single manufacturer. It has some product concentration to ICE, but is focused on higher value-added powertrain technologies related to vehicles motive power. This is underlined in sharply higher profitability than other core component manufacturers.

Garrett's geographic diversification matches other European auto suppliers', with a slightly higher exposure to the European (48% of revenues) and Asian (31%) markets. This is a function of proximity to OEM production, and is not a business profile weakness.

Derivation Summary

Relative to certain automotive technology suppliers, such as Aptiv PLC (BBB/Stable) or Visteon Corporation, which are increasingly focused on in-car advanced technologies, Garrett is largely dedicated to technologies for vehicles' motive power. It is smaller in size, with about one third the revenue of its largest competitor, BorgWarner, Inc. (BBB+/Stable), and less than one-tenth the revenue of Continental AG (BBB/Stable). Garrett's product portfolio is broadly similar, but less diversified than its close peer BorgWarner, Inc.'s (BBB+/Stable), and sales volumes are more exposed to electrification transition than core component manufacturers', like CIE Auto and Gestamp.

Nevertheless, driven by its focus on high value-added products and low-cost base, Garrett has one of the strongest EBITDA and FCF metrics among auto suppliers, which matches the 'A' rating median in our sector criteria. Garrett's pro-forma capital structure, following the issue of the new TLB, will be weak for the rating. Our expected EBITDA/net leverage of 3.5x is higher than 'BB' rated peers' and in line with the 'B' rating median. Nevertheless, Fitch expects strong FCF generation to allow Garrett to deleverage rapidly within the next two years to levels that are commensurate with 'BB' rated peers'.

Key Assumptions

Flat revenue in 2024, followed by low-to-medium single-digit growth to 2028, driven by turbo charger penetration and new product ramp-up

EBITDA margin gradually trending toward 16% to 2028

Partial working-capital reversal in 2024

Capex at 2.5%-2.8% to 2028

Share repurchase spends totaling USD350 million in 2024, no dividend distributions to 2028

RATING SENSITIVITIES

Factors That Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade:

Successful portfolio transition to electrification products while maintaining a strong financial profile

EBITDA gross leverage below 2x on a sustained basis

EBITDA net leverage below 1.5x on a sustained basis

Factors That Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade:

EBITDA margin below 12% on a sustained basis

FCF margin below 2.5% on a sustained basis

Failure to reduce EBITDA gross leverage below 3.0x, and EBITDA net leverage below 2.5x by end-2025

EBITDA interest coverage lower than 3.0x

Liquidity and Debt Structure

Ample Liquidity: Garrett ended 2023 with about USD250 million cash on balance sheet and a USD570 million revolving credit facility remains untapped. Fitch expects working capital to reverse to inflows on the back of flat sales volumes, easing raw material prices, and improving supply chain. Our forecast of solid FCF generation to 2028 further supports Garret's daily operations. In addition, the company has access to a factoring programme to fund its receivables. At end-2023, utilisation was around USD7 million.

Distant Bullet Debt Structure: Garrett has a distant bullet capital maturity profile and does not have material maturity over the rating horizon. With the placement of the new unsecured US dollar facility, the financing mixture is diversified in both security and interest-rate type and its longest-dated maturity will extend to 2032 from 2028.

Issuer Profile

Garrett is a global automotive supplier spun off from Honeywell in 2018.

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

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. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation of the materiality and relevance 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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