Fitch Ratings has assigned the benchmark-size senior unsecured notes due 2032 co-issued by
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
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
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
Leading Market Position: Garett is a global leader in the
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
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
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
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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