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  • 26-Apr-2024 | 17:33 HKT

Ford Otomotiv Sanayi A.S. Assigned 'BB-' Rating; Outlook Positive; $500 Million Unsecured Notes Rated 'BB-'

    • Ford Otomotiv (FO; doing business as Ford Otosan) is a licensed manufacturer of Ford Motor Co. (FMC; BBB-/Stable/A-3) branded commercial vehicles and passenger cars for the European and Turkish markets. We estimate it will contribute to about two-thirds and one-third of FMC's European CV and PC production this year, respectively.
    • FO sells to FMC Europe under a cost-plus contractual framework that we believe should allow FO to maintain relatively solid EBITDA margins. However, the prominent share of its revenue comes from the export of vehicles produced and assembled in Turkiye (B/Positive/B), which constrains credit quality.
    • We anticipate that FO could withstand a sovereign default of Turkiye and continue to service hard currency debt even in a hypothetical scenario of capital controls introduced by the Turkish government.
    • We therefore assigned our 'BB-' long-term issuer credit and issue ratings to FO and its completed issuance of $500 million in unsecured notes.
    • The positive outlook on FO mirrors that on Turkiye and our expectation that the group will continue to pass our hypothetical sovereign default and transfer and convertibility stress tests sustainably.

    PARIS (S&P Global Ratings) April 26, 2024--S&P Global Ratings today took the rating actions listed above. The rating on FO is constrained at one notch above our 'B+' transfer and convertibility (T&C) assessment on Turkiye due to the company's sizable operations in the country. We anticipate that the group will generate about 75% of its revenue and 85% of its EBITDA from assets in Turkiye over 2024-2025, meaning large exposure to the country's economic conditions and jurisdiction risks. In a hypothetical sovereign default, we anticipate that the group would maintain adequate liquidity thanks mainly to its strong share of revenue denominated in euros, largely mitigating its exposure to devaluation of the Turkish lira (TRY). We also estimate that the group can withstand sovereign-related stress, including capital controls, thanks to hard currency inflows from its plant in Romania and FO's ability to maintain at least a modest share of export revenue in hard currency from its Turkish assets. We think that, in this scenario, the company would retain sufficient hard currency cash to service its foreign debt obligations and continue to at least partially deliver on its production commitments to FMC in Turkiye. Overall, we rate FO above our T&C assessment on the sovereign because the company passes our stress test, but the uplift is limited to one notch since we expect its exposure to the country (measured in terms of EBITDA) will remain above 70% in the next two years.

    We assess FO's stand-alone credit profile (SACP) at 'bb', based on its strong commercial vehicle (CV) foothold and moderate leverage.Our assessment hinges on FMC's solid market position in the European CV market and FO's relatively solid operating margins thanks to a cost-plus contractual framework with FMC. The Ford brand has retained 13%-15% of the European CV market since 2016, ranking first by brand and second behind Stellantis by auto group. This position has been supported by healthy demand for its two-ton Ford Transit and one-ton Ford Custom models. Also, thanks to these vehicles, the group commands over 30% of the domestic Turkish medium CV market. FO's heavy truck business is less developed in Europe, translating in a market share of about 2.5% in 2023. Still, it ranks second by sales behind Daimler Trucks in the domestic market, with a share of close to 30%. In the passenger cars (PC) segment, the production of the Puma model in Romania represented about 1% of 2023 PC sales in Europe. In the domestic market, FO is the exclusive importer and reseller of Ford PCs, but its market share does not exceed 5%, well below that of leaders Fiat and Renault. Overall, we deem FO's sales of CVs as more profitable than PCs and view its overall business as somewhat smaller and less diversified than that of peers such as Renault S.A. (BB+/Stable/B), Tata Motors Ltd. (BB+/Positive/--), Volvo Car AB (BB+/Stable/--), and Mitsubishi Motors Corp. (BB+/Stable/--).

    From 2018-2023, FO posted S&P Global Ratings-adjusted free operating cash flow (FOCF) to sales averaging 6%, which we believe reflects a sound profitability and cash conversion capacity. FO's SACP is also supported by its modest debt leverage and our expectation that financial policy will continue to balance dividend distributions, growth investments, and leverage. While we anticipate higher dividend distributions and sustained capital expenditure (capex) needs in 2024-2025, we anticipate FO will see a limited increase in adjusted debt to EBITDA to 2.0x-2.2x, from 1.6x in 2023.

    FO has a sound profitability track record, although its margins remain exposed to cyclical auto markets and volatile domestic market conditions. The company's international volumes are sold to FMC Europe under a cost-plus contractual framework where FO receives a profit markup in hard currency per vehicle produced. The licensing contract covers the vast majority of variable and fixed production costs and provides an almost-total recovery of investments, limiting considerably the exposure to volume risk. We think this scheme supports FO's profitability, in addition to the high utilization rates of its Turkiye plants (ranging from 73% to 88% over 2017-2023) and a competitive labor cost base. This has allowed the group to maintain S&P Global Ratings-adjusted EBITDA margin above 8% since 2017. Still, we anticipate that FO's margins will remain exposed to cyclical auto demand and pricing, as well as volatile foreign exchange fluctuations. While about 75% of the group's revenue are in hard currency, about 50% of its expense is incurred in Turkish lira. Temporary margin volatility is a risk, notably because any potential higher costs are typically absorbed with a time lag under the cost-plus agreement. In addition, the exposure of domestic sales (about 25% of total revenue) to cyclical domestic auto and truck demand could add volatility to earnings.

    We view FO's vehicles electrification as a key operating challenge. The group plans to launch the electric versions of the Custom, Courier, and Puma in 2024 after the smooth start of the E-Transit production in 2022 (with 14,888 vehicles produced last year, or about 8% of total Transit volumes). FO has full access to FMC's research and development (R&D) capabilities and assembles key components such as battery arrays and trays and e-drives in house. This allows the company to optimize its R&D, which represented a mere 1% of its sales historically. The company's battery packs are sourced externally from LG Energy Solution Ltd. for CVs and SK Innovation Co. Ltd. for PCs, in line with FMC's European supply chain setup. We anticipate EV sales to be dilutive to the group's operating margins until the associated development and input costs will be abated by volume ramp-up. The transition to electric drivetrains will be gradual, with FMC targeting to offer an all-electric fleet of vehicles in Europe by 2035. In the ramp-up phase, FO will produce EV and internal combustion engine models on the same lines, providing operating flexibility to adapt to the pace of transition to the electrification of European CV and PC markets. We assume this flexibility could help the group smooth and partly offset the impact of the costly powertrain transition.

    FO's growth ambitions will translate in higher capex intensity and lower cash conversion through 2025. We anticipate the adjusted capex-to-sales ratio will stay elevated at about 5% in 2024-2025 as the company launches the electric version of its different vehicles and further increases production capacity at Yenikoy (new Custom) and Craiova (new Courier). This ongoing investment program resulted in the capex-to-sales ratio increasing to 7.3% in 2023, from an average of 3.0% over 2017-2022. Considering this jump in spending, alongside continued working capital investment needs, we project FOCF to sales will decline to about 1% in the next two years, from an average of about 6% over 2018-2023. Nevertheless, we maintain our view of sound cash conversion at FO, because we expect the dip to be temporary until the investment program's completion by 2025.

    We expect FO's financial policy will continue to ensure moderate debt levels despite increasing dividend payments. We project that most of the company's FOCF will remain allocated toward dividends in the next few years, in line with its minimum dividend payout ratio policy of 50%. This ratio averaged about 60% over 2017-2023, and we anticipate that the company could increase its dividend payment well in excess of our expected FOCF this year on the back of strong 2023 results. That said, we anticipate FO would likely reduce distributions if capex requirements were above target or if market conditions deteriorated in order to keep its debt leverage in line with its historical leverage. The total dividend payout fell to about $166 million in 2020 from $230 million in 2019, which helped the company maintaining strong credit ratios during the pandemic. We understand FO intends to limit reported net debt to EBITDA at 3.5x, although in practice it has not exceeded the 1.5x threshold (slightly above 2.0x in S&P Global Ratings-adjusted terms) over 2017-2023.

    Overall, we anticipate FO will continue to balance accordingly its earnings growth, investment plans, and shareholder distributions, translating in relatively sound S&P Global Ratings-adjusted debt to EBITDA of 2.0x-2.2x and funds from operations (FFO) to debt of 38% in 2024-2025. Our debt figure included a deferred purchase consideration of TRY10.7 billion linked to the Craiova acquisition from FMC and TRY1.1 billion of pension liabilities as of Dec. 31, 2023, and excludes available cash.

    We view FO as strategically important to FMC. Our assessment of FO's group status does not propel our rating because we think group support might not fully offset sovereign-related stress like the hypothetical introduction of capital controls in its home country. FMC's 41% stake in FO is balanced by an equal share held by Koc Holding A.S. (BB-/Positive/B), the investment holding of FO's founding family. FO has a longstanding relationship with FMC, having produced its first Ford licensed vehicle in 1967, but is not consolidated into FMC's perimeter. FO's growth since then is a testimony to its efficient manufacturing operations, supported by historically high production capacity utilization rates and a competitive cost base when compared with FMC's other production facilities in Europe. FO represents an asset-light investment for FMC Europe with steady returns (with about $250 million and $200 million of annual dividends paid to FMC in 2023 and 2022), allowing the Ford brand to maintain a leading position on the European CV market. We estimate that FO will produce about two-thirds and one-third of Ford-branded CVs and PCs in Europe in 2024. The company's share within FMC's European business has increased following the acquisition from FMC of the Craiova plant in Romania in 2022. We assume that capacity expansion at the Yenikoy and Craiova plants coupled with the transition to the production of EVs across its facilities will continue to support its contribution to FMC Europe's total volumes sold.

    The positive outlook on FO mirrors that on Turkiye and our expectation that the group will continue to pass our hypothetical sovereign default and T&C stress tests sustainably. We also base the outlook on our expectation that FO will maintain adequate liquidity and gradually increase its earnings outside its home country.

    We could revise our outlook on FO to stable following a similar rating action on Turkiye. We could also lower the rating if the company fails to pass our sovereign default and T&C stress tests. Failed tests could arise from setbacks in ramping up production and profitability at FO's Romania operations or reduced other sources of hard currency cash to cover foreign debt service and hard currency raw material imports.

    We could raise our rating if we take a similar action on Turkiye (including a higher T&C assessment), or we estimate that FO can sustainably generate more than 30% of its total earnings outside the country while continuing to pass our hypothetical sovereign default and T&C stress tests. An upgrade would also hinge on the company maintaining an adequate liquidity position and credit metrics in line with our current expectations.

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