Fitch Ratings affirms Nemak, S.A.B. de C.V.'s Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) as well as its senior unsecured notes at 'BBB-'.

The National Long-Term Rating is affirmed at 'AA(mex)'. The Rating Outlook is Stable.

Nemak's ratings reflect its strong competitive position in its main products of cylinder heads and engine blocks, particularly in North America and Europe, in addition to the company's increasing product diversification into structural and electric vehicle aluminum casting components. Fitch considers the company to be well-positioned to navigate the current challenges faced by the automotive industry stemming from inflationary pressures and production constraints due to persistent semiconductor shortages.

Key Rating Drivers

Strong Global Business Position: Nemak's strong business position in Europe and the Americas is complemented by its presence in high-growth regions such as Asia, and its high percentage of installed capacity in low-cost countries. Nemak's business profile benefits from its long-term customer relationships, use of aluminum price pass-through contracts that reduce raw material volatility, its position as an essential supplier for Detroit's OEMs and participation in several of the largest global engine platforms.

Downward Leverage Trend: Fitch expects net leverage to be between 2.3x and 2.5x by YE 2022 as margins improve in the second half of the year. This follows a net leverage decrease from 2.8x in 2020 resulting from revenues and EBITDA recovering from pandemic lows. This recovery was driven by higher revenue per unit and costs reduction programs that improved operating margins. Beyond 2022, Fitch forecasts the company to reduce leverage to below 2x as semiconductor shortages ease and industry production increases to meet the pent-up demand for light vehicles. The company should be well positioned to manage inflationary pressures and constrained industrywide production as well.

Investment in Electrification: The company is proactively addressing the market's transition toward electrification, with total awarded business to-date in its e-mobility and structural applications segment amounting to approximately USD1.4 billion in annual sales. Nemak was recently awarded business to produce battery housings for fully electric vehicles worth USD350 million in annual sales, and expects to invest USD200 million in three new facilities to fulfill the increasing demand for these products. Fitch expects these efforts to allow Nemak to maintain a competitive position in the industry in the long run.

Improved Cash Flow Generation: Nemak should experience a reduction in working capital requirements and return to neutral FCF in 2022 as a result of inventory rationalization. In 2021, inventory days surpassed 90 days versus the historical 60 days levels. This inventory build-up was an important factor in the company's realizing negative FCF for the year. Fitch expects the company will be able to bring this back to historical levels over the ratings horizon and return to positive FCF generation.

Comfortable Debt Maturity Profile: Nemak successfully issued two new sustainability linked bonds in USD and EUR in 2021, effectively extending debt maturities of over USD1 billion to 2028 and 2031. This represents the bulk of their total debt and provides the company significant financial flexibility to address a potentially challenging macro environment.

Derivation Summary

The complexity and technological innovation of Nemak's aluminum castings give it a strong competitive position, allowing it to operate as a sole supplier to OEMs in 90% of the products it sells. Nemak's business profile compares well with Metalsa, S.A. de C.V.'s (BBB-/Stable), as Metalsa has a less dominant position in its core businesses, and with Tupy S.A.'s (BB/Stable), which has smaller scale. Metalsa is focused in light truck and commercial vehicle frames that represent 86% of its sales and is regionally concentrated in the North American market where it obtains 88% of its revenues. Tupy is a niche producer of iron engine blocks and heads predominantly used in commercial off-road vehicles with less geographic diversification.

Nemak's business profile is similar to those of U.S. peers BorgWarner, Inc. (BBB+/Stable) and Dana Incorporated (BB+/Stable) in terms of competitive position, although both have larger scale than Nemak, with EBITDA volumes of about 3.5x and 1.5x Nemak's, respectively. Similar to Nemak, BorgWarner is focused on making vehicles more fuel efficient. Dana maintains a strong competitive position focusing primarily on driveline systems for light commercial and off-road vehicles, with a customer base including virtually every major vehicle and engine manufacturer for light vehicle, commercial vehicle and off-highway global markets.

Nemak's strong competitive position and its core focus on light vehicles, whose demand is considered more stable than heavily cyclical commercial and off-road vehicle segments, mitigate Nemak's relatively lower geographic, customer and product diversification when compared with Dana.

Nemak's profitability seats between BorgWarner's and Dana's. In 2022, Fitch estimates Nemak's EBITDA margin will be around 12% while Dana's will be under 10% and BorgWarner's closer to 15%. Nemak and Dana both maintain gross leverage levels above 2.5x while BorgWarner's stands slightly below 2x.

Key Assumptions

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

Consolidated equivalent unit volumes grow between 2%-2.5% in 2022, increasing to 8% on 2023 and 5% afterwards.

Inventory levels will normalize to historical values in 2022 from over 90 days in 2021 to just over 60 days from 2022 forward.

EBITDA of approximately USD500 million in 2022 and USD600 million in 2023.

Capex at company guidance of USD415 million in 2022 and at similar levels in 2023.

Dividend policy accommodates deleveraging.

The company continues to rollover short term debt and has an implicit average interest expense between 5%-6%.

Effective tax rate at 30%.

Mexican peso exchange rates do not weaken significantly below MXN22/USD1.

RATING SENSITIVITIES

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

A rating upgrade in the near term is unlikely considering Nemak's business and financial profile;

Gains in product, customer or geographical diversification;

Sustained net debt/EBITDA solidly below 1.5x;

Sustained gross EBITDA leverage solidly below 2x.

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

A rapid transition of the industry to electric vehicles in North America without a commensurate increase in Nemak's electric housings and structural components contracts;

A loss of competitiveness in the supply of precision cast aluminum parts;

Sustained net debt/EBITDA above 2.0x;

Sustained gross EBITDA leverage above 2.5x.

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

Sound Liquidity: Nemak's cash position of USD281 million as of YE 2021 adequately covers the USD221 million in debt obligations over the next 12 months. In addition, Fitch's base case expects Nemak to generate positive cash flow from operations of around USD400 million during 2022. The company has a total of USD405 million in availability under committed credit facilities that can be used as additional liquidity if necessary.

Nemak has a flexible dividend policy, reducing dividend payments in 2019 and revoking dividends scheduled for 2Q20, 3Q20 and 4Q20. Total dividends in 2020 were USD14 million and the Company did not pay any dividends as of Dec. 31, 2021. Nemak's shareholders have also decided not to pay dividends in 2022. The company maintains good access to bank lending, drawing credit lines of around USD650 million at the start of the pandemic to support liquidity, all of which have been fully repaid.

The company issued USD500 million of senior unsecured notes in June 2021 (BBB-) maturing in 2031. Net proceeds from the issuance were used primarily to refinance debt and for general corporate purposes. The company also issued EUR500 million in July 2021 (BBB-) maturing in 2028, and net proceeds from this issuance were used primarily to fund a cash tender offer of Nemak's EUR500 million 2024 notes and for general corporate purposes. The notes included a step-up in interest rate if Nemak fails to reduce greenhouse gas emissions by 18% by YE 2026.

Issuer Profile

Nemak is the largest global supplier of cylinder heads and engine blocks for automobiles and light trucks. Nemak's product portfolio also comprises battery and electric-motor housings used in hybrid and fully electric vehicles. The company has an important presence in North America where it generates approximately 51% of its revenues followed by Europe with approximately 37%.

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. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg

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