Fitch Ratings has upgraded Pirelli & C. S.p.A.'s Long-Term Issuer Default Rating (IDR) and senior unsecured debt ratings to 'BBB' from 'BBB-'.

The IDR Outlook is Stable.

The upgrade reflects Pirelli's strong profitability and robust free cash flow (FCF) allowing for deleveraging to below our previous positive rating sensitivity. We expect high-value tyre sales to remain resilient and support profitability, aided by more stable raw material prices despite fluctuations in electric vehicle (EV) demand.

Pirelli's ratings and Stable Outlook benefit from its leading position in premium car tyres, expertise in high-performance products, a stable aftermarket business and a strong brand. Although Pirelli is smaller and less diversified than competitors, its technological advantages and focus on less-cyclical markets mitigate these drawbacks.

Key Rating Drivers

Successful Deleveraging: Pirelli has successfully reduced debt, as Fitch-adjusted EBITDA net leverage fell to 2.0x in 2023 from 5.0x at the height of the pandemic. We expect deleveraging to continue to 2027, driven by stable FCF margins of around 4%, as the business mix continues to shift towards high-value products. Fitch expects Pirelli to maintain its deleveraging capability in line with its stated target even under more challenging market conditions, due to exposure to the less price-sensitive tyre segment.

Leading Operating Margins: Fitch expects EV sales growth to continue slowing in Europe in the absence of policy support, but to a lesser extent for premium EV. Nevertheless, Pirelli's new homologations in the high-value segment, increasing SUV penetration, slower raw material price increases and internal efficiency programmes should help support Fitch-defined EBIT margin expansion towards 14%, a leading level among auto suppliers.

Low Exposure to Trade Tensions: Pirelli has been capitalising on its presence in the Chinese market that has been witnessing strong EV sales, by servicing major auto manufacturers. Pirelli owns two plants in China and has another under a joint venture. Like other car suppliers, the group generally adopts a local-for-local approach to serve customers and aims to increase, by 2025, to around 90% the amount of locally produced goods from 85% in 2023. As a result, we believe the group is fairly insulated from trade tensions. A local supply chain should also increase control over sourcing and reduce the risk of logistics disruptions.

Limited Shareholder Influence: The Italian government's measures to limit the influence of Pirelli's main shareholder, Sinochem International Corporation (A-/Negative; 37% stake), are so far rating-neutral with no impact on Pirelli's strategic direction. The 'golden power' rules aim to ensure Pirelli's independence, limit Sinochem's influence on its corporate governance and halt any possible integration between the two entities. Fitch rates Pirelli on a standalone basis given the absence of any strategic, legal, and operating incentives of Sinochem to support Pirelli.

Antitrust Investigation Impact Unquantified: The EU antitrust authorities recently enquired Pirelli, and other leading tyre manufacturers, about alleged price cartel. The enquiry includes the possible creation of a cartel for replacement tyres sold in the European Economic Area. The process is in its early stages, and we cannot assess if the antitrust body will initiate an investigation. In the event of an investigation Fitch will ascertain its impact once provisional findings and more information emerge.

Strong Niche Supplier: Pirelli is smaller than other global tyre manufacturers but has leading market positions in its core segments. This is supported by its strong expertise in high-performance tyres, which is manifested in its higher margins than peers'. Pirelli's weaker product diversification and more limited scale are counterbalanced by the lower cyclicality of the group's end-markets.

Resilient Business Model: Pirelli's operations are less volatile than those of a typical auto supplier because of its much higher exposure to the more-stable replacement market. In addition, following the disposal of its industrial business, Pirelli focuses on premium and replacement tyres for cars, motorbikes and cycles. Demand predictability in these sectors is high, as replacement cycles are subject to safety requirements and regulation, while premium products are less susceptible to demand decline caused by weaker disposable income.

Derivation Summary

We assess Pirelli primarily as an auto supplier and compare it with tyre manufacturers including Compagnie Generale des Etablissements Michelin (A-/Stable) and Continental AG (BBB/Stable). However, we believe Pirelli's business profile also has consumer goods attributes. We estimate that the group generates about three quarters of its sales from the more stable and profitable aftermarket business, similar to Michelin and Continental. Pirelli also disposed its industrial business (tyres for heavy trucks and buses) to focus only on consumer products (tyres for cars, motorbikes, cycles) and in particular the more defensive premium segment.

Pirelli's business profile is characterised by a smaller scale and weaker product and customer diversification than that of direct competitors, despite its recognised brand and strong market position. However, Pirelli maintains a strong technological edge and comparable geographical diversification relative to its peers.

Pirelli's profitability and cash flow generation are among the highest in the auto supply industry with double-digit EBIT margins, as well as strong cash conversion and FCF margins. Pirelli's initially high leverage was the result of the corporate reorganisation completed in 2016. Since its return to the stock exchange in 2017, Pirelli has been steadily deleveraging, before it was temporarily interrupted by the pandemic in 2020.

Solid profitability is partly offset by a slightly more-leveraged financial structure than its European peers', but better than its lower-rated US peer The Goodyear Tire & Rubber Company's (BB-/Negative). We expect Pirelli's cash flow generation and conservative financial policy to continue to support deleveraging.

Key Assumptions

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

Revenue CAGR for 2023-2027 of 2% led by price/mix effects

EBIT margin above 13% in 2025-2026, due to continued focus on margin-accretive high-value business

Net working capital investments averaging 1.0% of sales for 2024-2027

Capex at 6% of sales until 2027

Dividend payout at 40% of net income in 2024; 50% for 2025-2027

Restricted cash at 2.5% of sales

RATING SENSITIVITIES

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

EBITDA net leverage below 1.0x on a sustained basis, supported by group financial policy

Cash flow from operations (CFO) less capex above 17.5% of debt on a sustained basis

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

EBIT margin below 9% on a sustained basis

FCF margin below 2.5% on a sustained basis

EBITDA net leverage above 2.0x on a sustained basis

Liquidity and Debt Structure

Sound Liquidity: At end-2023, Pirelli reported almost EUR1.25 billion of cash and equivalent. We treat EUR170 million (2.5% of sales) as restricted for intra-year net working capital swings and/or including funds located in countries with transfer restrictions. In December 2023, Pirelli upsized its revolving credit facility to EUR1.5 billion (from EUR1 billion), enhancing its financial flexibility. The group's strong cash flow generation limits external funding needs and allowed Fitch-adjusted gross debt reduction of more than EUR2 billion in 2021-2023.

Diversified Debt Structure: Pirelli's debt is diversified with a mix of banking and debt-capital market facilities (including an equity-linked bond). Since its return to a public listing, it has moved from secured to unsecured funding while progressively reducing financing costs, due also to its strong deleveraging. Capital-market access under more challenging conditions was tested in July 2024 when Pirelli's five-year EUR600 million 3.875% ESG bond was oversubscribed by more than 4.6x.

Issuer Profile

Founded in 1872 and based in Milan, Pirelli is a tier-1 tyre manufacturer with a presence in more than 160 countries and around 18,000 point of sales.

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

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' 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 on the relevance and materiality 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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