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COMMENTS

Japan Credit Spotlight: Pulp And Paper; Glass; Steel; Nonferrous Metals


Japan Credit Spotlight: Pulp And Paper; Glass; Steel; Nonferrous Metals

(Editor's Note: This article is part of the "Japan Credit Spotlight" series, which discusses major credit trends for the corporate sector, financial services, and structured finance in the country.)

PULP AND PAPER

The creditworthiness of Japan's pulp and paper industry is likely to be slightly negative for the next year or two, in S&P Global Ratings' view. The growth of online retail has fueled demand for containerboard and corrugated products, which has pushed up demand for paperboard in the country. However, demand for paper products in the domestic market will continue to gradually decline in the long term, particularly for newsprint, printer copy paper, and information-related products. This is because of the accelerating shift to electronic media and structural issues such as the declining birthrate and aging population. Price competition remains fierce in the paper segment as the current state of oversupply has not been fully resolved, despite a period of industrial realignment. The difficulty of passing on higher material and logistics costs has also weighed on the profitability of paper product companies. In the coming years, there is also likely to be an oversupply of cardboard products, which Japan's major paper companies focus on. This is mainly due to increased production capacity and a resulting rise in inventories in the domestic market, and partially to potential slower shipping times that may result from prolonged trade friction between the U.S. and China. Oji Holdings Corp., the top player in Japan, is likely to see profit growth through enhanced operations in China and Southeast Asia and improved financial health, in our view. Its biggest domestic peer, Nippon Paper Industries Co. Ltd., recently announced an agreement to purchase the packaging business of Australia-based company Orora Ltd. to strengthen its limited footprint in overseas markets. We foresee the industry's main players continuing to focus on improving profitability by strengthening their overseas businesses through similar activities.

Table 1

Japan Pulp And Paper Companies Subject To Assessment
Company Rated Business risk profile Financial risk profile Anchor Modifiers or group/govt. Issuer credit rating
Oji Holdings Corp. X Satisfactory Intermediate - - -

Nippon Paper Industries Co. Ltd.

X Fair Aggressive - - -
Business and financial risk profiles, subcomponents of our rating analysis framework, are by no means our final credit rating. Only a rating committee determines a final credit rating, taking into account our analysis of these two profiles in addition to modifiers that include other important factors such as financial policy, management and governance, and analysis of group or government influence. Our assessments of unrated companies rely solely on public information. We have not analyzed or assessed the modifiers and group or government influence essential to derive a final credit rating. Therefore, our assessments are only indications of limited aspects of a company's credit quality, in light of our analytical approach, and are not equivalent to our credit ratings.

Oji Holdings Corp. (Not rated)

Key strengths
  • Leading positions in the domestic paper market, ranking highest in the paperboard segment and second in the paper segment by production volume
  • Diversified business areas and product mix, which generate solid profits backed by increased sales of high value-added products such as thermal paper and specialty paper
  • Growing profit contributions from expanding overseas operations, mainly in China and Southeast Asia
  • Significantly improved cash flow-related ratios, thanks to stronger cash flow generation and reduced debt in recent years, which look like remaining at their current levels for the foreseeable future
Key risks
  • Relatively high risk from the cyclicality of the paper product market, which is inherent to the industry, along with susceptibility to changes in raw material costs and foreign exchange rates
  • A likely continued decline in demand for paper products, particularly for printer copy paper and information-related products, in the domestic market
  • Lower profitability than major global peers that have quickly focused on their core competencies and expanded their scope of business through acquisitions
  • The highly capital-intensive nature of the industry and aggressive investments aimed at enhancing production capacity

Nippon Paper Industries Co. Ltd. (Not rated)

Key strengths
  • Leading positions in the domestic paper market, ranking highest in the paper segment and third in the paperboard segment by sales volume
  • A lowered production capacity for paper products and a realigning of its facilities network in pursuit of more stable profits
  • Relatively strong interest coverage, backed by entrenched banking relationships, mitigating the impact of weakness in cash flow-related ratios on its financial risk profile
  • An expected strengthening of its business through the recently announced agreement to buy Australian company Orora's packaging business
Key risks
  • Relatively high risk from the cyclicality of the paper product market, which is inherent to the industry, along with susceptibility to changes in raw material costs and foreign exchange rates
  • Lower profitability than major global peers, with little prospect of a rapid improvement
  • The highly capital-intensive nature of the industry and aggressive investments aimed at enhancing production capacity for paperboard products, which continue to impose a very heavy debt burden
  • A likelihood of a near-term recovery in cash flow ratios becoming remote if the company completes the acquisition of Orora's packaging business as expected

Chart 1

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Chart 2

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GLASS

The credit quality in Japan's glass industry is likely to be stable in the next year or two, in S&P Global Ratings' view. AGC Inc. and Nippon Sheet Glass Co. Ltd., the two companies we assess here, rank among the top three in the global automotive and construction glass markets. Both generate a considerably high proportion of sales overseas in comparison with other Japanese materials producers, and AGC in particular has successfully diversified its business, in our view. We expect the two companies to maintain relatively stable overall earnings despite downward pressure from lower revenues in their automotive glass businesses, which stem from sluggish global auto unit sales. This drop in revenues could be offset by other segments such as construction glass. However, both companies plan aggressive investments in fields with growth potential, so we expect their key financial ratios to weaken slightly in the coming two years.

Table 2

Japan Glass Companies Subject To Assessment
Company Rated Business risk profile Financial risk profile Anchor Modifiers or group/govt. Issuer credit rating

AGC Inc.

O Satisfactory Modest bbb+ 1 A-

Nippon Sheet Glass Co. Ltd.

X Fair Aggressive - - -
Business and financial risk profiles, subcomponents of our rating analysis framework, are by no means our final credit rating. Only a rating committee determines a final credit rating, taking into account our analysis of these two profiles in addition to modifiers that include other important factors such as financial policy, management and governance, and analysis of group or government influence. Our assessments of unrated companies rely solely on public information. We have not analyzed or assessed the modifiers and group or government influence essential to derive a final credit rating. Therefore, our assessments are only indications of limited aspects of a company's credit quality, in light of our analytical approach, and are not equivalent to our credit ratings. All ratings and scores are as of Sept. 30, 2019.

AGC Inc. (A-/Stable/A-2)

Key strengths
  • Strong position in the global glass market, including for LCD glass substrates, thanks to its advanced technology
  • Diversified earnings sources, in terms of both business and location, contributing to steady profitability
  • Prospects for higher profit in its rapidly growing chemicals business, in both commodity and high value-added products, following business restructuring, acquisitions, and facility upgrades
  • Strong coverage ratios, supported by ongoing and entrenched banking relationships, underpinning the rating
Key risks
  • Exposure to cyclical, maturing, and capital intensive industries
  • Lower profitability in the glass business than global peers despite its strong market position
  • Likelihood that cash flow ratios will stay near the bottom end of the range for the rating in the coming year or so, mainly due to heavy investments

Nippon Sheet Glass Co. Ltd. (Not rated)

Key strengths
  • Solid global market position in sheet glass for construction and automobiles, based on the company's production technology
  • Relatively stable profitability thanks to restructuring and successful efforts to add value to products
  • A relatively strong interest coverage ratio supported by close relationships with creditor banks, which partially mitigates the impact of very weak cash flow-related measures on its financial risk profile
Key risks
  • Exposure to cyclical, maturing, and capital-intensive industries
  • Low likelihood of profitability improving, due to the company's limited product mix compared with rivals that have enjoyed high-margin earnings from products such as specialty glass
  • Less stable operating cash flow with volatile working capital
  • Excessive debt relative to cash flow, resulting in very weak cash flow-related metrics
  • Prospect of a continued heavy debt burden, given its large strategic investment plan for fiscal 2019 (ending March 31, 2020)

Chart 3

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Chart 4

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STEEL

Credit quality in Japan's steel industry is likely to remain stable in the next year or so, but downward pressure is growing on the sector, in S&P Global Ratings' view. The industry is highly cyclical and we believe Japanese steel companies are likely to face a difficult business environment. The global market has weakened compared with 2018, owing to the economic slowdown stemming from trade friction between the U.S. and China. We estimate that prices of materials like iron ore will remain high, because China, which accounts for 60% of global crude steel output, is likely to increase production of some steel materials for its infrastructure projects. Accordingly, we expect the profits of the two steel companies we assess here for fiscal 2019 (ending March 2020) will likely decline materially from the previous year and their profitability will deteriorate. Amid falling profitability, the companies have aggressively increased capital spending and business investment in recent years, resulting in higher debt. Consequently, we consider the key to maintaining credit quality for the companies will be to moderate the increase in debt through disciplined financial management.

Table 3

Japan Steel Companies Subject To Assessment
Company Rated Business risk profile Financial risk profile Anchor Modifiers or group/govt. Issuer credit rating

Nippon Steel Corp.

O Satisfactory Intermediate bbb - BBB

JFE Holdings Inc.

X Satisfactory Significant - - -
Business and financial risk profiles, subcomponents of our rating analysis framework, are by no means our final credit rating. Only a rating committee determines a final credit rating, taking into account our analysis of these two profiles in addition to modifiers that include other important factors such as financial policy, management and governance, and analysis of group or government influence. Our assessments of unrated companies rely solely on public information. We have not analyzed or assessed the modifiers and group or government influence essential to derive a final credit rating. Therefore, our assessments are only indications of limited aspects of a company's credit quality, in light of our analytical approach, and are not equivalent to our credit ratings. All ratings and scores are as of Sept. 30, 2019.

Nippon Steel Corp. (BBB/Stable/--)

Key strengths
  • Leader in Asia's steel market in scale and product mix
  • Strong competitiveness and leading technology in the global high-grade steel market
  • Long-standing relationships with domestic customers and high product quality, both of which enable it to maintain stable profitability compared with global peers
  • Favorable coverage ratios, supported by strong relationships with creditor banks, underpinning the rating
Key risks
  • A likelihood of earnings and profitability deteriorating in the current fiscal year, reflecting the difficult business environment and challenging price negotiations with customers
  • Likely negative free operating cash flow (FOCF) in the next one to two years because of its heavy debt burden and stagnant profitability
  • A likelihood of increased downward pressure on the ratings if the company fails to control rising debt despite having taken various measures to do so, or if it is unable to rapidly improve EBITDA, due to further adverse operating conditions

JFE Holdings Inc. (Not rated)

Key strengths
  • Strong position in Japan's and other Asian steel markets in scale and product mix
  • Strong competitiveness and high technological capability in high-grade steel, with a good customer base
  • Strong interest coverage, backed by entrenched banking relationships, that makes up for a weakness in cash flow-related ratios
Key risks
  • Lack of economies of scale and somewhat weak profitability compared with larger global peers
  • Lack of geographic diversification in operating areas and of vertical integration of raw materials procurement compared with some global peers
  • High capital intensity, which is inherent in the steel industry, and an increase in debt due to aggressive investments, leading to outstanding debt plateauing at a high level
  • Weak cash flow-related ratios for our assessment of its financial risk profile because of the difficult business environment and a heavy debt burden

Chart 5

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Chart 6

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NONFERROUS METALS

The credit quality in Japan's nonferrous metals industry is likely to remain stable over the next one to two years. The two Japanese nonferrous metals companies we assess are likely to capture growing demand related to automotive electrification and communications and electricity infrastructure. However, this is likely to be mitigated by growing pressure on earnings from:

  • Intensifying U.S.-China trade friction,
  • A fall in auto unit sales, and
  • Slowing growth of smartphone-related markets.

Compared with global peers, price swings in nonferrous metals have a limited impact on the two companies, in our view. This is because they are not engaged in upstream mining. Their profitability is likely to stay stable, albeit at slightly weak levels. Reduced costs and stronger sales of new products are likely to help cushion the impact of continued fierce competition and pricing pressure in their main businesses. Their stable cash flows are likely to largely cover the burden of ongoing costly investments in research and development (R&D) and capital expenditures needed to maintain or improve their competitiveness. Therefore, the two companies are likely to maintain financial standings commensurate with our current assessment of their financial risk profiles.

Table 4

Japan Nonferrous Metals Companies Subject To Assessment
Company Rated Business risk profile Financial risk profile Anchor Modifiers or group/govt. Issuer credit rating

Furukawa Electric Co. Ltd.

X Satisfactory Significant - - -

Sumitomo Electric Industries Ltd.

O Satisfactory Modest bbb+ 2 A
Business and financial risk profiles, subcomponents of our rating analysis framework, are by no means our final credit rating. Only a rating committee determines a final credit rating, taking into account our analysis of these two profiles in addition to modifiers that include other important factors such as financial policy, management and governance, and analysis of group or government influence. Our assessments of unrated companies rely solely on public information. We have not analyzed or assessed the modifiers and group or government influence essential to derive a final credit rating. Therefore, our assessments are only indications of limited aspects of a company's credit quality, in light of our analytical approach, and are not equivalent to our credit ratings. All ratings and scores are as of Sept. 30, 2019.

Furukawa Electric Co. Ltd. (Not rated)

Key strengths
  • Moderate global presence in some product categories, including optical fibers and automobile wiring harnesses
  • Prospect of some benefit from growing global demand for telecommunications and electricity infrastructure in the next two to three years
  • Strong interest coverage, backed by entrenched banking relationships and mitigating weak in cash flow ratios
Key risks
  • Still-low profitability despite restructuring and cost reductions
  • Potential pricing pressure, risk of obsolescence in technology, and fierce competition in its electronic component and optical fiber businesses
  • Somewhat high reliance on auto parts business, which has slightly high earnings volatility
  • Continued weakness in cash flow-related ratios owing to elevated levels of debt to finance R&D and capital investments

Sumitomo Electric Industries Ltd. (A/Stable/A-1)

Key strengths
  • Stable profitability thanks to the low correlation between the businesses in its diverse portfolio
  • Leading position in core businesses, backed by advanced technology and a solid customer base
  • Ability to produce competitive high-functional products, mitigating risk of obsolescence in technology, thanks to its strong R&D capabilities
  • Continued sound financial ratios, backed by relatively high and stable cash flow, which support high levels of development and capital investments
Key risks
  • Somewhat high reliance on auto parts business, which has slightly high earnings volatility
  • Potential pricing pressure, risk of obsolescence in technology, and fierce competition in its information-related communication and electronics businesses
  • Slightly lower consolidated profitability than major global competitors

Chart 7

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Chart 8

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This report does not constitute a rating action.

Primary Credit Analysts:Katsuyuki Nakai, Tokyo (81) 3-4550-8748;
katsuyuki.nakai@spglobal.com
Makiko Yoshimura, Tokyo (81) 3-4550-8368;
makiko.yoshimura@spglobal.com
Hiroyuki Nishikawa, Tokyo (81) 3-4550-8751;
hiroyuki.nishikawa@spglobal.com
Secondary Contacts:Taishi Yamazaki, Tokyo (81) 3-4550-8770;
taishi.yamazaki@spglobal.com
Kei Ishikawa, Tokyo (81) 3-4550-8769;
kei.ishikawa@spglobal.com

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