TOKYO (S&P Global Ratings) June 24, 2020--S&P Global Ratings today said that downward pressure on creditworthiness of Japan's heavy industries and capital goods sector will intensify throughout 2020 amid a pandemic-triggered global economic downturn. The outlook on five of the six rated companies in the sector is stable. Toshiba has a positive outlook (See the list below). However, we see a growing likelihood that business performance and finances at companies in this sector will deteriorate.
Among the six heavy industries and capital goods manufacturers we rate, Hitachi, Mitsubishi Heavy Industries, and Toshiba benefit from diversified profit sources. They have streamlined and consolidated low-profit businesses, which has enhanced their stability, in our view. Mitsubishi Electric, Komatsu, and Omron have strong competitiveness in their key businesses on a global basis and strong capabilities to reduce cost. These strengths ease pressure on their business performance. Reflecting these factors, the six companies performed generally in line with expectations and maintained financial health at levels generally commensurate with the current ratings in fiscal 2019 (ended March 31, 2020).
We expect performances at the six companies to diverge in the next one to two year. The degree to which COVID-19 impacts the companies will vary depending on their business portfolios. Demand is likely to remain weak in 2020 and 2021 amid an ailing global economy. Downward pressure on business performance and profitability will therefore grow at companies where sales are sensitive to macroeconomic performance, such as machine tools, products for automobiles, products for consumer electronics (e.g., smartphones), and construction machinery. In addition, the global airline industry has been seriously affected by the pandemic, and companies operating in the aircraft segment will therefore suffer a material decrease in orders from aircraft manufacturers in the next two to three years, in our view. The key to sustaining profitability will be their ability to reduce costs rapidly in response to radical changes in the business environment.
Meanwhile, stability is more likely at companies operating in areas where sales have less macroeconomic sensitivity, such as energy, including power generation systems, and public infrastructure. In comparison with global peers, Japan's rated heavy industries and capital goods manufacturers have smaller exposures to the oil and gas sectors, which are likely to suffer amid shrinking energy demand. Accordingly, downward pressure on business performances and creditworthiness will be somewhat curbed. In addition, companies that have well-diversified business mixes and strong market positions and competitiveness in each product are likely to more easily recover from the pandemic adversity.
Looking forward two or three years to economic recovery, we expect a relatively fast rebound for types of business that found new demand or met potential needs during the pandemic. Products for semiconductors and IT services are likely to be one such area as data utilization and digitalization needs have generated demand for such products. Factory automation is another case in point: There are growing needs for remote operations and automation. However, we have not incorporated possible recovery into our forecasts yet.
The six rated companies are unlikely to curb spending quickly in fiscal 2020. Heavy industries and capital goods manufacturers have been competing globally for better market positions amid declining order receipts. The companies have invested for growth and made acquisitions aggressively in the past one to two years, supported by relatively stable business performances and cash flow generation. Accordingly, free cash flow has been declining. For the next six months or so, we expect operating profit and operating cash flow at the six companies to decrease materially. If the companies continue to make large investments and acquisitions as they did in the past, their financial leeway may shrink, raising questions about how conservative their financial management is.
Among the five rated companies with stable outlooks, downward pressure on the ratings is relatively stronger for Hitachi, Mitsubishi Electric, Mitsubishi Heavy, and Komatsu. These four companies have business portfolios that are vulnerable to economic downturns. Some are also likely to suffer deteriorations of their financial profiles because of heavy investment burdens over the next year or so. Our forecasts for the four companies follow.
- Hitachi: Despite growing downward pressure on business performance, mainly on mass-produced goods, the company plans to make heavy investments for growth and restructuring in fiscal 2020. The company acquired Hitachi High-Technologies Corp. at a cost of about ¥530 billion as a wholly owned subsidiary in April 2020. Hitachi also plans to spend about ¥704 billion to acquire the power transmission and distribution business of Switzerland-based engineering company ABB Ltd. in the first half 2020. We expect Hitachi, with disciplined financial management, to work to ease the financial burden. However, if this is delayed or if performance looks less likely to recover from the second half in fiscal 2020 onward, its debt-to-EBITDA ratio may exceed and remain above 2.0x. Under such circumstances, the rating would come under stronger pressure.
- Mitsubishi Electric: Air conditioning equipment and energy and electric systems are supporting companywide earnings to a certain extent. However, the impact of the global economic slowdown and upfront investment in fiscal 2019 materially weakened the factory automation and automobile equipment businesses that had driven the company's profits until fiscal 2018. We expect the businesses to further deteriorate in fiscal 2020. We expect a recovery of demand in parts of the factory automation business, such as 5G and lithium-ion batteries. However, we consider the recovery of overall demand, including that for automobiles, and a full-scale recovery of profitability may take one to two years. We estimate the company's EBITDA margin was around 10.5% in fiscal 2019. We may consider a downgrade if the margin falls below 11% and remains there.
- Mitsubishi Heavy Industries: We lowered our rating to 'BBB+' from 'A-' on Mitsubishi Heavy Industries on Feb. 19, 2020. The downgrade reflected our view that a further delay in development of SpaceJet, a small passenger jet, is likely to keep development costs at a significantly high level. In addition, the downgrade partly reflected the impact of the COVID-19 pandemic, which is likely to weaken the earnings of industrial products, such as forklift trucks and turbo chargers for automobiles, leading to deterioration of profitability and key financial ratios, in our view. Development costs for SpaceJet are likely to decrease in fiscal 2020. However, the weaker economy has led to more pressure on industrial products than we had previously assumed. Accordingly, the EBITDA margin is likely to fall below 7% in fiscal 2020. We will consider a downgrade if the EBITDA margin does not stay comfortably above 6%, or if we believe the debt-to-EBITDA ratio will exceed and remain above 3.0x.
- Komatsu: The slowdown of demand for construction and mining machinery globally is likely to further weaken Komatsu's business performance in fiscal 2020. We expect the company's EBITDA margin for fiscal 2020 to drop to 11%-12% in fiscal 2020 from our estimate of around 14.5% for fiscal 2019, after incorporating sales of high value-added products and a reduction in fixed expenses into our forecasts. Given the close link between the company's performance and that of the economy, the company's debt-to-EBITDA ratio, which was at a sound level relative to the rating, is likely to drop to around 1.5x as of March 31, 2021, while economic recovery remains weak. Its financial leeway is shrinking; it is likely to take about two years for the ratio to recover to the fiscal 2019 level of about 1.0x. We will consider a downgrade if the EBITDA margin remains below 11%, or if the debt-to-EBITDA ratio exceeds 2.0x consistently.
Meanwhile, we consider pressure on our ratings on Omron and Toshiba to be limited for the time being. Our forecasts for the two companies are below.
- Omron: The industrial automation business is likely to remain competitive. The business is sensitive to capital expenditure by the manufacturing industry, and generates about 70% of the companywide operating profits. The company's earnings sources are thus highly concentrated. However, industrial automation is backed by the company's technology and capability to propose solutions. Despite the weakening economy, we expect the company to maintain its EBITDA margin at 11%-12%, as it was in fiscal 2019, in the next one to two years by slashing fixed expenses and maintaining high operational efficiency. The company's continuous review of its business portfolio has so far supported profitability, in our view.
- Toshiba: The outlook on Toshiba is positive. Even in the difficult market and competitive environment and under the shadow of the pandemic, the company's core infrastructure and energy businesses are likely to remain less susceptible to the volatility of the economy. The EBITDA margin stood at about 8% in fiscal 2019, up from 4.5% on the previous year. Stable performance in its mainstay infrastructure business and cost reduction efforts helped the margin. The debt-to-EBITDA ratio, a key financial indicator, stood at about 1.6x, better than we had assumed. Given that the company has been reducing costs and promoting structural reform, profitability is likely to remain relatively stable in the next one to two years. The company will continue to make aggressive investments for growth, which will increase the debt burden and weaken its major financial ratios. However, the worsening of the ratio will be limited to a certain range, in our view. The company has made some progress in enhancing its governance. However, its record is insufficient to determine the certainty of disciplined financial management. We will consider an upgrade if we see more likelihood that the EBITDA margin stays above 7.5% consistently, while the debt-to-EBITDA ratio remains below 3.0x. We may also consider an upgrade if enhancement of governance strengthens business performance and stability of financial management. We haven't incorporated the sale of shares in flash memory chip maker Kioxia Holdings Corp., which is its equity-method affiliate, in our base-case scenario. If the sale of shares materializes, the majority of sales proceeds will likely be used for shareholder returns. Even so, its impact on key financial ratios will be neutral, even if debt is not repaid.
S&P Global Ratings acknowledges a high degree of uncertainty about the evolution of the coronavirus pandemic. The consensus among health experts is that the pandemic may now be at, or near, its peak in some regions, but will remain a threat until a vaccine or effective treatment is widely available, which may not occur until the second half of 2021. We are using this assumption in assessing the economic and credit implications associated with the pandemic (see our research here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.
Issuer Credit Ratings On Heavy Industries And Capital Goods Companies
- Hitachi Ltd. A/Stable/A-1
- Mitsubishi Electric Corp. A+/Stable/A-1
- Mitsubishi Heavy Industries Ltd. BBB+/Stable/--
- Komatsu Ltd. A/Stable/A-1
- Omron Corp. A/Stable/A-1
- Toshiba Corp. BB/Positive/B
- Hitachi Ltd. Investments Amid Downturn To Weigh On Ratings, June 1, 2020
- Japan Corporate Creditworthiness Faces Mounting Pandemic Pressure, April 30, 2020
- Mitsubishi Heavy Industries Downgraded To 'BBB+' On SpaceJet Risk; Outlook Stable, Feb. 19, 2020
A Japanese-language version of this media release is available on S&P Global Research Online at www.researchonline.jp, or via CreditWire Japan on Bloomberg Professional at SPCJ <GO>.
This report does not constitute a rating action.
|Primary Credit Analyst:||Makiko Yoshimura, Tokyo (81) 3-4550-8368;|
|Secondary Contacts:||Taishi Yamazaki, Tokyo (81) 3-4550-8770;|
|Roko Izawa, Tokyo (81) 3-4550-8674;|
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