TEXT-Fitch Street InterView: Sharp & Panasonic Rating Rationale
(The following was released by the rating agency)
SEOUL/SYDNEY/SINGAPORE, November 12 (Fitch) This week Matt Jamieson spoke with Alvin Lim, Fitch's TMT sector analyst based in Seoul, about the recent downgrade of Sharp Corporation ('B-'/RWN) and his views on Panasonic Corporation's ('BBB-'/Negative) latest financial results.
Mr Jamieson is Head of APAC Research in Fitch's Corporate Ratings Group. Alvin explains that very weak liquidity and substantial operating losses drove the Sharp downgrade. Panasonic's EBIT margins have recently improved to stave off a rating action at this juncture.
However a failure to generate higher cash flow could result in a downgrade to speculative grade within the next 12 months.
Matt: Fitch recently downgraded Sharp by six notches from 'BBB-' to 'B-', a level which indicates the presence of a material default risk. Can you explain the main factors behind such a dramatic downgrade?
Alvin: By way of background let me explain that Fitch downgraded Sharp's rating to the lowest investment grade level of 'BBB-' in December 2011 and changed the Outlook to Negative in February 2012 due to poor operational performance, particularly at its core LCD TV and panel businesses which make up over 60% of the company's total revenue. Further, in September 2012 Fitch placed Sharp's ratings on Negative Watch, based on escalating liquidity and operating issues. Now in early November 2012 Sharp's financial results for H1FY13 revealed a negative EBIT margin of 15%, that the company continues to hemorrhage cash and it is facing a severe liquidity crisis. Cash on hand of JPY221bn is significantly short of the JPY898bn of debt maturing within the next 12 months, and there is a risk that continued support from its creditor banks may not be forthcoming. Hence in light of the acute liquidity risk and substantial operating losses, we downgraded the ratings to the bottom of the single 'B' category, and maintained the Negative Watch.
Matt: As part of the rationale for the downgrade, Fitch also commented that it doesn't expect any meaningful operational turnaround in the company's core business over the short-to-medium term. Can you explain the basis for such a pessimistic outlook?
Alvin: Firstly their position in the global TV market continues to deteriorate, the gap is widening with Korean TV makers, and this trend is not likely to reverse any time soon. For the past two to three years the company focused on producing and driving the market for super large-sized TVs; however, demand has been well below expectations and they have had to discount prices to generate sales. This, in turn, has weakened the company's panel business, especially at its 10th generation facility in Osaka. Secondly, their technology development remains a step behind that of Korean manufacturers. Supposedly Sharp had a good reputation for technology for small- and medium-sized panels, but the company recently was not able to mass-produce them at an acceptable quality and in a timely manner to supply key clients, including major mobile device makers. While the quality or the yield rate of its TV panels may improve, contribution from this area remains uncertain. Thirdly, the high yen continues to work against the company. While there is some expectation that the Japanese yen could depreciate, so long as the USD/JPY remains at around the 80 mark, price competiveness and profitability will continue to erode.
Matt: Panasonic also reported a huge net loss for H1FY13. What is Fitch's view of Panasonic compared with Sharp?
Alvin: Firstly, let me explain that we downgraded Panasonic's rating to 'BBB-'/Negative in February 2012 due to deteriorating operating and financial results. At the time we expected that the company would be taking on substantial restructuring initiatives to streamline its cost structure. Now, while it is true that in Q2 FY13 Panasonic reported a substantial net loss, this was largely due to restructuring charges at the non-operating level. Most of these restructuring charges were non-cash items, such as impairment charges and income tax provisions after writing off deferred tax assets. Importantly at the operating or EBIT level, the company's performance actually improved during the first six months of FY13 with an EBIT margin of 2.4% versus just 0.1% in same period last year.
Matt: What will it take to downgrade or stabilise Panasonic's ratings then?
Alvin: Panasonic's operations are slowly improving, and the company's CEO is clearly focused on restructuring. However, the company's cash flow from operations (CFO) remains very low, and free cash flow (FCF) generation remains negative. Therefore, Fitch will focus not only on whether the company can further improve its operating margins, but also if this can flow through to higher CFO generation and positive FCF in the short-to medium-term. If the company is not able to achieve this, its ratings are likely to be downgraded to speculative grade.
Matt: Finally, why are Samsung Electronics ('A+'/Stable) and LG Electronics ('BBB'/Negative) significantly more profitable than the Japanese technology names?
Alvin: In short it is because the Koreans have better price competitiveness, product quality and technology. While the overall global market for key electronics products such as flat panel TVs has slowed down, the Koreans are taking a significantly large slice of the market compared with two to three years ago. Since their TVs are selling well, this enables their component panel divisions to achieve necessary economies of scale. This is particularly true for Samsung Electronics, as its high profitability and cash flow generation enable the company to continue investing heavily into R&D and capex so that it remains at the forefront of the technology curve.