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TEXT-Fitch:Japanese tech giants - fallen angels
(The following statement was released by the rating agency)
Nov 22 - In this Fitch Street InterView Matt Jamieson speaks with Steve Durose, Fitch's Head of Asia Pacific TMT ratings, about Fitch's latest rating downgrades in the Japanese technology sector. Mr Jamieson is Head of APAC Research in Fitch's Corporate Ratings Group.
In a previous Fitch Street InterView dated February 2012 and titled "The Fall of the Japanese Tech Giants" Mr Durose explained the rating rationale for Panasonic Corporation (Panasonic), Sharp Corporation (Sharp), Sony Corporation (Sony) and the likelihood that all three would be downgraded to speculative grade. Over the past nine months the extent of the turnaround task facing these businesses has only increased and, in Sharp's case, liquidity has become a significant rating issue.
Matt: Focusing on Panasonic, Sharp, Sony and Toshiba, what rating changes have you made since our last Fitch Street InterView in February 2012 and how do the ratings now compare with mid-2008 levels?
Steve: In February we rated Sharp, Sony and Panasonic at 'BBB-' with a Negative Outlook and Toshiba 'BBB-' with a Stable Outlook. We've subsequently downgraded Sharp by six notches to 'B-', Sony three notches to 'BB-' and Panasonic two notches to 'BB'. Sharp's rating is on Negative Watch, while Sony and Panasonic are on Negative Outlook. Toshiba's rating remains at 'BBB-'/Stable
Since mid-2008 Sharp has fallen 11 notches from 'A+', Panasonic eight notches from 'AA-' and Sony six notches 'A-' and Toshiba a single notch from 'BBB'.
Matt: Clearly Sharp has been the biggest downgrade this year - what's driven that?
Steve: Sharp's sources of cash generation are significantly less diversified compared with those of its peers; the company is overly reliant on a turnaround in LCD TVs/panel and solar cells segments. However, these markets remain very competitive and oversupplied where only the strongest manufacturers are making profits at the moment. Moreover, Sharp's weak position is exacerbated by a flawed strategy to focus on super large-sized TVs and panels (60-inch plus) at a time when economic growth in developed markets remains weak.
Sharp posted another record loss during H1FY13 (year ending March 2013) as revenue fell 16% yoy to JPY1,104bn with a negative 15.3% EBIT margin (H1FY12: 2.6%). Cash flow from operations (CFO) also fell further to negative JPY104bn (H1FY12: negative JPY28bn). LCD TV shipments fell dramatically by 43% yoy during H1FY13 and the company's advanced technology for small- and medium-sized panels has failed to make any meaningful profit contribution so far.
In September 2012, the company obtained JPY360bn in new funding, but banks required security for this debt and the term of the loans was just nine months. CDS levels indicate that Sharp's access to new debt capital will remain limited and the company is undertaking asset sales to raise cash. Fitch's 'B-'/Negative Watch rating indicates this high level of liquidity risk.
Matt: Turning to the Sony and Panasonic downgrades, why is Fitch now rating Sony ('BB-') one notch lower than Panasonic ('BB')?
Steve: We think Sony is the higher risk of the two, hence its lower rating of 'BB-'/Negative. But even at this lower rating, we think there is little headroom for Sony. One positive for Sony has been that over the last five years its pictures and music divisions have delivered relatively stable profits compared with the rest of its portfolio, although both businesses may come under pressure in the next 18 months. In general Fitch believes that the pictures and music businesses are less able to support Sony's overall debt level than successful high-end tech businesses or lower-end tech manufacturers with a strong franchise such as Panasonic's domestic appliance business.
Fitch believes that Sony is substantially more reliant on a strong turnaround in its core electronics segments than Panasonic. In particular we believe that Sony will struggle to record operating profits in its home entertainment, mobile phone and PC product divisions over the short-to-medium term. Our view is that Panasonic, with its slightly stronger product portfolio, including a comparatively stable appliance business, is ahead of Sony in its turnaround efforts, as evidenced by an improved EBIT margin in H1FY13. Nevertheless Panasonic's margins and cashflow generation remain thin, and significant execution risks remain, warranting a Negative rating Outlook.
Matt: What is the business outlook for Sony and Panasonic? Could a devaluation of the yen in 2013 turn their business fortunes around?
Steve: The future of both companies will depend on their ability to curb loss-making segments and re-discover the kind of technological leadership which historically enabled them to develop must-have products. However, at the moment their weak financial performance does not enable them to invest in new technologies anywhere near the extent of their competitors. For example, we expect Sony's capex to average around USD2.5bn p.a. over FY13 and FY14 and Panasonic's capex to average around USD4bn p.a. This compares with USD22bn p.a. for Samsung and USD5.5bn p.a. for LG Electronics on a consolidated basis, including LG Display.
While a significant devaluation of the yen would be positive for these Japanese exporters, without a radical change to the structure of their businesses it is difficult to see profitability improving enough for them to regain investment-grade ratings. The downside risks for Sony are higher than for Panasonic.
Matt: What about Toshiba, how is it managing to beat the negative trend in this sector?
Steve: Toshiba's financial performance is underpinned by its higher-margin and more stable social infrastructure systems business, comprising power and other industrial systems and medical equipment sales. This segment accounted for 38% of revenue, 66% of operating income and 44% of group employees in FY12. This is despite its sizable digital products (PCs, DVDs, TVs) and electronic devices and components (principally semi-conductor business) segments. Therefore Toshiba's business mix and risk is quite different from the other companies we've been discussing.
Matt: For Sharp, Panasonic and Sony, can you tell us what factors may result in further rating downgrades?
Steve: It's different for each company, but the following future developments may individually or collectively result in a rating downgrade. Firstly in the case of Sharp, liquidity is the major issue, and hence a failure to obtain further sources of liquidity to meet short-term obligations would result in a downgrade. For Sony, it would be on-going negative EBIT margins or funds flow from operations (FFO)-adjusted leverage remaining above 4.5x, noting that these metrics exclude the financial services business. And in Panasonic's case, a downgrade could result if EBIT margins fall below 2% or if FFO-adjusted leverage remains above 4.5x
Matt: And finally, on a more positive note, what developments are necessary for Fitch to stabilise the rating Outlooks on these three companies?
Steve: Sharp will need to improve its liquidity and demonstrate an on-going ability to meet its short-term obligations. Sony's EBIT margins will need to rise above 1% or its FFO-adjusted leverage will need to fall below 4x on a sustained basis, noting again that Fitch's analysis excludes Sony's financial services business. And lastly in Panasonic's case, sustained EBIT margins above 2.5% or FFO-adjusted leverage sustained below 4x will be necessary for a stabilisation of its rating Outlook.
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