(The following statement was released by the rating agency)
Dec 07 -
-- We expect GS E&C's financial risk profile to deteriorate due to profitability erosion in its overseas businesses and the prolonged downturn in the property development market in Korea.
-- We lowered our long-term rating on GS E&C to 'BBB-' from 'BBB'.
-- The outlook is negative, reflecting the heightened likelihood of the company having to take over guaranteed debts for property developers amid an increasingly difficult refinancing environment.
On Dec. 7, 2012, Standard & Poor's Ratings Services lowered its long-term corporate credit rating on GS Engineering & Construction Co. Ltd. (GS E&C) to 'BBB-' from 'BBB'. The outlook on the rating is negative.
The downgrade of GS E&C reflects Standard & Poor's view that profitability erosion from overseas plant construction and the prolonged downturn in Korea's property development market will weaken the company's financial risk profile over the next 12 to 18 months. We expect the company's debt to EBITDA ratio to rise to over 5x in 2012 under our base-case scenario. We have lowered the company's financial risk profile to "significant," while its business risk profile remains "satisfactory."
In our view, the company's aggressive expansion into overseas markets and heightened competition in domestic and overseas engineering, procurement, and construction markets is likely to dilute its gross margin to around 9% over the next 12 months, compared with 11.5% in 2011. The lower EBITDA and continuous burden on working capital will likely limit GS E&C's capacity to deleverage and improve its financial risk profile, in our view.
Furthermore, a large balance of payment guarantee that GS E&C extended to small property developers-worth Korean won (KRW) 2.2 trillion as of the end of September 2012--remains a negative factor for its credit quality. The activation of such a guarantee could pressure the company's liquidity and its debt profile if developers fail to pay the interest and principal they owe to creditors and GS E&C is obligated to take over or repay such debt.
Our base-case scenario is predicated on modest growth in revenue of between 3% and 7% in 2012 and 2013 due to lower new orders in the last 12 months. However, the gross margin in the plant and civil engineering businesses, in our view, will deteriorate close to 10% and 3%, respectively, in 2012 and 2013. We expect the company's ratio of adjusted debt to EBITDA to rise above 5x in 2012 and gradually fall back toward 4x in 2013 assuming that the company will utilize its cash holdings rather than increase debt for its operations.
We assess GS E&C's liquidity to be "adequate," as defined in our criteria. We estimate that the company's sources of liquidity to uses of liquidity will exceed 1.2x over the next year. The company will have KRW1.6 trillion in liquidity, comprising cash, funds from operations, and committed revolving credit facilities. We estimate the company will need about KRW1.3 trillion to cover debt maturities due in the next year as well as a shortfall in working capital, planned capital spending, and dividends. We incorporate into our assessment of the company's liquidity an expectation that the company will need extra funds as a buffer against volatility in working capital and contingent liabilities.
The negative outlook reflects our view that GS E&C may need to take over the guaranteed debt of property developers amid an increasingly difficult refinancing environment for small developers and prolonged weak property market in Korea, which would negatively affect the company's financial risk profile.
We may lower the ratings on GS E&C if the activation of payment guarantees or weaker-than-expected operating performance from overseas plant construction further weakens its financial profile. The ratings on GS E&C could also come under downward pressure if the company's cash flow deteriorates further or adjusted debt to EBITDA stays above 4x over the next 12 to 18 months.
We may revise the outlook to stable if the company's debt to EBITDA stabilizes below 4x on a sustained basis. This would require the company to reduce its debt through stable operating performance or by disposing of noncore assets and to reduce its exposure to developers' project finance debt.
Related Criteria And Research
-- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
GS Engineering & Construction Corp.
Corporate Credit Rating BBB-/Negative/-- BBB/Stable/--