(The following statement was released by the rating agency)
Dec 14 -
Summary analysis -- Hon Hai Precision Industry Co. Ltd. ----------- 14-Dec-2012
CREDIT RATING: A-/Stable/-- Country: Taiwan
Primary SIC: Computers,
Mult. CUSIP6: 438090
Credit Rating History:
Local currency Foreign currency
09-Nov-2007 A-/-- A-/--
10-Apr-2005 BBB+/-- BBB+/--
The rating on Taiwan-based Hon Hai Precision Industry Co. Ltd. reflects the company’s strong market position in the global electronics manufacturing services (EMS) industry, strong operating efficiency backed by the company’s unrivalled vertically integrated production model, and modest debt leverage. Nevertheless, significant business risks associated with the global contract EMS industry, continuing margin pressures on the company’s profitability, and the company’s increasing customer concentration partly offset these strengths. We assess Hon Hai’s business risk profile as “Strong” and financial risk profile as “Modest”, compared with obligors worldwide.
In our view, Hon Hai’s strong market position as the world’s largest EMS provider strongly supports the rating on the company. Hon Hai has established a strong customer base consisting of major global players in a wide range of electronics products. Market share gains in smartphones, tablet PCs, and liquid crystal display TVs helped Hon Hai to enhance its revenue by 16.4% year on year in the first three quarters of 2012. We believe these product segments will continue to support the company’s revenue growth in the next few quarters.
Hon Hai is the most efficient company in the global EMS and ODM industry, in our view. The company’s vertically integrated production model, strong component manufacturing capabilities, and scale benefit will enable the company to retain its leading market position over the next one to two years. In addition, we believe that the company’s completion of new facilities in inland China and increasing automation in its production process will support the company’s strong operating efficiency and enable the company to maintain its low cost structure.
We expect Hon Hai to adhere to its prudent financial policy and modest debt leverage through its strong operating cash flow and moderate dividend policy. This is despite a recent increase in the company’s total debt coping with possible capital expenditure needs to support Hon Hai’s continued revenue growth. Hon Hai’s adjusted ratio of funds from operations (FFO) to debt was 83% in the first three quarters of 2012 and its adjusted debt-to-EBITDA ratio was 1.1x, which are still satisfactory for the rating. However, we expect the company’s free operating cash flow to improve and its leverage to remain at the current level over the next few quarters, as its major capital expenditures for facilities in inland China have mostly been accomplished.
Our base case projection on Hon Hai incorporates the following assumptions:
-- We believe revenue contribution from consumer electronics will continue to grow, particularly from mobile devices such as smartphones and tablet PCs. The growth for PC, TV, and other feature phones is likely to be much lower, while growth for networking and communication business will remain stable to strong. However, in the forecast, we believe that an uncertain global economy and fierce competition in downstream electronic products is likely to slow the company’s growth momentum.
-- We believe the margin erosion for Hon Hai’s business will ease over the next one to two years due to the relocation of its facilities relocation to inland China, more automation, and cost sharing with its major clients. However, for over the long term, we believe that margin pressure will continue, mainly due to increasing wages in China.
-- The company’s capital expenditure over the next few quarters is likely to be lower than in previous years’ as the construction of most of its production bases in China has been accomplished.
-- As a result, we expect Hon Hai’s EBITDA margin to be 4.3% in 2012 and 4.0% in 2013, compared with 3.9% in 2011. The company’s ratio of adjusted debt to EBITDA is likely to remain low at 1.2x in 2012 and 1.3x in 2013.
However, Hon Hai may continue to face increasing competition over the next few years as competitors try to follow the company’s successful business model. We expect more consolidation and convergence between EMS and ODM business that has enhanced industry competition. Meanwhile, we believe that Hon Hai’s main customers may attempt to increase their suppliers to reduce their supplier concentration risk. However, we believe this will not significantly erode Hon Hai’s competitive advantage over the next one to two years, given the company’s strong technology base, cost position, and economies of scale.
We expect Hon Hai and its rivals to face continuous profitability pressures over the next few years due mostly to intensifying competition and rising production costs in mainland China. However, we believe that the sharing of incremental costs with its customer and cost reductions through new low-cost facilities in China and manufacturing automation will partly offset this risk. Hon Hai’s consolidated EBITDA margin increased to 4.3% in the first three quarters of 2012, from 3.6% in the same period in 2011.
We believe that Hon Hai’s rising sales concentration in its top clients is likely to increase the company’s business volatility if such clients fail to maintain their market positions. However, we believe that Hon Hai’s strong competiveness to acquire new orders and its customers’ solid performance could largely offset this risk over the next one to two years. The company’s largest ten clients accounted for 86.8% of its consolidated revenue for the first three quarter of 2012, only slightly up from 85% in the same period in 2011. However, the company’s sales concentration particularly in its largest client has increased over the past two to three years due to strong growth in demand for consumer electronics products and stagnant demand for PCs.
We believe that the company currently has “strong” liquidity to meet its needs over the next two years. Our view of the Hon Hai’s liquidity profile incorporates the following major assumptions:
-- The ratio of liquidity sources (including cash, liquid financial assets, and funds from operations) to liquidity uses (capital expenditures, cash dividends, working capital needs, and debt maturities) is likely to be above 1.5x over the next 12 months and remain above 1x over the next 12-24 months.
-- Hon Hai could absorb, without refinancing, high-impact, low-probability events.
-- Liquidity sources will continue to exceed uses, even if USI’s EBITDA were to decline by 30%.
-- Hon Hai has well-established, solid relationships with banks in Taiwan.
-- Hon Hai has prudent financial risk management, in our view, as evidenced by the company’s high cash balance and moderate cash dividend payout policy.
The stable outlook reflects our view that Hon Hai’s strong competitive position will enable the company to generate profitability and cash flow protection measures adequate for the rating over the next one to two years, despite continued margin pressures. There is limited potential that we will upgrade the company in the next 12 months, given the heightening competition in the EMS industry, continued margin pressures, and increasing concentration on its top clients.
The rating may come under pressure if Hon Hai takes on a more aggressive financial policy and increases its adjusted ratio of total debt to EBITDA to more than 2.0x for an extended period of time. This could result from: (1) the company taking on more debt due to over-aggressive capital expenditures and rising working capital needs, (2) increased competition, deterioration in cost and technology advantages, or (3) a severe industry downturn erodes Hon Hai’s margin.
Related Criteria And Research
-- Methodology: Management And Governance Credit Factors For Corporate Entities And Insurers, Nov. 13, 2012
-- Business Risk/Financial Risk Matrix Expanded, Sept.18, 2012
-- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Methodology And Assumptions On Risks In the Global High Technology Industry, Oct. 15, 2009
-- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008