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Japanese Tech Faces Stern COVID-19 Tests – S&P Global


TOKYO (S&P Global Ratings) June 3, 2020–S&P Global Ratings today said that the creditworthiness of Japan’s technology hardware companies will remain under pressure through 2020 amid a global economic downturn triggered by the COVID-19 pandemic. Of the eight Japan-based electronics companies in the technology hardware industry we rate, the ratings on four have either negative outlooks or are on CreditWatch with negative implications (see list below).

Creditworthiness is under pressure despite business performances in fiscal 2019 (ended March 31, 2020) that were generally within tolerances for the current ratings (except for Canon Inc. and Sharp Corp.) and production returning to normal. We took negative rating actions on Sharp and Canon in May 2020.

We expect pressure to build on the profitability of electronics companies that generate sales largely from highly cyclical products, such as automotive and consumer electronics (including smartphones, TVs, and digital cameras). We expect the global economic downturn to dampen consumer demand into 2021. The office electronics market, meanwhile, is likely to shrink rapidly. Demand for copying and printing documents is likely to decline as people globally take to working from home.

One key to propping up profitability is swiftly reducing costs in response to falling sales. The companies have in recent years cut fixed costs during restructuring drives. Companies with competitive products that have well-established market positions, or that have diversified businesses are likely capable of staging relatively strong recoveries after the pandemic has run its course, in our view.

We expect both operating profit and operating cash flow at the eight companies to fall dramatically for at least the coming six months. Most of the eight companies have some financial cushion for the current ratings. They have kept key financial ratios, such as debt to EBITDA, at favorable levels in the past one to two years, securing robust profit even as they accelerated growth investments and enhanced shareholder returns. However, if they continue to make large investments and deliver generous shareholder returns, even as their profit and operating cash flow plummet, it would not only diminish their financial cushions but also raise uncertainties over their financial prudence.

If new car sales remain substantially weak and fail to recover in full until 2021, operating profit at Renesas Electronics Corp., Panasonic Corp., and TDK Corp. may decline sharply. Automotive products account for a large proportion of sales at these companies; Renesas generates half of its sales from auto-related products. The rating outlooks on Renesas and Panasonic have been negative since 2019, before the impact of the pandemic surfaced.

Our projections for the four companies with ratings that have either negative outlooks or are on CreditWatch negative are:

  • Renesas: We might consider downgrading the company if profit comes under pressure and it is unable to swiftly reduce debt. In financial terms, this would be if we determined that its ratio of debt to EBITDA won’t improve to below 3x in fiscal 2020 (ending Dec. 31, 2020) or thereafter. This could occur, for example, if new car sales don’t show signs of recovering in the July-September 2020 quarter or thereafter. The company’s finances are already under pressure from the financing burden of a large acquisition made in early 2019.
  • Panasonic: The company likely needs another one to two years to monetize the automotive battery and products businesses in which it has invested in recent years. We estimate that cost reductions led to an EBITDA margin of mid-8% in fiscal 2019, despite the squeeze on earnings from the slump in its auto-related business and the pre-pandemic economic slowdown. We would consider downgrading Panasonic if we believed its EBITDA margin was likely to drop to below 8.5% and remain there. This could occur if it fails to: offset prolonged weakness in demand in its auto-related business by streamlining its underperforming businesses in areas such as semiconductors, liquid crystal display (LCD), and TVs; diversify its earnings sources with a wide-ranging business portfolio; and further reduce costs.
  • Canon: Profit and key financial ratios are likely to far undershoot our assumptions. This is because the pandemic is likely to quickly and structurally shrink the markets for cameras and office equipment, which are Canon’s main products. We might consider downgrading the company if we think its profit and key financial ratios are unlikely to recover quickly. Our ratings on Canon have been on CreditWatch negative since May 8, 2020.
  • Sharp’s operating profit is likely to make a muted recovery in fiscal 2020, having declined sharply the previous year. Operating profit plunged because the pandemic disrupted its supply chain in China, particularly for its LCD panel business. We may consider a downgrade if we see a growing possibility that the ratio of debt to EBITDA will continuously exceed 5.5x in the coming year or so; it stood at 5.9x as of the end of March 2020. We revised the outlook on Sharp to negative on May 25, 2020.

We expect limited downward pressure on our ratings on Sony Corp., TDK, Ricoh Co. Ltd., and Fujifilm Holdings Corp. for now. Their highly competitive core businesses and diversified business portfolios are likely to help ease pressure on their overall operating profit, even amid the global economic downturn. Sony, TDK, and Ricoh are likely to maintain the financial cushions they have relative to our ratings on them, because they have improved their financial health through fiscal 2019.

  • Sony: The company can maintain its relatively stable EBITDA and profitability, benefiting from having expanded business lines that generate recurring revenue, such as its gaming network and music streaming operations. These will partially offset the sluggishness in its consumer electronics business. Its ratio of debt to EBITDA is likely to worsen, although within tolerances for the current ratings, from the extremely sound level it is now at. Specifically, we expect the ratio to stand at about 0.7x as of the end of fiscal 2020. This is because it plans to finance with debt its acquisition of shares (approximately ¥395.5 billion) in a listed financial arm that it aims to turn it into a wholly owned unit in the second half of this calendar year.
  • TDK: Business may come under increased pressure if car sales don’t show signs of recovering in the July-September 2020 quarter or thereafter. This is because its auto-related business generates a large proportion, about 20%, of overall sales. Nevertheless, its highly competitive and profitable lithium-ion rechargeable batteries for smartphone and consumer electronics are likely to help ease the impact of a drop in profit from industrial and automotive products. We expect its EBITDA margin to slip slightly but stay at about 16%.
  • Ricoh: The company’s ok information technology service targeting small and medium-size enterprises, a business that has ok improving profitability, is likely to help its overall operating profit. This is although, like Canon, profit from its office equipment business is likely to sink further. Its EBITDA margin is likely to deteriorate slightly from fiscal 2019 but stay at about 6%-7%.
  • Fujifilm: The company’s diversified business portfolio is likely to help ease downward pressure on its profitability. We expect a continued decline in revenue from its office equipment business, but robust performance in its health care and highly functional materials businesses. Nevertheless, its financial cushion is likely to narrow because its planned acquisition of Hitachi Ltd.’s diagnostic imaging business (for about ¥180 billion) in fiscal 2020 is likely to worsen its ratio of debt to EBITDA to mid-1x. The ratio has been deteriorating because of cash outflows for a string of acquisitions and share buybacks.

S&P Global Ratings acknowledges a high degree of uncertainty about the rate of spread and peak of the coronavirus outbreak. Some government authorities estimate the pandemic will peak about midyear, and we are using this assumption in assessing the economic and credit implications. We believe the measures adopted to contain COVID-19 have pushed the global economy into recession (see our macroeconomic and credit updates here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.

Issuer Credit Ratings On Technology Hardware Companies

  • Fujifilm Holdings Corp.: AA-/Stable/A-1+
  • Renesas Electronics Corp.: BBB-/Negative/A-3
  • Panasonic Corp.: A-/Negative/A-2
  • Sharp Corp.: BB-/Negative/B
  • Sony Corp.: A-/Stable/A-2
  • TDK Corp.: A-/Stable/A-2
  • Canon Inc.: A+/Watch Neg/A-1
  • Ricoh Co. Ltd.: BBB+/Stable/A-2

Related Research

  • Outlook On Sharp Revised To Negative As COVID-19 Hobbles Recovery Momentum; ‘BB-/B’ Ratings Affirmed, May 25, 2020
  • Sony Corp. ‘A-/A-2’ Ratings Affirmed, Outlook Stable On Plan To Take Full Control Of Financial Unit, May 20, 2020
  • Japan-Based Canon Inc. ‘A+/A-1’ Ratings Placed On CreditWatch Negative As Core Business Markets Shrink Amid COVID-19, May 8, 2020
  • Japan Corporate Creditworthiness Faces Mounting Pandemic Pressure, April 30, 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.

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