March 2, 2017 / 4:22 AM / 5 months ago

Fitch Affirms LG Electronics at 'BBB-'; Outlook Stable

15 Min Read

(The following statement was released by the rating agency) SEOUL, March 01 (Fitch) Fitch Ratings has affirmed LG Electronics Inc.'s (LGE) Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) and senior unsecured rating at 'BBB-'. The Outlook is Stable. The ratings reflect LGE's well-established positions in its core products globally, its diverse product portfolio and its relatively stable financial structure. We believe that LGE's competitive strength in home appliances, TVs and flat-panel displays will support its overall operating performance and offset continued weakness in its handset operation. The Stable Outlook reflects our view that LGE's financial profile - including proportional consolidation of 37.9%-owned LG Display Co., Ltd (LGD) - will remain commensurate with the lowest investment grade. KEY RATING DRIVERS Competitive Position Maintained: LGE's strong market presence and product diversification may provide some cash flow stability during the downturn in the consumer electronics industry and the weak macroeconomic outlook. LGE holds competitive positions in the global flat panel TV and home appliance markets. LGD is the largest flat panel display manufacturer with a 23% share of the global market in terms of unit shipments. Handset Recovery is Key: Improvement in LGE's handset business will remain the key to enhancing the company's credit profile, although we expect LGE will continue to face keen competition and to struggle to expand its global presence in the short term. However, the operating losses in its handset unit are likely to bottom out after reaching their largest ever level in 2016 due to disappointing sales of its flagship G5 model and substantial restructuring costs. LGE has abandoned the G5's modular design to cut manufacturing costs and reduced fixed costs, which could improve the segment's profit. Tightened LCD Panel Supply: We expect the more balanced supply and demand conditions in the liquid-crystal display (LCD) panel industry to help LGD deliver better operating results in 2017. While Chinese and Taiwanese manufacturers continue to add new capacity for large-sized LCD panels, Korean manufacturers are likely to focus on OLED production, which will decelerate overall LCD panel capacity expansion. The recovery in LCD panel prices and a shift in product mix towards premium models are likely to lead to a gradual increase in margin in the medium term. Weakening TV Profitability: The widening in LGD's profit margins as panel prices recover may come at the expense of margins in LGE's TV segment. We believe LGE's TV segment margin will remain highly volatile due to fluctuating panel prices. However, the short-term demand for flat-screen TVs is likely to be solid, driven by consumers buying larger-sized TVs and further penetration of premium products like OLED and ultra-high definition (UHD) TVs. We expect LGE's TV margin to narrow slightly in 2017 from the historically high margin of 7.1% in 2016. Solid Appliances Supports Margin: We expect LGE to maintain its strong positions in refrigerators, washing machines and air conditioners. Operating profits for the home appliance and air-conditioning businesses are likely to remain steady over the long term because LGE has been expanding exposure to business-to business markets and the high-end market. However, slower economic growth in developed markets, intensifying competition with emergence of the Chinese manufacturers and volatile currency movements may constrain profitability in the short term in these segments. Aggressive Expansion in OLED: LGD's expansion in the organic-light-emitting diode (OLED) screen business to spur long-term revenue growth and margin improvement is likely to result in negative free cash flow in the short term. The company plans to produce more small to medium sized displays to capture increasing adoption of OLED in premium smartphones, as well as increase capacity for OLED displays for TVs. LGD plans to increase its capex to KRW4trn-5trn in the next two years, of which, more than 50% will be dedicated to OLED manufacturing facilities. DERIVATION SUMMARY LGE's thin margin compared to peers in the technology sector is the main constraint on its ratings. Its exposure to markets with fierce competition and fragmented structure, such as handsets, TVs and appliances, limit the company's ability to expand its profit. However, its relatively strong balance sheet and financial flexibility provide buffer against any negative impact on the company's financial profile from sudden adverse changes in the operating environment. LGE is rated one notch below Panasonic Corporation (Panasonic, BBB/Stable) due mainly to lower profitability. Panasonic's restructuring has delivered stronger profitability and more solid and steady cash generation compared with LGE. LGE's rating is two notches above Sony Corporation's (BB/Positive), reflecting LGE's stronger business profile and better financial leverage, including its strong market presence and technological leadership in its core products, such as display panels, appliances and TVs. In contrast, Sony has lost its leading position in consumer electronics. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - LGE's revenue growth to be limited at low-single digit due to high competition and slower economic growth. - LGE's operating margin in 2017 to be comparable to 2016's 2.4%. Cost control measures, especially in its handset segment, and the gradual shift to premium products are likely to help offset pricing pressure in key markets and rising raw material prices. - Better supply and demand conditions in LCD panel industry to improve LGD's margin to mid-single digits (2016: 4.9%). - LGE's capex to remain at similar level to the previous years while LGD to increase its spending to around KRW4trn-5trn (2016: KRW3.9trn) in the short term - Free cash flow generation to remain minimal for LGE and free cash flow deficit for LGD. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action; - Sustained operating EBIT margin above 4% (2016: 2.9%) - Total adjusted debt/EBITDAR is sustained below 2x (2016: 2.5x) Future Developments That May, Individually or Collectively, Lead to Negative Rating Action - Sustained operating EBIT margin below 2.0% - Total adjusted debt/EBITDAR is sustained over 3x The company's credit metrics are based on proportionate consolidated financials of LGD to LGE. LIQUIDITY Adequate Liquidity: The liquidity profiles of LGE and LGD remained adequate at end-2016, with the cash balance comfortably covering the debt maturing within a year. LGE also held an unutilised credit facility of around KRW3.8trn. Fitch does not foresee any liquidity shortage in the short to medium term, although liquidity may weaken slightly due to margin erosion. Contact: Primary Analyst Shelley Jang Fitch Ratings Australia Pty., Korea Branch 9F Kyobo Securities Building 97, Uisadang-daero, Yeoungdeungpo-Gu Seoul, Korea Director +82 2 3278 8370 Secondary Analyst Kelvin Ho Director +852 2263 9940 Committee Chairperson Vicky Melbourne Senior Director +61 2 8256 0325 Media Relations: Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@fitchratings.com. Additional information is available on www.fitchratings.com Applicable Criteria Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here _id=1019933 Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. 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