Supporting factors for the ratings include the FP group’s strong operating efficiency through significant economies of scale and highly integrated production facilities, strong market position in the domestic petrochemical industry and number two position in Taiwan’s duopoly oil refinery and marketing sector. The ratings also reflect the group’s satisfactory cash flow generation. Several factors offset these strengths. These include significant industry risks due to volatile pricing in the commoditized oil refining and petrochemical businesses. Additional offsetting factors include the group’s satisfactory business diversity but with significant asset concentration risk from the group’s asset concentration on a single production site in Taiwan, and the group’s financial policy to support its high-risk non-core investments such as its dynamic random access memory (DRAM) business. We view its investment in such non-core activities as relatively aggressive. We assess the FP group’s business risk profile as “Strong” and financial risk profile as “Intermediate”.
We expect the FP group’s scaled productions and highly integrated operations to continue to support its strong cost competitiveness and operating efficiency. We also expect the group to maintain its strong market positions outlined above. The group’s significant economies of scale and good product diversity enable it to maintain above-average and stable profit margins relative to its peers’, in our view.
In addition, we expect the FP group’s strong cost competitiveness and operating efficiency to enable it to generate satisfactory cash flow measures through business cycles, despite significant capital expenditures. The group’s ratio of funds from operations (FFO) to debt remained satisfactory at 36.2% in 2011, despite weak demand and a fire that temporarily shut down its refineries and reduced utilization at downstream facilities. The ratio is likely to decrease moderately in 2012 due to weak market conditions. In addition, the implementation of the group’s safety inspection plan at its Mai-Liao complex remains somewhat uncertain and could lead to a material impact on the group’s available capacity in 2012.
In our opinion, the FP group’s operating performance is still highly sensitive to cyclical changes in supply-and-demand conditions at regional and global levels, despite its high degree of vertical integration. Weakening market conditions amid a protracted sovereign debt crisis in Europe and the Chinese government’s tightening policies on its economy are likely to further pressure the group’s profitability and cash flow over the next few quarters. The four core companies’ EBITDA declined 44% year on year in the first quarter of 2012 and is unlikely to recover rapidly due to weak demand particularly from China.
We believe that the group will continue to face asset concentration risk over the next few years, as its plan to build a petrochemical complex in China awaits approval from the Chinese and Taiwan governments. The FP group’s Taiwan-based Mai-Liao complex generated more than 70% of the group’s revenue in 2011. Any significant disruption in the operations at the site will significantly affect its operating performance and cash flow. Heightened regulatory risk and rising environment protection pressures have aggravated the already high asset-concentration risk at this site, in our view.
The FP group’s involvement in the DRAM industry through its subsidiaries Nanya Technology Corp. (not rated) and Inotera Memories Inc. (not rated), also creates additional risks to the group’s financial profile, in our opinion. The FP group injected New Taiwan Dollar (NT$) 30 billion equity into Nan Ya Technology at the end of 2011. This is in addition to the NT$9.9 billion it injected in late 2010 to support the DRAM companies, which suffered huge losses over the past two years amid an unprecedented industry downturn. We believe the group will continue to support these financially weak subsidiaries to ensure their financial viability and technology competitiveness over the next few quarters.
The FP group has “strong” liquidity to meet its needs over the next two years. Our view of the group’s liquidity profile incorporates the following major assumptions:
-- The ratio of liquidity sources (including cash, liquid financial assets, and funds from operations) will exceed liquidity uses (capital expenditures, cash dividends, working capital needs, and debt maturities) by more than 1.5x over the next 12 months and remain above 1x over the next 12-24 months.
-- The FP group could absorb, with limited refinancing, high-impact, low-probability events.
-- Liquidity sources should continue to exceed uses, even if the FP group’s EBITDA were to decline by 30%.
-- The FP group’s sound banking relationship will continue to support its financial flexibility. The group is the second largest domestic corporate bond issuer second to state-owned Taiwan Power Co. (A+/Stable/--, cnAAA) and has a very low credit spread.
-- The FP group’s financial management is prudent without taking excessive financial risks, in our view.
The negative outlook reflects our view that the FP group’s profitability and cash flow are likely to weaken substantially due to weakening market conditions, as well as its efforts and costs to improve safety measures at its Mai-Liao complex over the next three to four quarters.
We may lower the ratings if: (1) the FP group fails to meet safety standards that result in significant capacity losses; (2) the group’s cost competitiveness deteriorates significantly causing its operating performance to remain weak for an extended period of time; or (3) market conditions worsen significantly such that the FP group fails to maintain its adjusted ratio of consolidated funds from operations to debt above 30% or its ratio of consolidated debt to capital increases above 45% for an extended period of time.
Conversely, we may revise the outlook back to stable if the FP group improves its safety measures and meets requirements to resume its normal operations at its Mai-Liao complex on a timely basis while maintaining its competitive cost position, as well as credit metrics consistent with the ratings in spite of continued market volatility.
Related Criteria And Research
-- Criteria | Corporates | General: Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Business Risk/Financial Risk Matrix Expanded, May 27, 2009
-- Criteria | Corporates | Industrials: Key Credit Factors: Business And Financial Risks In The Commodity And Specialty Chemical Industry, Nov. 20, 2008
-- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
-- Subsidiaries/Joint Ventures/Nonrecourse Projects; Finance Subsidiaries; Rating Link to Parent, Oct. 28, 2004