R&I Rating Methodology by Sector

Transcription

1 R&I Rating Methodology by Sector Electric Wires and Cables December 3, 2013 R&I applies this rating methodology to electric wire and cable manufacturers that position three sectors "electric wires and cables," a segment that manufactures electric wires and cables, optical fibers and cables, and optical communications equipment and components, "automobile components" and "electronic components" as their main businesses. An earnings composition by business may differ among companies. Since sources of technology, which serves as the core of such businesses, are the same, those companies' orientation towards businesses diversification has little difference. R&I does not use this rating methodology when evaluating firms that handle only one or two of these sectors. I. Evaluation of Business Risk 1. View of industry risk Businesses handled by electric wire and cable manufacturers have expanded the global reach of their markets, and the size of their businesses is correspondingly large. Manufacturers also can expect comparatively rapid market growth along with expansion of the global economy. Because sales volumes are affected by customers' capital investments and inventory adjustments, however, fluctuations in demand are somewhat large. Moreover, many products, including electric wires and cables and electronic components, have become commodities and are exposed to relatively severe competition. Because of the strong process industry nature of the business, a comparatively sizable capital investment is needed in order to maintain and strengthen the earnings base. Accordingly, the fixed cost burden tends to be heavy. After comprehensive consideration of these points, R&I judges the electric wires and cables industry to have a medium degree of risk. (1) Market size, market growth potential and market volatility Electric wire and cable manufacturers continue to diversify their business portfolios. Reflecting this, they offer a broad array of products. The size of the market in each of the three business sectors, "electric wires and cables," "automobile components" and "electronic components," is believed to be tens of trillions of yen globally. 1/6

2 The market growth potential is comparatively high. Viewed globally, relatively high growth can be anticipated for "electric wires and cables" in conjunction with expansion of infrastructure investment in emerging countries and the development and broadening of telecommunications networks. "Automobile components" and "electronic components" are expected to maintain comparatively high growth potential as well because of growth in the demand for final products. Market volatility is somewhat high. Demand is dictated largely by factors such as the trend in customers' capital investment and business sentiments. If it is supplying parts, orders tend to fluctuate more easily because a manufacturer will also be affected by its customers inventory adjustments. (2) Industry structure (competitive environment) With the exception of specialized products, electric wires and cables have increasingly become commodities. Since there also are manufacturers that specialize in only certain types of products, it is impossible to avoid severe cost-centered competition. In optical fibers and cables, new entrants are limited because the process industry aspects are even stronger than in electric wires and cables, and a substantial upfront investment burden is required. The market for the various devices and components required for optical telecommunications is formed from the aggregation of numerous niche markets. Although many firms handle devices and components for optical telecommunications, there is an aspect of compartmentalization by product to a certain extent in the market. In "automobile components" and "electronic components," the competition is relatively intense. Customers' cost demands are relentless and complying with these demands has become critical for ensuring sales. For products that are also produced by numerous market participants other than electric wire and cable manufacturers, the competitive picture is becoming even more ferocious. Overall, R&I evaluates the competitive environment surrounding electric wire and cable manufacturers to be comparatively severe. (3) Customer continuity and stability Customer continuity and stability are not very high. Firms that will receive orders for "electric wires and cables" are decided by tender for each project. However, when a firm handles installation and maintenance work in addition to the manufacturing and sales of products, it is easier to secure follow-up business. 2/6

3 "Electronic components" have a short product life cycle. While "automobile components" orders also are decided after competitive bidding, if a manufacturer is able to deliver its products once, it usually is able to ensure continuous orders until the next model changeover. (4) Capital and inventory investment cycles "Electric wires and cables" is a business with process industry aspects and tends to require a substantial initial investment burden. However, the risk that manufacturing facilities and products will become obsolete is limited. Typically, there is no problem if funds invested in capital assets are recovered over a comparatively long timeframe. In many cases, investments in "automobile components" and "electronic components" do not require investments on the size of those for materials-related businesses, but are generally under pressure for relatively fast investment recovery. Firms in each sector will begin production only after receiving an order. There is thus relatively low risk of recording massive inventory valuation losses, in general. While fluctuations in the price of main raw material copper can basically be passed on to selling prices, there is a time lag between changes in the price of a raw material and in the sales price. This results in short-term changes in inventory value and effects on a working capital burden. (5) Protection, regulations and public aspects From the aspect of protection, regulations and public aspects there are no parameters that have a material impact on creditworthiness. (6) Cost structure In addition to personnel expenses, there generally is a tendency for the fixed-cost burden, including depreciation and amortization expense and R&D spending, to be comparatively substantial, although the degree of process industry or labor-intensive aspects may vary depending on types of businesses a firm handles. The cost of materials, especially copper, accounts for a large share of variable costs. Over the short term, changes in the price of copper can cause fluctuations in earnings. On the whole, the structure can be described as one in which profits and cash flow will vary relatively easily in response to changes in sales. 3/6

4 2. View of individual firm risk In contrast to industry risk, which highlights the standard risks of the industry of which the subject firms are a part, the business risk of each company will differ depending on the individual firm risk as explained below. (1) Competitiveness of main businesses and business diversification Firms which handle "electric wires and cables" comprehensively can enjoy advantages such as stable profits and cash flow that can be secured on the whole by absorbing falls in earnings from a certain business with profits from other businesses and the financial flexibility to allocate necessary funds for R&D and capital investment across business segments. To make the most of advantages derived from business diversification, it is important that main businesses have strong competitiveness and make contributions to overall earnings in a balanced manner. (2) Diversification of customers and operating regions When evaluating the stability of a firm's earnings base, it is not sufficient to examine only the competitiveness of each business and the balance of earnings. This is because, regardless of the number of businesses and products it handles, a concentration in certain clients (industries) or regions (production and marketing) could make a firm's earnings base susceptible to trends in specific industries or regions. Accordingly, R&I needs to confirm the diversification in terms of client and region. (3) Technical and R&D capabilities Electric wire and cable manufacturers have a history of evolution by making adjustment to their business portfolios in response to changes in the business environment. To make the most of advantages derived from business diversification, firms will need to take similar actions in the future as well. Together with responding sufficiently to changes in the environment for their existing businesses, a capacity to continually search for and construct new earnings sources, and enhance the earnings base, will prove indispensable. Consequently the strength of a firm's technical and R&D capabilities, which serve as the source for such capacity, becomes an important evaluation factor. 4/6

5 II. Evaluation of Financial Risk In addition to quantitative factors in the form of financial data, R&I also evaluates qualitative factors, such as a firm's financial management policy and liquidity risk, in its analysis of financial risk. For the electric wires and cables industry, R&I emphasizes the following financial indicators based on its business characteristics. (1) Earning capacity EBITDA/average total assets, ROA, operating income margin Electric wire and cable manufacturers engage in businesses that require upfront investment in principle. One strong aspect of such manufacturers is the use of their balance sheets to create added value. In consideration of the tendency for assets to expand easily, when analyzing earning capacity R&I emphasizes profitability on the capital invested. Because capital investment is relatively high, and the depreciation and amortization expense burden tends to become heavy, R&I focuses on EBITDA as an indicator of profits. (2) Scale and investment capacity EBITDA, equity capital Having the capacity to undertake sustained investment is essential to maintaining and enhancing competitiveness. In the process of revising a firm's business portfolio in particular, to strengthen its expansion into new sectors, a firm will often need to start new R&D or capital investment. To provide for such investment, it is important to have a certain size of cash flow. Firms must also accumulate equity capital to serve as a risk buffer. As a company develops multiple businesses and products, it is inevitable that changes in the business climate will result in businesses or products that generate only red ink. Provided it has sufficient equity capital at such times, a firm will flexibly be able to narrow its focus on specific businesses while deciding to scale down less profitable operations. (3) Debt redemption period Net debt to EBITDA ratio Because electric wire and cable manufacturers handle businesses that require a certain size of capital investment in order to maintain competitiveness, they possess a reasonable amount of tangible fixed assets. The balance between debt and cash flow becomes a key indicator for analyzing 5/6

6 the years to repay debt and, ultimately, investment efficiency. (4) Financial profile Equity ratio, net D/E ratio (ratio of net debt to equity capital) Earnings levels can vary easily in response to the business trend or other factors. During a deteriorating earnings phase, not only must a firm secure profitability through steps such as shrinking unprofitable sectors and slashing fixed costs, for example, it must always make a certain amount of investment to maintain competitiveness, even as it experiences losses. As a financial buffer that determines sustainable investment and fundraising capacities, R&I also emphasizes the equity ratio and the net D/E ratio, along with the amount of equity capital. III. Rating for Electric Wires and Cables Industry Issuer Rating Individual Firm Risk Financial Risk Importance Indicator Importance Competitiveness of main businesses Earning capacity EBITDA/average total assets and business diversification ROA Diversification of customers and Operating income margin operating regions Scale and investment EBITDA Technical and R&D capabilities capacity Equity capital Debt redemption period Net debt to EBITDA ratio Financial profile Equity ratio Net D/E ratio Industry risk: Medium Note) Importance is indicated by : extremely important, : important, or relatively important. * This report replaces all previous versions that have been released to date. The Rating Determination Policy and the Rating Methodologies R&I uses in connection with evaluation of creditworthiness (collectively, the "Rating Determination Policy and Methodologies") are R&I's opinions prepared based on R&I's own analysis and research, and R&I makes no representation or warranty, express or implied, as to the accuracy, timeliness, adequacy, completeness, merchantability, fitness for any particular purpose, or any other matter with respect to the Rating Determination Policy and Methodologies. Further, disclosure of the Rating Determination Policy and Methodologies by R&I does not constitute any form of advice regarding investment decisions or financial matters or comment on the suitability of any investment for any party. R&I is not liable in any way for any damage arising in respect of a user or other third party in relation to the content or the use of the Rating Determination Policy and Methodologies, regardless of the reason for the claim, and irrespective of negligence or fault of R&I. All rights and interests (including patent rights, copyrights, other intellectual property rights, and know-how) regarding the Rating Determination Policy and Methodologies belong to R&I. Use of the Rating Determination Policy and Methodologies, in whole or in part, for purposes beyond personal use (including reproducing, amending, sending, distributing, transferring, lending, translating, or adapting the information), and storing the Rating Determination Policy and Methodologies for subsequent use, is prohibited without R&I's prior written permission. Japanese is the official language of this material and if there are any inconsistencies or discrepancies between the information written in Japanese and the information written in languages other than Japanese the information written in Japanese will take precedence. 6/6