Sharp Corp. Upgraded Two Notches To #B+# From #B-# On Strong Operating Performance, Issue Rating To #B#; Outlook Stable

Stocks and Financial Services Press Releases Friday July 21, 2017 17:18
TOKYO--21 Jul--S&P Global Ratings

TOKYO (S&P Global Ratings) July 21, 2017--S&P Global Ratings today said that it has raised by two notches to 'B+' from 'B-' its long-term corporate credit rating on Japan-based electronics maker Sharp Corp. and has raised by one notch to 'B' its senior unsecured debt rating on the company.

We also raised by two notches to 'B+' from 'B-' our long-term corporate credit rating on overseas Sharp subsidiary Sharp International Finance (U.K.) PLC.
We affirmed our 'B' short-term corporate credit and commercial paper programs on both companies. The outlook on the long-term corporate credit ratings on both companies is stable.

We raised our long-term corporate credit rating on Sharp given its operating performance has largely exceeded our assumptions because of the benefits of cost reductions it has realized steadily since joining Taiwan-based Hon Hai Precision Industry Co. Ltd.'s (A-/Stable/--) corporate group in mid-2016.

The upgrade also reflects our expectation that a gradual recovery of the company's ability to generate earnings and somewhat stabilize its financial standing will continue for the next one to two years thanks to its steps to stabilize earnings, mainly in its liquid crystal display (LCD) business. Since receiving a capital injection from Hon Hai in August 2016, Sharp has enjoyed mutual benefits as part of the Hon Hai group, mainly in the form of lower costs.

Use of Hon Hai's supply chain has allowed the company to reduce procurement costs, underpinning a substantial recovery in operating performance in fiscal 2016 (ended March 31, 2017). Although fluctuations in supply and demand are likely to produce volatility in the earnings of its main LCD business, we expect Sharp to somewhat improve and stabilize the business' ability to generate earnings compared with previously.

This is because Sharp is using Hon Hai's network to expand its own customer base, and it is taking steps to increase its operating rate by shifting its product mix to items that enjoy relatively higher demand, such as camera modules rather than commoditized LCD panels.

We also think Sharp will continue to generate stable profits from its home electric appliance and copier businesses thanks to their unique characteristics and its solid customer base. Nonetheless, Sharp will not find it easy to maintain its market position and competitiveness in the LCD market, where growth is slowing, in our view, because of fierce competition with cash-rich Korean electronics makers and Chinese rivals that have significantly increased capacity.

Furthermore, organic light emitting diode (OLED) displays have rapidly expanded their share of the market for high-definition and high-value-added displays, in which Sharp has had strengths. Sharp plans to bring an OLED pilot production line into operation by the end of fiscal 2017, but earnings contributions from the OLED business will be very limited in the immediate future, in our view. Also, its other areas of focus, camera modules and electronic devices, are very susceptible to market fluctuations, as is its LCD business. Accordingly, we revised out assessment of Sharp's business risk profile to weak from vulnerable.

Sharp recovered its capital base in fiscal 2016 with a capital injection from Hon Hai and a narrower net loss. It also broke out of negative net worth in fiscal 2016 with the completion of Hon Hai's capital injection and applied to the Tokyo Stock Exchange at the end of June 2017 to have its shares moved to the bourse's first section from the current second section.

If the Tokyo Stock Exchange approves the move, Sharp's access to capital markets will improve, allowing it more financial flexibility, in our view.

However, the company will begin to enhance its production facilities--a task it put on the back burner while performing poorly--which is likely to produce negative free operating cash flow in fiscal 2017, in our view. Although we expect Sharp's debt to EBITDA to recover to the lower-5x range in fiscal 2017 from 5.9x the previous year, thanks to improved operating rates and a recovery in profitability under Hon Hai, Sharp's ability to generate cash flow is potentially vulnerable to external conditions and is likely to remain weak. Accordingly, we continue to assess Sharp's financial risk profile as highly leveraged.

Nonetheless, given ample cash at hand and our expectation of moderately improving financial stability in the future, we regard the company's financial risk profile as in the upper end of the highly leveraged category.

We assess Sharp's liquidity as less than adequate. Sharp has received extensions on syndicated loans and retains Hon Hai's capital injection as cash and deposits.

As a result, we estimate Sharp's liquidity sources over the next year will be at least 1.5x annual uses. However, the company's liquidity will continue to come under pressure, in our view, because its funding remains vulnerable to the attitudes of banks supporting the company as well as to the prospect of increasing working capital requirements.

These factors constrain our assessment of the company's liquidity as less than adequate.

Our base-case scenario for Sharp assumes the following: Profits from the LCD business will increase year on year in fiscal 2017 because changes in the application of LCD panels and an enhanced customer base will far outstrip the effect of fierce competition and price declines; Sound profitability will continue in copiers and home electric appliances in non-LCD segments;Sharp will continue to utilize Hon Hai's supply chain and reduce costs; andAnnual capital investments will total about ¥140 billion, including for an OLED pilot production line.Under these base-case assumptions, we expect the following key financial ratios for Sharp in fiscal 2017:

Operating profit of just over ¥80 billion and an EBITDA margin in the upper 6% range; and Debt to EBITDA in about the lower-5x range and EBITDA interest coverage in the 8x-9x range. Our assessments of Sharp's business risk and financial risk profiles produce a stand-alone credit profile (SACP) of 'b' for the company; the SACP excludes the likelihood of extraordinary support from the Hon Hai group. Our corporate credit rating on Sharp incorporates one notch of uplift for support from Hon Hai, which has much higher creditworthiness than Sharp.

We make this adjustment because we believe Hon Hai is likely to support Sharp if it is financially weakened, given Sharp's importance to Hon Hai's medium- to long-term strategy, under which Hon Hai aims to change its business model from its current one as an electronics manufacturing service provider. .

Our rating on Sharp's senior unsecured debt is a notch lower than the long-term corporate credit rating.

To arrive at this rating, we lower the senior unsecured debt rating on Sharp two notches from the long-term corporate credit rating on the basis of our estimate that priority liabilities, including secured debt, account for about 40% of Sharp's total assets.

We had also incorporated two notches of uplift in the senior unsecured debt rating, reflecting our expectation of continued support from banks on the basis of Hon Hai's strong creditworthiness, but we have narrowed the uplift to one notch in this latest rating action.

The somewhat stabilizing credit quality of Sharp under Hon Hai leads us to believe that if the company defaults on any of its debt, there is a slightly reduced possibility the company will receive banks' support in the form of a debt-to-equity swap (or a loan waiver).

partnership with Hon Hai and will somewhat stabilize earnings in its LCD business and gradually improve major financial ratios.

We also believe Sharp is able to increase capital investments using capital Hon Hai injected. We might consider a downgrade if we see a heightened likelihood of Sharp's operating profits decreasing substantially and its EBITDA margin falling to and remaining below 6% despite support from Hon Hai and cost reductions.

This could occur primarily if its LCD business loses competitiveness. We might also consider a downgrade if we see a heightened likelihood of increased capital investments causing widely negative free operating cash flow, which would again erode the soundness of Sharp's capital base.

Conversely, we might consider an upgrade if Sharp improves its ability to generate cash flows by offsetting cash flow volatility in its LCD business with cash flows from stable businesses and we determine that debt to EBITDA will fall to and stay below 4x on a sustained basis while Sharp retains abundant cash and deposits.


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