Mitsubishi Heavy Industries Ltd. Placed On CreditWatch Negative On Dimming Prospects Of A Recovery In Profitability

Stocks and Financial Services Press Releases Thursday May 10, 2018 19:30
TOKYO--10 May--S&P Global Ratings

TOKYO (S&P Global Ratings) May 10, 2018--S&P Global Ratings today said it has placed its 'A-' long-term corporate credit rating on Japan-based diversified capital goods company Mitsubishi Heavy Industries Ltd. (MHI) on CreditWatch with negative implications.

The CreditWatch placement reflects our view of a growing likelihood that MHI's profitability will take time to recover. This is because earnings in its main businesses are slow to pick up, with its operating profit and EBITDA margin falling far short of our expectations in fiscal 2017 (ended March 31, 2018). It also bears a heavy burden of development costs for its small to midsize passenger jet Mitsubishi Regional Jet (MRJ). Although MHI has reduced debt by enhancing working capital management and selling assets, key financial ratios for the company are unlikely to recover in line with our assumptions. This is because MHI might step up business investments amid a slow recovery in EBITDA.

MHI's potential to generate earnings might recover only sluggishly even if it undertakes restructuring, such as a reshuffle of its workforce. This is because its thermal power system business, which was a core profit earner, faces worsening market conditions amid a global shift away from carbon-emitting activities. The MRJ division remains in the red because of development delays, and development costs are likely to stay at elevated levels in fiscal 2018. We think it can limit the risk of impairment losses from the MRJ division to a degree because it will reduce the value of MRJ-related assets to zero upon MHI's transfer to International Financial Reporting Standards starting in fiscal 2018. Nevertheless, we see lingering risks that MHI might extend additional financial support to the MRJ division and might need substantial time to recover its investments. Furthermore, the engineering business set aside a large amount of litigation and loss reserves in fiscal 2017, slightly intensifying uncertainty over the business' potential to generate earnings and stability of future cash flows, in our view. We had viewed the business' potential to generate earnings as being on track for improvement thanks to enhanced risk management. MHI has suffered a drop in operating profit for two straight years through fiscal 2017. As a result, we estimate its consolidated EBITDA margin has fallen to 7%-8%, below the 8% threshold we consider a downgrade trigger. We see a growing likelihood that the pace of recovery in MHI's overall profitability is likely to be slower than we assumed even if the company improves the profitability of its businesses by boosting productivity and expanding its services business and further enhances its risk management.

Although EBITDA fell far short of our assumption, we estimate that debt to EBITDA, a key financial metric for MHI, somewhat improved to closer to 2x as of the end of fiscal 2017 from 2.5x a year earlier. This is because enhanced capital management and asset sales substantially increased operating cash flow and free cash flow. But we expect any further reduction in debt and a recovery in the ratio to stall because, under its new three-year business plan through fiscal 2020, MHI is likely to pour massive funds into new businesses, including MRJ development, and in investments.

In resolving the CreditWatch placement, we will examine MHI's prospects of better profitability and the stability of its financial standing despite its plan to step up business investments. To review its prospects of better profitability, we will look at its earnings prospects based on developments in the restructuring of its thermal power system business and enhancements in its service business, specific effects of improvement resulting from enhanced risk management, and the swiftness and effectiveness of measures to improve its low profitability and loss-making businesses. We, based on these factors, will confirm the probability that MHI's consolidated EBITDA margin will recover to 10% in fiscal 2018. We think key cash flow ratios are unlikely to deteriorate substantially, and any downgrade is likely to be limited to one notch.


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