Moody's Japan KK has changed to negative from stable its outlook for the A3 senior unsecured debt ratings of JFE Holdings Inc and its subsidiaries, and the Baa2 .rating of its subordinated convertible bond.
The outlook change reflects Moody's concern that the recovery of profitability and leverage will be slower than our previous assumption, given expectations of continued worsening of global demand for steel and the negative impact on JFE of a strong Japanese yen. The business environment of steel industry continues to deteriorate. JFE has revised down their financial guidance of FYE3/2012 in their 1st half earnings announcement.
Globally, Moody's sees an excess of supply vs demand in the steel industry. This is particularly pronounced the Asia Pacific region. JFE, along with its primary competitors, continues to struggle in an environment in which producers have little pricing power. Moody's ratings have expected a continuation of slow but relatively consistent improvement in the company's financial profile from the lows seen in FYE 2009. A modest recovery has been evident in the past two fiscal years but in Moody's opinion, the current industry and economic circumstances call into question a continuation of this improvement and a return to financial metrics more supportive of the company's A3 rating.
JFE's profitability is negatively affected by strong Japanese yen. While the company's raw material inputs are imported and therefore shielded from the strength of the yen, its primary customers are more directly effected and continue to struggle with the negative impact of the appreciation of the yen. As the company's customers shift production to non-Japanese locations, they generally increase procurement of the steel products from non Japanese steelmakers there. These negative impacts on JFE's profit margin are expected to continue for some time.
Recently the prices of raw materials have declined reflecting slowing demand worldwide. However, it is Moody's opinion that steelmakers will not enjoy lower input cost because of the oversupply situation in the industry and almost certain requests to reduce selling price from customers. The higher likelihood of ongoing decline in profitability will reduce or possibly eliminate JFE's ability to continue to improve its leverage which was damaged by 2008 financial crisis.
The current ratings factor in JFE's stable and strong relationships with its major banks (a regional factor for Japan), and which uplift the ratings by two notches from the company's fundamental level of creditworthiness.
A rating upgrade is unlikely in the near term due to the negative outlook. The rating outlook, however, would revert to stable if the company improves its financial profile by recovering profitability and leverage. For example, if operating margins remain over above 5% or adjusted debt/EBITDA remains below 3.5 times on a sustained basis an adjustment in the outlook could be considered.
JFE's rating will be downgraded if profitability declines below current levels or if leverage deteriorates further. If its operating margin remains well below 5% or adjusted debt EBITDA remains above 3.5 times on a sustained basis a further downward adjustment of the rating could be considered.
