Rating agency Standard & Poors announced that it has placed its 'BBB+' long term corporate credit and senior unsecured debt ratings on Nippon Steel Corporation on CreditWatch with negative implications.
The CreditWatch listing reflects our decision to incorporate the merger with Sumitomo Metal Industries Limited (Sumitomo Metals; not rated), which is to be completed in October 2012, into our ratings on Nippon Steel.
While the merger will be positive for Nippon Steel's business risk profile, we expect weakness in Sumitomo Metals' financial risk profile to pull down the financial risk profile of the new entity.
In addition, we believe weaker earnings and profitability at Nippon Steel due to a drop in shipments and deterioration of its export margins are likely to delay a recovery in its financial risk profile, and we will examine the impact such a delay will have on the ratings. The Japan Fair Trade Commission approved the merger of Nippon Steel and Sumitomo Metals with minor conditions on December 14th 2011.
We believe the merger is highly likely to proceed and, thus, we incorporate the merger into the ratings on Nippon Steel, despite the remaining need for the companies to obtain the approval of foreign governments and of shareholders. In our view, the need for the commission's approval was the biggest obstacle to the merger.
We believe the merger of the two companies will produce an enhanced product portfolio because their products complement one another, and the benefits of the merger, through more streamlined operations, will underpin the new entity's earnings and profitability.
The JFTC's swift approval improves the likelihood that the merger will proceed smoothly, in our opinion. On the other hand, we believe that the new entity's financial risk profile is likely to deteriorate, because Sumitomo Metals' financial risk profile is weaker than Nippon Steel's.
In addition, Nippon Steel's operating performance has suffered from a decrease in shipments following the Great East Japan Earthquake in March 2011 and severe flooding in Thailand this fall as well as from deteriorating export margins. The company's cash flow has weakened as a result, and we hold the view that its financial risk profile is likely to recover more slowly than we had previously anticipated.
In addition, we expect business conditions in Asia's steel industry to weaken, which could also make it difficult for the company to improve the financial risk profile of the new entity. Standard & Poor's will resolve the CreditWatch listing as the merger progresses, including the approvals of foreign governments, and we complete our examination on the new entity's credit risk profile.
We will examine prospects for a recovery in the earnings of both companies, the benefits that materialize from the merger, and prospects for a recovery in the merged entity's financial risk profile. We will also need to assess whether the merged entity's financial policy will remain as conservative as that of Nippon Steel.
We are likely to limit any downgrade of Nippon Steel to one notch, because we believe the enhanced business of the new entity and a recovery in profitability due to the benefits of the merger will to some degree offset a deterioration we expect to occur in the new entity's financial risk profile.
