Taiwan Top 50 Corporates: Slowdown To Follow 2004 Bonanza
By Tony Tsai, Director, Taiwan Ratings
John Bailey, Managing Director, Asia, Corporate & Infrastructure Ratings, Standard & Poor's
Taiwan's top 50 corporates further improved their credit quality in 2004, reporting record high sales and earnings as a result of the robust upswing in both the old-economy and high-tech industries. The top 50 companies' total sales grew by 30% year-on-year to Taiwan dollar (NT$) 7,113 billion (US$222 billion) in 2004, and their aggregate net income increased by 59.4% year-on-year to NT$735 billion (US$23 billion). The strong earnings performance of Taiwan 's top 50 corporates mirrors the robust growth of the island's economy since the severe recession in 2001 (see table 1). The outlook for 2005 and 2006, however, is not so rosy, given expectations of slowing domestic and global economic growth, rising oil price, and more difficult operating conditions in the semiconductor and thin film transistor liquid crystal display (TFT-LCD) sectors. As a result, Taiwan 's top 50 corporates face more challenging industry conditions in 2005 and 2006 and won't be able to sustain the strong earnings results reported in 2004. Standard and Poor's Ratings Services estimates that aggregate net income of Taiwan 's top 50 corporates will decline 29% year-on-year to NT$527 billion (US$16.5 billion) in 2005.
Table 1 Taiwan Top 50 Corporates Profitability & Economic Growth Summary
Year ended Dec. 31
|Top 50 corporates' total sales* (bil. NT$)||3,830||3,696||4,307||5,470||7,113||-|
|Top 50 corporates' total net income* (bil. NT$)||408||159||313||461||735||-|
|Real GDP (annual change) (%)||5.8||(2.2)||3.9||3.3||5.7||3.6|
*Company data; Taiwan Ratings Corp. Taiwan 's Directorate-General of Budget, Accounting and Statistics
- Credit Trends
Standard & Poor's has analyzed the key financial ratios of Taiwan 's top 50 corporates and summarized the credit trends in the following sections. Among the top 50 corporates in 2004, 28 of them belong to Taiwan's high-tech industry (see chart 1), including the electronics (23) and semiconductor (5) sectors, and the remaining 22 belong to the auto (3), aviation (2), oil (2), petrochemicals/plastics (4), power (1), retail (1), shipping (3), steel (3), and telecommunications (3) sectors. The 23 corporates representing the electronics sector come from computer hardware/components/peripherals, electronic contract manufacturers, motherboards, notebook PCs, TFT-LCD, and other electronics sub-sectors (see chart 2).
The top 50 corporates' median sales grew by 18% in 2004, and their median operating margin improved slightly to 11.5% from 11% in 2003, reflecting a more favorable demand and pricing environment (see chart 3). The median pretax interest coverage for these 50 companies increased to 17.5x in 2004 from 14x in 2003, and their median EBITDA (earnings before interest, taxes, depreciation, and amortization) interest coverage improved to a five-year high of 22x from 16x over the same period (see chart 4). The stronger ratios can be attributed to a combination of robust profitability and lower interest expenses as a result of Taiwan 's low interest rate environment. Standard & Poor's expects the median pretax and EBITDA interest coverage ratios for the top 50 corporates to remain solid in 2005 and 2006 as Taiwan 's benchmark interest rates are not expected to rise significantly over the next two years because of moderating economic growth and minimal inflation pressure.
Furthermore, the median ratio of funds from operations to total debt for the top 50 corporates improved to 49% in 2004 from 46% in 2003 (see chart 5). The median ratio of total debt to capital dropped to 30% in 2004 from 32% in 2003, as a result of a larger equity base boosted by strong earnings. Standard & Poor's expects the median ratio of total debt to total capital for the top 50 corporates to remain around the 30% level over the medium term (see chart 6).
- Electronics Sector
For the 23 electronics corporates analyzed in this study, there is a clear trend of the big players growing larger at the expense of their smaller rivals in a highly competitive environment, which is pushing operating margins even lower. The median sales for the sector grew by a strong 40% in 2004, reflecting across-the-board growth in the computer hardware/components/peripherals, electronic contract manufacturers, motherboards, notebook PCs, TFT-LCD, and other electronics subcategories. However, the already weak median operating margin fell to 5.2% in 2004, down from 6.2% in 2003 and 7.6% in 2002, reflecting the current level of intense competition, customers' strong bargaining power, and sharp falls in product prices. All sub-sectors, except for TFT-LCD, experienced declining operating margins in 2004. With weaker operating margins offsetting stronger sales growth, the median return on permanent capital dropped slightly to 12.3% in 2004 from 12.5% in 2003.
Despite the weaker median operating margin, however, the median financial ratios for Taiwan 's electronics sector remained relatively healthy in 2004, reflecting generally prudent financial policies, which are necessary in an industry that faces short product life cycles, volatile market demand, and intense price competition. The median pretax interest coverage for the electronics sector fell to 15x in 2004 from 20x in 2003, while the median ratio of funds from operations to total debt dropped to 41% from 60% over the same period. The declines can be attributed to increased debt usage to support business growth and capital spending, which was also reflected by a rise in the median ratio of debt to capital to 30% in 2004 from 25% in 2003. Nevertheless, most of Taiwan's leading electronics corporates maintain large cash balances to provide cushioning against the high cyclical nature of their businesses, as evidenced by median cash on hand of NT$11.7 billion in 2004 compared with median total debt of NT$12.4 billion. Moreover, the median EBITDA interest coverage for the electronics sector was still a strong 21x in 2004 despite the decline in the median pretax interest coverage, mainly because the ratio excludes depreciation and amortization expenses, which are generally high for those corporates that continuously need to make large capital investments, in particular TFT-LCD manufacturers. Standard & Poor's expects the median EBITDA interest coverage for the electronics sector to remain stable over the medium term.
The computer hardware/components/peripherals sector accounted for seven of Taiwan 's top 50 corporates in 2004. The median operating margin was 5.2% in 2004, but there were wide differences between the seven operators, ranging from 0.7% for Tatung Co. Ltd. ( Tatung ) to 13.2% for Delta Electronics Inc. (Delta), one of the world's largest switching power supply producers, which also reflects the differing credit quality of the companies.
Standard & Poor's considers Delta to have one of the stronger credit profiles in Taiwan 's electronics sector, as it has been able to maintain a relatively high operating margins above 12% in 2002-2004 and robust financial ratios. Moreover, Delta has maintained a substantial net cash position over the past few years.
Acer Inc.'s credit profile has also shown signs of improvement following a strategy refocus that has resulted in stronger brand recognition and an increasing share of the global PC market. As a result, the company's sales and core earnings grew strongly in 2002-2004.
Tatung 's financial profile, however, remains weak as evidenced by its consistent negative ratio of funds from operations to total debt in 2001-2004, though its levels of negative funds from operations and total debt are shrinking. Nevertheless, the company has not experienced any liquidity problems, and it has been able to roll over its short-term debt and refinance maturing term loans as a result of ample liquidity at domestic banks.
Standard & Poor's affiliate Taiwan Ratings Corp. in May 2005 revised its outlook on BenQ Corp. to negative from stable to reflect the deterioration in the company's operating performance and profitability measures in the six months ended Mar. 31, 2005 . The corporate credit ratings on BenQ are not immediately affected by the company's acquisition of the loss-making mobile handset business of Siemens AG (Siemens, AA-/Stable/A-1+). Under the agreement, BenQ will acquire all the assets and liabilities of Siemens' mobile handset business on a debt-free basis and Siemens will pay BenQ 250 million euros in the period between September 2005 (when the transaction closes) and the end of 2006 to help support the loss-making business. Also later this year Siemens will also pay 50 million euros for a 2.5% equity stake in BenQ.
The total cash payment of 300 million euros by Siemens will help prevent an immediate deterioration in BenQ's financial profile. Nevertheless, this sizable acquisition(which will more than double BenQ's revenues(involves significant integration and execution risks. The ratings on BenQ may come under pressure if the company has difficulty in making the acquisition work or if its operating performance does not improve.
Electronic contract manufacturers
The median sales for the electronic contract manufacturers sector grew by 58% in 2004, the highest growth rate of all the industries represented in the top 50 corporates, boosted by continuing outsourcing by global original equipment manufacturer (OEM) customers. Although pricing pressure from OEM customers caused the median operating margin for the electronic contract manufacturers sector to fall to 5.3% in 2004 from 7.3% in 2003, strong sales growth helped keep the median return on capital at about 21% in 2004, unchanged from 2003. Despite higher debt usage to support sales growth, the median financial ratios for the sector remained strong in 2004. The median pretax interest coverage was 35x, EBITDA interest coverage 40x, and the median ratio of funds from operations to total debt was 76%.
Hon Hai Precision Industry Co. Ltd. (Hon Hai, BBB+/Stable), the largest electronic contract manufacturer in the world, has consistently posted strong revenue and earnings growth over the past ten years. In recognition of the company's strong operating performance and consistent operating execution, Standard & Poor's , on April 11, 2005, raised its long-term corporate credit rating on Hon Hai to 'BBB+' from 'BBB'.
Similar to electronic contract manufacturers, the median operating margin for the motherboard sector fell to a low 4.5% in 2004 from 6.4% in 2003. This sector continues to face pricing pressure as a result of increasing product commoditization and intense competition. Asustek Computer Inc. (Asustek), the largest company in this sector, continues to enhance its motherboard leadership position. The trend in the motherboards sector is similar to that of other subcategories in the electronics sector: that the largest operator is expected to grow stronger at the expense of its smaller rivals. This is evidenced by the fact that there were only two motherboard companies among Taiwan 's top 50 corporates in 2004 compared with four in 2003. Asustek's financial profile remains strong, supported by the company's good profitability, conservative financial policy, and substantial net cash position. Its pretax interest coverage was 882x in 2004, while its ratio of funds from operations to total debt was 130%.
Taiwan manufacturers account for about 80% of the global supply of notebook PCs, yet the median operating margin for the island's notebook PC sector, which fell to 3% in 2004 from 3.9% in 2003, is the second-lowest of all the industries represented in the top 50 corporates in 2004. Standard & Poor's does not expect an improvement in the median operating margin in 2005 given the sector's lack of pricing power. Nevertheless, demand for notebook PCs is expected to remain strong in 2005 and to continue to outpace that for desktop PCs.
Weak operating margins reflect the strong bargaining power of large global customers like Dell Inc. (A/Stable) and Hewlett-Packard Co. (A-/Stable/A-1), which has produced strong price competition among domestic notebook PC producers looking to boost sales growth. The total sales of the sector's four largest operators(Quanta Computer Inc. (Quanta Computer), Compal Electronics Inc. (Compal, BBB-/Stable), Inventec Corp., and Wistron Corp.(grew by 90% to NT$814 billion in 2004, up from NT$428 billion in 2002, but their aggregate net income fell to NT$20.1 billion from NT$23.8 billion over the same period.
Despite low operating margins and increasing debt usage to support sales growth, the median financial ratios for the notebook PC sector remained solid in 2004, with the median EBITDA interest coverage at 17x and the median ratio of funds from operations to total debt at 40%. Both Quanta Computer and Compal maintain net cash positions and Standard & Poor's expects their financial ratios to remain healthy in 2005.
Taiwan and Korea are the leading global manufacturers of TFT-LCD panels, which are primarily used in computer monitors and notebook PCs, and increasingly in LCD TVs, which are expected to drive future TFT-LCD growth. The sector performed strongly in 2003 and the first half of 2004, but experienced a sharp fall in prices in the second half of the year. As a result, all five of Taiwan's TFT-LCD panel manufacturers(AU Optronics Corp., Chi Mei Optoelectronics Corp., Chunghwa Picture Tubes, Ltd., Quanta Display Inc. and HannStar Display Corp.(reported net losses in the last quarter of 2004 and the first quarter in 2005, compared with strong net profits earned in the first half of 2004.
Taiwan 's TFT-LCD manufacturers have some major weaknesses relative to their Korea rivals, namely their smaller size, less integrated operations, lower margins, lagging technology, and weaker customer relationships. Another key credit concern is the Taiwan operators' persistently large negative free cash flows because of their substantial capital spending on advanced production facilities to keep pace with the industry leaders. As a result, they have had to use debt and equity finance to fund their capital spending.
A separate commentary analyses the latest developments in Taiwan 's TFT-LCD industry and compares the creditworthiness of the top five domestic TFT-LCD panel manufacturers.
- Semiconductor Sector
Taiwan 's semiconductor sector, which comprises semiconductor foundry and dynamic random access memory (DRAM) makers, reported strong earnings in 2004 as a result of a favorable pricing environment and higher utilization rates. However, industry conditions deteriorated in the fourth quarter of 2004 and the downturn continued in the first half of 2005. Semiconductor foundries anticipate a rebound in the second half of this year in the sector that should result in higher capacity utilization rates and more stable average selling prices.
The global semiconductor foundry industry continues to be dominated by Taiwan-based operators Taiwan Semiconductor Manufacturing Co. Ltd. (TSMC) and United Microelectronics Corp. (UMC, BBB+/Stable). The two companies together account for about 70% of the global semiconductor foundry sector. TSMC has an above-average business profile, which is supported by its leading market position, advanced process technology, good operating efficiency, and solid customer relationships. It also has a very strong financial profile. UMC also has very conservative financial policy and substantial cash on hand, but compared to TSMC, it has a smaller customer base, lower average selling prices, and lagging process technology in 0.13-micron technology. UMC aims to catch up with TSMC in terms of volume output by migrating to the more advanced 90-nanometer process technology, but the results are not expected to materialize until the fourth quarter of 2005 or early next year.
The semiconductor sector reported very strong financial ratios in 2004, reflecting robust earnings and cash flow generation, as well as moderate debt usage. The median operating margin for the sector was 53% in 2004, which was the highest of all the industries represented in the top 50 corporates. The median EBITDA interest coverage was a strong 40x and the ratio of funds from operations to total debt was a strong 129%. Nevertheless, the median EBITDA interest coverage and median ratio of funds from operations to total debt are expected to fluctuate in line with industry conditions going forward.
- Auto Sector
Taiwan 's top three auto companies exhibited the strongest financial ratios of all the top 50 corporates in 2004. Hotai Motor Co. Ltd. and Yulon Motor Co. Ltd. had zero debt in 2004, while China Motor Co. Ltd.'s ratio of total debt to capital stood at 19% at the end of the year. (These companies all produce and market cars for the world's major carmakers). Hotai Motor, which is the local distributor for Toyota Motor Corp. (AAA/Stable/A-1+), strengthened its market position in 2004 as a result of the successful launch of its new models in the passenger car and recreational vehicle segments. Hotai Motor commanded a market share of 28.2% in 2004 (25% in 2003), followed by China Motor with 18.8% (20.8% in 2003), and Yulon Motor with 15% (16.2% in 2003). Standard & Poor's expects the credit trend for this sector to remain stable over the medium.
- Aviation Sector
Despite strong sales and earnings growth in 2004, Taiwan 's aviation sector still exhibited the weakest financial ratios of all the industries represented in the top 50 corporates in 2004, largely as a result of high leverage. China Airlines Ltd. and Eva Airways Corp. both reported good earnings performances in 2004, as stronger passenger volume and cargo demand helped offset higher fuel costs. Nevertheless, China Airlines' debt increased 18% in 2004, as a result of its aggressive fleet expansion, compared with a 9% reduction for Eva Airways. As a result, China Airlines' ratio of funds from operations to debt was a weak 7.5% in 2004, compared with 14.8% for Eva Airways. Looking ahead, higher fuel costs are expected to pressure both companies' earnings despite increased passenger volume and cargo demand.
- Oil Sector
Taiwan's oil sector is controlled by the duopoly of state-owned Chinese Petroleum Corp. (CPC, A+/Stable) and Formosa Petrochemical Corp. (Formosa Petrochemical, BBB+/Stable). CPC has a 70% share of the domestic petroleum market, conservative leverage, but a high cost structure. In contrast, Formosa Petrochemical has a 30% market share, moderate leverage, but a low cost structure. CPC recorded the highest sales amount among the top 50 corporates in 2004, and Formosa Petrochemical recorded the third-highest amount. The global oil refining and marketing industry had a banner year in 2004, as a result of surging oil prices, and the positive trend is expected to continue in 2005. In particular, refiners able to process heavy, sour crude oil, such as Formosa Petrochemical, have financially benefited most from the wide spreads on sweet and sour crudes. As a result, Formosa Petrochemical posted stronger growth in earnings and operating cash flow in 2004 than CPC. Despite its lower operating margins, CPC was still able to report stronger financial ratios than Formosa Petrochemical because of its smaller level of debt. In 2004, CPC had EBITDA interest coverage of 33x and a ratio of funds from operations to total debt of 98%, compared with 13x and 43% for Formosa Petrochemical. Standard & Poor's expects the two companies' ratios to remain strong and healthy in 2005 and 2006 in line with the rosy outlook for the oil refining sector.
- Petrochemicals/Plastics Sector
Taiwan 's petrochemicals/plastics industry is dominated by the Formosa Plastics Group companiesGÇöFormosa Plastics Corp. (BBB+/Stable), Nan Ya Plastics Corp. (BBB+/Stable), and Formosa Chemicals & Fibre Corp. (BBB+/Stable). The recovery in the global petrochemical industry gained momentum in 2004, as renewed pricing power and volume gains allowed most operators to expand margins and improve cash flow generation. The Formosa Plastics Group companies and Chi Mei Corp all registered record high sales and earnings in 2004, and the sector's financial ratios also strengthened. The median operating margin increased to 19% in 2004 from 16% in 2003, the median EBITDA interest coverage doubled to 16x from 8x, and the median ratio of funds from operations to total debt strengthened to 51% from 26%. However, these ratios are likely to decline somewhat in 2005 as a result of the recent weakness seen in commodity chemical prices.
- Power Sector
Taiwan Power Co. (TaiPower, A+/Negative) is the sole vertically integrated power producer in Taiwan and has a power transmission and distribution monopoly. The government owns 94% of the company's shares. Although TaiPower continues to report steady sales growth, its financial profile has deteriorated in the past three years as a result of its inability to increase tariffs, and its large capital expenditure requirements and rising production costs. The company's ratio of debt to capital rose to 52.6% in 2004 from 47.7% in 2002, and its ratio of funds from operations to total debt fell to 14% from 21.4% over the same period. TaiPower's financial ratios are expected to deteriorate further in 2005, with the company likely to report its first ever operating loss if it is unable to raise tariffs to offset rising production costs.
- Steel Sector
The world's steelmakers enjoyed cash windfalls in 2004 as a result of strong demand for steel products, particularly from mainland China , which helped boost prices and extend the current industry upturn. Although steel product prices have recently started to decline as a result of weaker demand and increasing supply, Standard & Poor's does not expect this to have much of an impact on the credit profile of Taiwan's largest integrated steelmaker, China Steel Corp. The company maintains a dominant position in the domestic steel market and has a highly competitive cost structure in comparison to its global peers. China Steel has used its strong operating cash flows to reduce outstanding debt, and as a result has very strong credit protection measures.
Table 2 Taiwan Top 50 Corporates Median Analysis
Operating margin (%)
Pretax interest coverage (x)
EBITDA interest cover (x)
|Electronic contract manufacturers||5.3||7.3||7.4||7.7||8.0||34.7||60.6||18.0||8.1||8.9||39.6||58.3||20.2||7.9||7.0|
N.M.- Not meaningful.
Table 2 Taiwan Top 50 Corporates Median Analysis (continued)
Total debt/capital (%)
|Electronic contract manufacturers||76.1||98.9||89.0||65.9||34.0||21.4||21.7||19.2||19.6||20.6||29.9||22.4||15.8||37.6||47.8|
|N.M.- Not meaningful.|
[The article is an abstract from RatingsDirect, Standard & Poor's Ratings web-based credit research and analysis system ( www.ratingsdirect.com ). To learn more, please click on About RatingsDirect .]