[ANALYST REPORT] Credit quality to remain stable, but retail and steel sectors face challenges

Most Korean non-financial companies’ leverage will remain stable or improve. Despite continued macro-related challenges, we expect financial leverage for most of the Korean companies (excluding unlisted government-related issuers) that we rate to remain largely stable or improve over the next 12 months, driven by the corporates’ austerity efforts as well as earnings improvement from 2015 levels. This forecast also reflects our expectations for soft but steady global and domestic economic growth, broadly stable oil prices and exchange rates, and supportive financial markets.

Credit profiles of companies in refining, chemical, telecommunications and auto sectors will remain robust. We expect financial leverage, as measured by adjusted debt/EBITDA, of rated companies in the refining, chemical, telecommunications and auto sector to improve or remain healthy over the next 12 months, owing to robust earnings and/or sizable free cash flow generation (auto and refining). Earnings are likely to be robust on the back of supportive industry fundamentals (refining and chemical) and easing competition (telecommunications).

Retail and steel sectors will continue to face challenges. We expect adjusted debt/EBITDA of many companies in the retail and steel sectors to remain elevated or deteriorate further, mainly owing to their weak earnings. Retailers’ operating profit will likely decline moderately when compared with the depressed levels in 2015, owing to continued weak consumer spending as well as intense competition from other retail formats. Meanwhile, persistent overcapacity in the steel sector and increasing trade frictions with importing countries should hinder POSCO’s (Baa2 negative) ability to improve its financial profile and keep its leverage elevated.

Negative rating actions will outnumber positive actions over the next 12 months. About a quarter (27%) of the rated private-sector Korean companies have negative-leaning outlooks, exceeding the 18% with positive outlooks. The negative outlook for many companies reflect their challenging industry conditions and/or company specific factors. In particular, POSCO Engineering & Construction Co Ltd (Baa3 review for downgrade), POSCO, Lotte Shopping Co Ltd (Baa2 negative), E Mart Inc (Baa2 negative) and SK E&S Co Ltd (Baa2 negative) are under downward rating pressure, given their high financial leverage relative to their rating levels. Upward rating pressure is limited to fewer companies including KT Corporation (Baa1 positive), SK Innovation Co Ltd (Baa2 positive), SK Global Chemical Co., Ltd. (Baa2 positive), and Hyundai Steel Company (Baa3 positive), whose credit profiles we expect will improve or remain robust when compared with their rating levels.

Source: Moody‘s Investors Service