Profitability Forecast to Remain Weak
Moody's Investors Service has changed the outlook on the ratings for Hyundai Motor Co. (HMC), Kia Motors Corp. and Hyundai Mobis Co. to negative from stable.
At the same time, Moody's has affirmed the Baa1 issuer ratings of HMC, Kia and Hyundai Mobis, and the senior unsecured bond ratings of Kia.
"The change in the rating outlook for HMC reflects the increasing likelihood that the company's profitability will remain weak over the next 1-2 years, because of challenging operating conditions in its key markets and continued cost pressures," says Wan Hee Yoo, a Moody's vice president and senior credit officer.
HMC's operating margin has registered below 3.5% over the last four consecutive quarters; results which were meaningfully lower than the 4.8% in 2017 and 5.6% in 2016.
In particular, the company's operating margin fell to 0.5% in 3Q 2018 from 5.0% in 3Q 2017, owing to the unfavorable movement in foreign exchange rates and higher provision-related expenses associated with recalls, as well as quality-related expenses, moderate sales performance and elevated incentive expenses.
In addition, equity income from its joint venture in China has shown a slower than expected recovery so far in 2018 from the very low base in 2017, owing to a softening in auto demand and stiff competition from local Chinese brands.
Given HMC's weak operating performance during the first nine months of 2018, Moody's expects the company's adjusted EBITA margin — including equity income from its China joint venture — to fall to about 3.6% in 2018 from 5.6% in 2017.
In the absence of sizable provision and quality-related expenses, Moody's expects HMC's adjusted EBITA margin to improve to 4.5%-5.0% in 2019, underpinned by: (1) a modest recovery in its sales in China from a low base in 2017-18; (2) higher utilization in its U.S. plant, driven by increasing production of SUVs; and (3) a stabilization or slight decrease in incentive expenses, following the launch of new models in 2018-19.
Despite the moderate improvement, this level of profitability is meaningfully lower than the company's historical averages over the past four to five years, reflecting the heightened challenges in its key U.S. and China markets, Moody's says.
In addition, there is a considerable downside risk to Moody's projections, given the increasing challenges in managing product quality and uncertainties in the global auto market.
That said, these concerns are partly mitigated by its large liquidity holdings, which continue to provide an adequate financial buffer. Moody's estimates that HMC's reported net liquidity holdings — ex-finance — totaled about 11.7 trillion won at the end of September 2018, down from 13.3 trillion won at the end of 2017.
"The outlook changes for Kia's and Hyundai Mobis' ratings mirror the rating action on HMC's rating, given the companies' high degree of linkages with HMC, both from an operational and ownership perspective," adds Yoo.
Kia's ratings benefit considerably from operational support through a high degree of integration with HMC in all areas except marketing and design. In addition, Kia's Baa1 ratings reflects the high likelihood of support from HMC in times of stress, which results in a one-notch rating uplift.
Hyundai Mobis' rating is closely linked with HMC's rating, given the high likelihood of extraordinary mutual support between the two companies, based on their strategic importance to each other.
In addition, Hyundai Motor group controls most of its group companies through circular shareholdings among HMC, Kia and Hyundai Mobis, which reinforces the three companies' close linkages.
HMC's rating outlook could return to stable if the company improves its profitability through enhanced sales performance and/or a reduction in expenses, while maintaining its strong balance sheet. These developments could be evidenced by adjusted EBITA margins above 4.5%-5.0% and adjusted net debt/EBITDA below 0.5x on a sustained basis, excluding its finance subsidiaries.
On the other hand, Moody's could downgrade HMC's rating if the company's earnings remain weak or if it undertakes significant investments, such that adjusted EBITA margins stay below 4.5%-5.0% or adjusted net debt/EBITDA exceeds 0.5x on a sustained basis, excluding its finance companies.
Kia's and Hyundai Mobis' ratings outlooks could return to stable if: (1) HMC's rating outlook returns to stable, and (2) Kia and Hyundai Mobis maintain their sound financial profiles.
Moody's will downgrade Kia's and Hyundai Mobis' ratings if Moody's downgrades HMC's rating.
Hyundai Mobis Co., Ltd. is Korea's largest manufacturer of automobile parts by revenue, with facilities in Korea, China, Slovakia, India, the Czech Republic, Russia, Mexico, Turkey, Brazil and the US. The company is one of the key members of the Hyundai Motor group, and is the main auto parts supplier for Hyundai Motor Company and Kia Motors Corporation.