Here's the second part of a sectoral company-by-company look at Standard & Poor's
credit ratings for the high-technology outfits followed by its credit analysts -- along with S&P's comments on the financial strength and business outlook for each company. (The first part covered companies in communications gear, and computers, components, and peripherals.) Additional portions of the review will be published in subsequent days (also see S&P's sector-by-sector overview of the tech industry).
In this portion, S&P Ratings looks at:
Diversified technology companies
Electronic equipment manufacturers
Benchmark Electronics (BHE)
Benchmark continues stable growth, with fiscal 2004 sales up 8% and stable EBITDA margins of about 6% that compare favorably with those of top-tier EMS companies. Benchmark had no funded debt as of Dec. 31, 2004.
Celestica's fourth-quarter revenues grew 22%, to $2.3 billion, while lease-adjusted operating income more than doubled, to $121.9 million. However, these gains were overshadowed by $836 million in predominantly noncash restructuring charges relating to the decision to exit high-cost geographies that included a $161 million credit provision for a distressed customer. Liquidity is adequate.
Flextronics International (FLEX)
Revenue growth decelerated somewhat in the December quarter, to 3% from 20% generated earlier. Expectations are for sales to flatten at current levels because of constrained handset demand. Margins continue incremental improvement. Financial flexibiliy is expected to remain stable, despite approximately $700 million of payments for the Nortel acquisition, because of positive internally generated cash flow.
HannStar experienced a dramatic downturn in 2004 because of volatile TFT-LCD flat panel prices. Its EBITDA margin dropped further to negative 1% in fourth-quarter 2004 from 17% in third-quarter 2004. Operating loss is expected in the first half of 2005 because of depressed panel pricing. In response to the severe market conditions, HannStar has slowed its capital spending and maintained sufficient liquidity on hand.
The company has NT$16.2 billion cash on hand as of Dec. 31, 2004, compared with NT$14.6 billion debt maturing in one year. In addition, HannStar has successfully issued US$263 million GDRs in March, 2005, which would help further enhance its liquidity position.
Jabil Circuit (JBL)
Revenues increased 21% in the November quarter compared with the year-earlier period, as its new Philips contract ramped up. Jabil Circuit is somewhat more exposed to the seasonality of consumer markets following the Philips transaction. As a result, March revenues likely will decline slightly. EBITDA margins have been stable, at around 7% over the past three quarters. Internally generated cash and existing liquidity should cover increased capital spending over the near term, to expand low-cost production and the recently announced Varian acquisition.
Revenues continue a steady climb from the prior year but remain flattish sequentially, reflecting overall sluggish demand. Expectations for a modest drop in Sanmina-SCI's computing segment likely will suppress March revenue. EBITDA margins improved to 4%, up from the mid-3% range, but continue to be at the low end of its peer group. Sanmina-SCI announced additional restructuring charges in the December quarter to migrate production to lower cost areas. Proceeds of a recently issued $400 million note, supplemented by cash on hand, are adequate to meet Sanmina-SCI's $632 million put in September 2005.
Solectron experienced a weak revenue quarter, with sales down 11% sequentially because of weakness in its networking and handset sectors. Margins, however, improved sharply to 4.2% from earlier levels of around 3%, in part because of lower sales in the consumer-electronics segment. Despite negligible free operating cash flow for fiscal 2004, asset sales contributed to ample liquidity of $1.6 billion.
Vestel Elektronik's full-year results are expected to show sustained top-line growth, plus increased debt levels, because of continued investment in working capital and expansion of its production capacity. Vendor financing and its $393 million cash balances (at the end of June, 2004) will be used to fund the company's organic growth plans. Its credit metrics were improved, however, thanks to to a strengthening operating performance in the first six months of 2004, with revenues up 38% to about $1.2 billion year-over-year and EBITDA of 18%. Headroom (about 17% at at the end of June, 2004) under the bond-related financial covenants currently is adequate.
Sales for the first nine months ended Sept. 30, 2004, have increased 28% from the year-earlier period, reflecting improving business conditions in Viasystems' markets, although the September sales level was 9% below June. EBITDA margins have slipped very modestly to 9% from about 10% to 11% generated in the first half of 2004 because of increasing raw material costs. Current credit statistics likely will remain stable, as Viasystems' free cash flow will be directed to capacity expansion, rather than reducing debt. Total debt to EBITDA is almost 5x as of September 2004.
Diversified Technology Companies
3M continues to exhibit good sales growth momentum through increased organic volumes and growth in international operations, with revenues up 8% for the December quarter over last year. 3M keeps generating improvements in operating profitability from sales growth and cost-efficiency initiatives. It's accumulalting cash, with December balances of $2.8 billion, compared with $1.8 billion at the beginning of the year. This level reflects high levels of discretionary cash flow, modest acquisition activity, and moderate levels of share repurchases. 3M recently announced a new share repurchase program of $2 billion for fiscal 2005.
Agilent Technologies (A)
Revenue growth remained healthy in the December, 2004, quarter, at 16% year-over-year. Relatively stronger performance in the test and measurement and life sciences segments offset a slowdown in automated test equipment, which is exposed to the semiconductor-manufacturing market. While operating volatility remains a factor in the business risk profile, Agilent's profit is still relatively healthy. The financial profile is strong as well, with leverage and liquidity healthy for the rating. Based on these factors, Standard & Poor's will evaluate the rating for a possible upgrade in the near term.
The stabilization in Bull's second-half 2004 revenues and EBIT, and a growing order book, led to an outlook revision to positive. The rating could be upgraded in the next 12 months if operating performance continues to improve and liquidity remains satisfactory.
Revenues for the nine months ended Sept. 30, 2004, were up 20%. The increase was because of a combination of unit growth and a 7% overall product-price increase resulting from higher materials costs. EBITDA margins improved to 27.9% from 26.3% on higher product prices and cost-reduction initiatives. Leverage remains high, but relative stability of operating profitability is a partial offset.
Fujitsu's total debt is expected to decrease to lower than 1 trillion yen, and net debt to capital also is likely to improve, to around 40% over the medium term.
Hitachi's operating profit during the quarter ended December, 2004, decreased by 46% from the same period last year. The IT Systems and the Electric Devices segments suffered severe product price declines. Although improved cost structure contributed to profit recovery in the hard-disk-drive business and the display business earlier this fiscal year, these segments both recorded operating losses in the quarter ended December, 2004.
Nevertheless, Hitachi's nine months' performance remained far stronger than the year-earlier period. Hitachi maintains a sound balance sheet, with 725 billion yen of cash and marketable securities, partly offsetting its still-weak earnings.
Integrated Alarm Services (IASGE)
Integrated Alarm recently announced that it would be delaying the release of its financial results for the year ended December, 2004. It has not completed the work necessary to make its report regarding internal control over financial reporting, and it expects to report material weakness. While the scope and magnitude of these deficiencies could be significant, it's too early to tell if they will affect S&P's ratings or outlook on Integrated Alarm.
Koninklijke Philips Electronics (PHG)
While the fourth quarter of 2004 only showed a reported EBIT improvement in Philips' consumer-electronics division, compared with the previous year, the overall annual performance for the group was strong. This was particularly true in medical systems, and Philips also was surprisingly stronger in consumer electronics, traditionally a troublesome segment. Free operating cash flow for 2004 increased 39%, to €1.4 billion, compared with 2003. Philips currently has significant balance-sheet flexibility and continues to have strong liquidity, bolstered by its noncore financial assets.
Considerable action has been taken over past quarters to decrease earnings volatility. This has been done by reducing the percentage of total earnings contributed by semiconductors and consumer electronics by pursuing an asset-light strategy. This should have a positive impact on S&P's assessment of Philips' business profile in the future.
LG Electronics generally enjoys good profitability, but the EBIT margin deteriorated significantly in the fourth quarter of 2004, to 1.5% from 6.8% in the first quarter of 2004. This occurred as a result of the strengthening Korean won and high raw material prices. LG Electronics exports almost 80% of sales and is significantly exposed to foreign-exchange fluctuations. With the continued strong won, earnings pressure should persist this year.
LG Electronics' capex plans total Korean won (KW) 1.7 trillion in 2005. Concerns also lie in the TFT-LCD business, where pricing pressures continue while demand growth remains unclear. Still, LG.Philips LCD is No. 2 in the industry, with a superior cost structure benefiting from economies of scale. Plus, it has the financial cushion to withstand further pricing decline -- an advantage smaller competitors don't have. LG.Philips LCD has significant capex plans, totaling KW4.58 trillion in 2005, an increase from KW3.8 trillion last year.
Sound overseas and domestic demand for its key industrial products is expected to sustain Mitsubishi Electric's overall profitability. Operating margin after depreciation for the first nine months as of December, 2004, increased to 3.4%, from 1.7% one year ago, and it's expected to improve further.
Revenues increased more than 10% during the 12 months ended December, 2004, compared with the previous comparable period, as Monitronics continued to actively purchase contracts. However, free operating cash flow remains modestly negative, as Monitronics has not expanded its contract base to the point that internal cash flow generation supports its growth initiatives. A continued effort to increase standards for customer-account acceptance has stabilized attrition rates in the low teens percentage area.
Still, an increase in the attrition rate or acceleration in customer account acquisitions could increase leverage and result in lower ratings.
Diversified Technology Companies (cont'd)
Higher revenues and improved operating margins in NCR's three major business units (partially because of foreign currency fluctuations) continued to be offset by price erosion and the negative impact of exited businesses within the customer-services business unit. Slightly higher pension expenses during 2004 also hurt performance. NCR has been successful in cost-containment efforts, expected to continue through 2006, and this should continue to drive modest margin improvement. Positive net cash balances and moderate free operating cash flow generation (much of which will continue to be used for stock repurchases) are expected over the intermediate term.
NEC's EBITDA margin was 5.9% in the nine months ended December, 2004, compared with 6.3% in the year-earlier period. This decline was due to weaker performance of the Network Solution and Electron Devices segments in the quarter ended December, 2004. In the Network Solution segment, the profit margin declined to 1.6% from 3.2% in the year-earlier period as a result of weaker sales of mobile handsets. The Electron Devices segment's operating margin sharply declined to 1.0% from 7.5%, on decreased sales in semiconductors and increased depreciation expense. Both of these outweighed cost-reduction efforts in LCD.
The IT Solution segment continued to generate solid earnings supported by demand growth, despite persistent price pressure. NEC had revised downward its projection for both sales and profit. However, sharp deterioration of NEC's financial strength is unlikely, given its ability to improve cost structure and strong commitment to further improving its balance sheet.
Oki Electric Industry
Oki has strengthened its profitability through structural reforms and concentration on niche businesses, such as information and telecommunication systems, semiconductors, and printers. These are areas of Oki's traditional expertise, and more focus on these areas should mean steadily improving profits. Oki turned to operating profit in the six months ended in September, 2004, and is maintaining this trend.
Operating profit for the quarter ended Dec. 31, 2004, increased by 48.3% compared with one year earlier. While net debt to net capital remains high, at 67% at the quarter end, the ratio is expected to improve gradually. Oki recognizes debt reduction as an important management priority, and capital expenditure will be kept within funds from operations.
Profitability has improved over the past six quarters, with revenue growth in the 10% range, year-over-year, and EBITDA margins in the mid- to high-teens range. Debt-protection metrics continue to be better because of a combination of rising cash flow and debt repayment. Funded debt declined about $22 million in the December, 2004, quarter, resulting in adjusted total debt-to-EBITDA of 2.1x. Liquidity levels remain adequate, with $198 million of cash as of Dec. 31, 2004. Continuation of current trends could cause Standard & Poor's to revise the outlook to positive in the near term.
Protection One Alarm Monitoring
Following Protection One's recent out-of-court debt restructuring and plans to refinance near-term debt obligations with a new bank facility, the company will have a substantially improved financial profile. It has also essentially completed a shift to an internal sales model, which benefits the company through lower customer-creation costs, better control over customer quality, and less reliance on debt to fund growth, compared to the dealer model.
Although Protection One has not yet seen revenue growth resume, we expect revenue to stabilize in the near term, largely because of the company's efforts to stabilize attrition rates. Protection One is expected to continue to generate modest amounts of free operating cash flow.
The DRAM -- dynamic random access memory -- industry this year is expected to see some slowing from 2004's strong growth, along with some earnings pressures in the semiconductor business. This will be further exacerbated by the strengthening Korean won. Samsung's capex plans have increased, to KW10.3 trillion in 2005, from KW7.7 trillion last year. Samsung has announced another KW557.6 billion capital injection for Samsung Card this year, once again showing continued willingness to use its own resources to support other group companies that have limited strategic ties to its core operations.
Thermo Electron (TMO)
The announced acquisition of Kendro Labs for $834 million in cash and debt will use a substantial amount of flexibility in Thermo's financial profile. The acquisition of Kendro, which generates about $400 million of revenues per year, should strengthen Thermo's business profile by complementing its product line and deepening its market position, particularly in Europe. Thermo's core operating performance continues at a steady pace, with organic growth in the mid- to high-single digits and gradually expanding profit margins.
Thomson's debt measures at yearend 2004 were in line with the ratings, with FFO coverage of net adjusted debt of 35%, after €55 million of the group's €400 million share buyback plan were completed. Management's partnership strategy for its TV tubes division is progressing gradually, which will leave Thomson with a 2004 pro forma revenue base and EBIT margin of €5.9 billion and 11%, respectively. Free cash flow generation should be strong in 2005.
Concerns remain over Toshiba's electronic-device business, which is vulnerable to market fluctuations given its heavy reliance on so-called NAND flash memory -- though demand is expected to continue to grow for the foreseeable future. Operating margin after depreciation for the first nine months was still low, but improved to 1.2% from 0.1% one year ago.
TRM Corp. (TRMM)
Boosted by small acquisitions, revenue grew 13% for the nine months ending last September, while EBITDA margin improved to 29%. The $150 million eFunds transaction, which will triple TRM's base of installed ATMs, closed in the December quarter. Debt to EBITDA is expected to be about 3x, pro forma for the acquisition.
With the acquisition of Aeronautics, pro forma revenues for 2004 are approximately $439 million. The acquisition increases Wyle's presence with the Navy, providing technical services, which complements Wyle's existing position with NASA and other federal government agencies. Pro forma leverage is expected to be relatively high, at about 5x as of Dec. 31, 2004.
Electronic Equipment Manufacturers
Canon posted record operating and financial performance in 2004. It continues to enjoy stable and strong profitability from printers and copiers. Stepper and aligner business recovered significantly and turned profitable compared to an operating loss in the year-earlier period. Despite severe price pressures on digital cameras, particularly low-end models, Canon maintains solid profits on its cameras, unlike many of its competitors. This is supported by strong market position, strength in high-end models, and the ability to introduce new products on a timely basis.
Canon's net-cash position increased to 850 billion yen at Dec. 31, 2004, from 593 billion yen at Dec. 31, 2003.
Matsushita Electric Industrial (MC)
Matsushita's profitability continued to improve in the third quarter ended December, 2004. Operating profit increased by 24% from the year-earlier period. The profit growth is backed by continuous cost reductions and sales growth in video/audio eqipment, including PDP TV and digital cameras, and home appliances. This offsets price pressures, while sales in components/devices and mobile-phone handsets weakened.
Matsushita maintains a strong balance sheet, with 1.01 trillion yen of debt and more than 1.26 trillion yen of cash and cash equivalents as of December, 2004. Its ample liquidity -- relatively high compared with peers globally -- is expected to help the company meet its investment requirement. In February, Matsushita made an upward revision of its consolidated results forecast for the fiscal year ending Mar. 31 and now forecasts total sales of 8.80 trillion yen and operating profit of 300 billion yen.
Omron's financial performance remained strong during the nine months ended December, 2004. The EBITDA margin was 15%, compared with 13.9% in the same period last year. This improvement was due largely to a growth in earnings from industrial automation systems, reflecting recovering capital expenditures by Japan's industrial sector. Omron is expected to post a record profit again in fiscal 2004, ending March, 2005.
It also benefited from increased demand for renewal and modification of ATMs and automated moneychangers in preparation for new banknotes. Omron is expected to continue to generate free cash flow, and its net cash position of about 52 billion yen as of Dec. 31, 2004 is expected to increase.
Although the car-electronics business should maintain solid profitability, it isn't sufficient to offset the poor performance of home electronics. The EBITDA margin is expected to decline to about 7% in fiscal 2004, ending Mar. 31, 2005, from 12% in the previous year. The funds from operations to total debt ratio likely will remain low, at around 20% to 30% over the next few years.
Ricoh's financial performance remains solid, on growing revenues from maintenance services and consumable supplies for color multifunction printers. Its profitability is expected to be weaker for fiscal 2005 (ending March, 2005) than fiscal 2004, on slipping performance of its optical disk business, costs associated with the sale of its optical-related analog business, additional sales-promotion costs for color multifunction printers, and increased R&D expenses.
Nevertheless, we believe Ricoh's competitive position and ability to generate profits and cash flow from its core business remain strong. Funds from operation to total debt likely will remain well above 50%, and the net cash position should continue to increase.
Sanyo Electric faces severe price declines and increased inventories in some of its core products, including digital cameras, where OEM products account for a high proportion of Sanyo's digital-camera business. While Standard & Poor's expects the deterioration in its financial profile to be a temporary setback, the rating could be lowered, if a sufficient recovery in profitability and cash flow fails to materialize.
Sharp's financial preformance remained strong in the nine months ended December, 2004, on robust LCD sales. Sharp is expected to continue to maintain solid earnings backed by good operating performance in its high value-added LCDs and other devices, such as CCD and CMOS, where its technological strength lies. Strong earnings are also expected in various consumer-electronics products using its key devices.
Although Sharp will be required to make ongoing investments in devices such as LCD displays to maintain its position amid rising competition and price pressures, its balance sheet should remain strong, supported by solid cash flow and a conservative financial policy.
Sony's profitability has been strained by product and price competition, especially in its core electronics business. Sony's efforts to strengthen its product portfolio have lagged behind those of an increasingly competitive market. In the quarter ended in December, 2004, Sony's operating profit decreased by 13% from the year-earlier period. In January, Sony revised its consolidated results forecast for the fiscal year ending Mar. 31, 2005, to sales of 7.15 trillion yen and operating profit of 110 billion yen -- reductions of 200 billion yen and 50 billion yen, respectively -- from its previous forecast.
The decrease mainly can be attributed to the weak performance of Sony's electronics business because of price declines in audiovisual products, a competitive market environment for portable audio equipment, and lower sales of semiconductors and electronics components. The domestic-sales decrease is expected to be as much as 7% to 9% compared to a year earlier. We believes it will take some time for Sony to recover its profitability in electronics.
Victor Co. of Japan (JVC Corp.)
JVC's financial performance in the nine months ended September, 2004, was weaker than the year-earlier period. Continuous cost reductions could not offset severe price pressures on its main products amid rising competition. JVC has not achieved a sufficient result yet in its attempt to shift its profit structure toward digital products from analog products. Plus, its electronic-devices business has not turned profitable yet.
The rating continues to take into account the advantages JVC derives from its relationship with its parent and majority shareholder, Matsushita Electric Industrial. From S&P Ratings Services