DBRS Confirms Komatsu at A (low)

DBRS has today confirmed the ratings for Komatsu Ltd. and its subsidiaries (collectively, Komatsu or the Company) at A (low) and R-1 (low). The trends are Stable. Komatsu is the second largest global capital equipment producer and has generated steady improvement in its financial profile over the past several years. The Company has notably benefited from strength in global construction and mining equipment demand, particularly in emerging markets. The commercial paper rating is supported by the Company’s favourable liquidity position and free cash flow generation.

Komatsu’s financial profile improved over the past year. Earnings growth has led to solid operating margins (from weak levels in F2003 and F2004), and has been driven mainly outside of the Company’s core markets of North American and Japan. Strong construction and mining activity has been the key driver of new equipment sales, particularly in greater Asia (i.e., China, Southeast Asia, the CIS and Middle East) and Europe. Robust demand, combined with new product offerings (i.e., DANTOTSU) and generally tight industry supply have also contributed to rising prices. Volume growth and price increases, particularly in these regions, have more than offset the impact of sharply higher input costs (namely steel), declining business in the United States (mainly related to the residential housing market deterioration) and relatively soft business conditions in Japan.

Over the near term, the trend of earnings and cash flow growth is expected to continue, led by favourable emerging market mining and construction activity. Komatsu is increasing capacity, notably in Japan, Russia and India, to support continuing demand strength. A larger share of more flexible production (i.e., KOMTRAX) and ongoing efficiency gains are also expected to support growth.

Despite the positive factors noted above, Komatsu continues to face challenges that could constrain earnings and cash flow growth. Weaker-than-expected economic conditions in the United States are a key near-limit risk, as this market remains an important source of sales and earnings (the Americas account for over one-quarter of the Company’s sales). In addition, further strength in the yen (which has increased close to 15% from late-2007 relative to the U.S. dollar) would pressure margins, given the large share of production based in Japan. Furthermore, energy and raw material prices are unlikely to materially decline, which also adds pressure.

Komatsu has continued to fund operations internally, which provides financial flexibility. While net free cash flow has been close to break-even due to large working capital uses since F2006, asset sales have been used toward debt repayment. The Company’s key credit metrics have steadily increased mainly from growth in earnings and cash flow, combined with lower debt, and are favourable for the rating. Further evidence of Komatsu’s ability to maintain the strength in its balance sheet and profitability would likely lead to a positive rating action. Downside to the rating is limited, given the improvement in the Company’s financial profile.