DBRS Confirms Komatsu at A (low), Stable

DBRS has today confirmed the Issuer Rating of Komatsu Ltd. (Komatsu or the Company) at A (low). The trend remains Stable. The rating confirmation reflects the Company’s strong business profile as the second largest global construction and mining equipment manufacturer with well-diversified revenues and a financial profile that continued to show solid improvement year-over-year with metrics that remain compatible with the rating. Going forward, we expect that that underlying mining and construction industry fundamentals will further support demand for Komatsu’s equipment, thereby keeping its business and financial profile commensurate with the rating in the near to medium term.

Komatsu’s revenues and EBITDA showed steady improvement through the first nine months of fiscal 2011 (FY2011, ending March 31, 2012) compared with the same period last year. Strong mining and construction activity was the key driver for higher equipment sales. All geographic segments saw growth in revenues except China, which experienced a sharp decline in demand for equipment due to government-imposed credit squeeze measures. Higher pricing, volume growth and achieved efficiencies more than offset increases in raw material costs, higher fixed overhead costs and the ongoing forex headwinds.

Despite higher earnings, the Company generated negative free cash flows at the end of Q3 F2011, given higher capex, dividend and working capital requirements. Komatsu incurred debt to support these spends as well as a share repurchase program during the quarter. Due to stronger earnings, the higher debt levels only led to a slight deterioration in metrics at December 31, 2011, compared to the period ending March 31, 2011. The Company’s metrics remain in line with the rating.

Going forward, the Company forecasted revenues for FY 2012 to be flat to modestly higher compared with FY 2011. Our views on any significant volume growth in the coming year remain tempered given the uncertainty surrounding growth in the global economy. However, DBRS expects that sales to China will improve slightly in FY2012 from FY2011 levels as the government relaxes its credit squeeze measures. In addition, we expect that Japanese demand will support sales due to need for equipment for use in the reconstruction of disaster-stricken regions. With on-going emphasis on reducing production costs, and expanding the higher-margin and more stable parts and services business, we expect overall operating margins to modestly improve. There is risk that the Company may not be able to meet its revenue target due to some significant headwinds. Given the large share of production based in Japan, margins would be pressured if the Japanese yen continues to appreciate against foreign currencies. In addition raw material prices are also unlikely to materially decline, which also adds cost pressure.

In light of slightly higher projected earnings, DBRS expects cash flow from operations to also show a modest increase. DBRS forecasts that Komatsu will generate positive free cash flows given expected lower capital expenditure spending, stable working capital requirements and despite slightly higher dividends. Komatsu will likely use its net free cash flows to support further share repurchase activity, as opposed to any significant debt repayments. Given that the Company is committed to maintaining conservative financial policies, we expect that Komatsu will be judicious in its share buyback activity to meet its FY2012 target of net debt-to-equity at 0.4 times or below. As such, we expect the Company’s metrics to remain in line with the rating. In addition, DBRS does not expect the Company to face any problems in refinancing its upcoming debt maturities.

DBRS expects the rating to be stable in the near to medium term, as underlying fundamentals in the mining industry (due to attractive commodity prices) and in the construction industry (particularly infrastructure development in emerging economies) support continued demand for Komatsu’s products.

Notes:
The applicable methodology is Rating Companies in the Industrial Products Industry, which can be found on our website under Methodologies.