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 confirmation reflects that the Company’s business risk and financial risk profiles remain compatible with the current rating, despite recent weaker operating performance and attendant credit metrics. Furthermore, the current rating is expected to remain stable in the near future, as Komatsu’s financial profile still has room to cushion further weakness in debt coverage metrics.

The Company’s operating performance in the first nine months of fiscal 2012 (year ending March 31, 2013) was below expectations. Slow demand in some key markets (particularly in China and Indonesia), higher operating expenses and the ongoing strength of the Japanese yen (which, however, has moderated considerably following the Japanese elections in late 2012) have more than offset the contribution of higher product prices. Lower earnings and the resultant weaker internal cash generation were insufficient to fund capital expenditures, working capital and dividends, with the shortfall met by a modest increase in debt. Although weaker, all debt coverage ratios remain well within the current rating range.

Regional market conditions in F2013 are expected to remain mixed, similar to those of F2012. Slowing economic activities precipitated by the Chinese government’s actions to cool the domestic real estate market, the cause of a sharp decline in demand for equipment in 2012, appear to have stabilized. Equipment demand in China is still uncertain, but is likely to remain soft. Weak coal prices, which have caused coal miners in Indonesia to curtail equipment purchases, are expected to continue to weigh on demand. Finally, Europe is expected to stay weak, due to the ongoing fiscal crisis. Nevertheless, improving economic conditions in North America and ongoing reconstruction activities in Japan are expected to have positive effects on demand.

In summary, the demand for equipment in F2013 is expected to stay relatively flat compared to F2012. Slowing demand in China, Indonesia and Europe is expected to be offset by growth in Latin America, Oceania, North America and Japan.

However, DBRS expects the Company to report modestly higher operating profits, despite flat sales in F2013. Product pricing continues to support operating profit, and DBRS expects actions taken by the Japanese government to stimulate the domestic economy will likely keep the yen well below F2012 levels. This is a key contributor to higher profits in F2013, rather than a drag, as in the recent past (a decline of one yen against the U.S. dollar would add ¥1.4 billion to operating profit; this decline has been over ¥90 per USD since the start of calendar 2013, compared to an average rate of ¥79.8 per USD for the first nine months of F2012).

Internal cash generation in F2013 is expected to improve modestly in line with earnings. Capital expenditures are expected to be comparable to F2012, supporting ongoing capacity expansion and investment in emerging markets. The Company has done a good job in managing inventory with its “Zero Inventory at Distributors” program and working capital is not expected to be a major source of cash usage. However, the Company is still likely to incur a modest deficit in free cash flow, barring any material acquisitions. Nevertheless, the Company’s financial profile still has room to cushion further weakness in the balance sheet, and the current rating is expected to remain stable in the near future.

The Company is about to announce a new mid-range three-year plan at the end of F2012, positioning itself accordingly by recently reorganizing its senior management team. DBRS does not expect the new three-year plan has to show material changes from the Company’s current strategic objectives or financial policy, and therefore will not have any impact on the current rating. The medium- and long-term outlooks for the demand for equipment are positive, supported by the ongoing urbanization and industrializing of emerging markets, and the Company is well positioned to benefit from the upturn. The Company has actively commercialized its information and consumer technology-based product system, Komatsu Machine Tracking System (KOMTRAX), which has been well received by customers. The increased number of KOMTRAX-installed machines should provide the Company a competitive advantage to improve equipment performance and after-sales services to customers. Furthermore, a growing equipment population base should boost the parts and services business, which is more stable and profitable, adding to profitability and earnings stability. DBRS expects the rating to be stable in the near to medium term.

Notes:
All figures are in Japanese yen unless otherwise noted.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

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