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 the Company’s reporting of modestly improved results in the first nine months of F2013 (year ended March 31, 2014) despite mixed market conditions, reversing the declining performance a year ago. The Company’s financial profile is firmly within the current rating range. Additionally, the Company is making progress on its recently announced Mid-range Management Plan (MMP) to grow and improve profitability through innovation, structural reforms of its operations and sales expansion in the value chain. DBRS notes that achieving the strategic goals in the MMP would strengthen the Company’s business profile and profitability, and could lead to positive rating actions.

Komatsu’s operating results declined moderately in F2012, following a sharp retrenchment in the mining industry. A sharp decline in commodity prices induced by a slowdown in China led to a large-scale cancellation of mining projects and the resultant drop in equipment sales. Komatsu was especially affected by the sharp decline in coal mining activities in Indonesia. Nevertheless, the credit metrics at Komatsu, although weakened, were still within the current rating range. Market conditions were mixed in F2013. Conditions in the mining industry have stabilized and the demand for construction equipment strengthened, especially in Japan and China, the Company’s key markets, a net positive to Komatsu’s Construction & Mining Equipment (Equipment) business segment. However, revenue in the Industrial Machinery and Others (Machinery) business segment still reported a decline due to the impact of continued weakness in the wire saw market, despite higher demand for machinery from the automotive manufacturing industry. Overall, operating profit (excluding the write-off of wire saw inventories and net of corporate expenses) reported a more than 13% increase in the first nine months of F2013, compared to the same period in the previous year. Stronger demand, improved selling prices, benefits from ongoing efforts to lowering fixed costs and a depreciated yen all contributed to this improvement.

The Company has also generated free cash flow in the first nine months of F2013. Stronger cash flow from operations, in line with earnings, and tighter control over working capitals have more than covered capital expenditures and dividends. Moreover, all debt coverage metrics also strengthened modestly.

In April 2013, the Company announced a new MMP for the three-year period from F2013 to F2015 with a slogan, “Together We Innovate GEMBA Worldwide.” This new MMP has the following performance targets: (1) attaining the industry’s top-level profitability and financial position, (2) increasing the level of profit redistribution to shareholders and (3) improving the net debt-to-equity ratio and return on equity (ROE). The Company has set the following financial targets to be achieved by the end of F2015 (March 31, 2016): (1) operation income ratio of 18% to 20%, (2) ROE of 18% to 20%, (3) net debt-to-equity ratio of 0.3 times (x) or below and (4) consolidated payout ratio of 30% to 50%. These are ambitious but attainable targets, compared to the Company’s current performance. The basic strategies of the MMP involves (1) growth strategies based on innovation, (2) growth strategies of existing businesses and (3) structural reforms designed to reinforce the business foundation. Komatsu aims at leveraging its expertise in information and communication technology (ICT) and other strengths in development and production technologies to bolster its value preposition to customers. Additionally, Komatsu would boost growth from introducing new products and expanding sales of existing parts and services, rental and used equipment and financial services businesses. Finally, Komatsu targets structural reforms at its facilities to control cost and improve production efficiencies to boost operating margins. Success in executing these strategies would increase its competitiveness through stronger ties to customers and strengthen its market position with the resultant stronger operating results and credit metrics.

Near term, DBRS expects market conditions to remain stable and Komatsu to report modestly higher operating profit, supported by benefits from internal actions (cost reduction and production efficiency initiatives). The Company’s financial profile is to remain stable. However, recent weaker economic data has created uncertainty regarding the direction of the Chinese economy. An unexpected sharp decline in China could interrupt the improving trend at Komatsu. Nevertheless, DBRS notes that the Company’s financial profile has room to cushion any unexpected deterioration in its performance and remain compatible with the current rating.

The medium- and long-term outlook for the demand for equipment is positive, supported by the ongoing urbanization and industrialization of emerging markets, and the Company is well-positioned to benefit from the upturn. The Company has actively commercialized its ICT-based products, KOMTRAX (Komatsu Machine Tracking System), which have been well-received by customers. Increases in KOMTRAX-installed machines would 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 anticipates that steady progress from the MMP should strengthen the Company’s business profile and operating results. A meaningful improvement in the Company’s financial profile could lead to positive rating actions. However, a sharp reversal in market conditions could lead to lower demand and a much weaker profit, with a resultant sharp deterioration in financial profile. Pushing the Company’s credit metrics beyond the current rating range could lead to negative rating actions. DBRS notes that the Company’s financial profile has built up a reasonable cushion to absorb any unexpected deterioration in market condition. Hence, DBRS deems rating action in the near term to be highly unlikely.

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.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

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