DBRS Confirms Komatsu Ltd. at A (low) with a Stable Trend

DBRS Limited (DBRS) has today confirmed the Issuer Rating of Komatsu Ltd. (Komatsu or the Company) at A (low) with a Stable trend after the Company completed the acquisition of Joy Global Inc. (now known as Komatsu Mining Corp. (KMC)) as planned. The confirmation is primarily supported by a stronger business risk profile at Komatsu after the acquisition of KMC. DBRS notes that Komatsu’s overall credit profile is acceptable for the current rating because the stronger business profile is able to offset the deterioration in its financial risk profile caused by a sharp increase in debt to fund the acquisition. However, DBRS also notes that the Company’s financial profile has no more cushion to absorb further deterioration of its key credit metrics (as defined by DBRS). Although not expected, further decline in the key credit metrics could lead to a negative rating action. With this rating action, the Company’s Issuer Rating is removed from Under Review with Developing Implications where it was placed on July 25, 2016.

The acquisition of KMC has meaningfully strengthened Komatsu’s mining equipment business, a positive to the Company’s business profile. KMC is a leading manufacturer of both underground and surface mining equipment. The addition of KMC will enhance Komatsu’s above-ground mining equipment offerings with complementary products such as wheel loaders, shovels and draglines. In addition, Komatsu will be able to compete in a new market: the underground mining equipment segment. Moreover, DBRS does not anticipate any material integration issues in view of the complementary nature of the operations of Komatsu and KMC.

Komatsu funded the approximately USD 2,891 million (about JPY 303.6 billion at JPY 105.00/USD 1.00) acquisition cost with cash on hand and bank loans as intended when it announced the acquisition of KMC. However, at closing, the Company did not disclose the amount of additional debt incurred to effect the acquisition. DBRS notes that Komatsu has about JPY 122.2 billion in cash and time deposits as at the end of F2017, which ended March 31. DBRS has assumed that Komatsu will maintain a cash-on-hand balance of about JPY 100 billion — similar to levels over the last few years. As a result, DBRS has conservatively estimated that the Company’s gross debt post-acquisition will increase to about JPY 800 billion from just below JPY 409 billion as at the end of F2017. (The gross debt comprises Komatsu’s existing debt, KMC’s existing debt as at the end of January 2017 and DBRS’s estimate of the acquisition debt.) Despite a stronger performance in the latter half of the fiscal year, Komatsu has reported weaker operating results in F2017 compared with a year ago. Consequently, Komatsu’s financial risk profile, on a pro forma basis, suffered a meaningful deterioration as a result of the combination of an increase in debt levels and a decline in operating results, and as such, the key credit metrics are weak for the current rating. Furthermore, the Company anticipates that operating performance at KMC will remain weak and the earnings of the combined operations, excluding start-up costs, in F2018 will only be slightly above F2017 levels. Hence, the Company’s financial risk profile is not likely to show much improvement in F2018.

Since the beginning of calendar-year 2017, market conditions for capital equipment are improving. More importantly, the demand for construction equipment, especially in China where Komatsu has a strong market position, is showing increasing strength. Furthermore, major mining companies are showing signs that they are ready to invest in projects again after they have restored their financial positions. However, stronger demand for mining equipment is not likely to materialize until well into calendar-year 2018. Nevertheless, the improving market conditions bode well for Komatsu in the medium term. DBRS expects the Company to generate stronger sales and operating results beyond F2018 supported by the improving market conditions. Furthermore, ongoing efforts by the Company to improve operating efficiencies and potential synergy savings from the acquisition will also add to earnings. In short, DBRS expects the Company’s key credit metrics to show gradual improvement, returning to the current rating range in F2019.

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 no longer endorsed by DBRS Ratings Limited for use in the European Union.

The principal methodology is Rating Companies in the Industrial Products Industry, which can be found on dbrs.com under Methodologies.

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