Fitch Affirms KCE Electronics at #A-(tha)#; Outlook Stable

Stocks and Financial Services Press Releases Monday May 13, 2019 16:58
Bangkok--13 May--Fitch Ratings
Fitch Ratings (Thailand) Limited has affirmed KCE Electronics Public Company Limited's National Long-Term Rating at 'A-(tha)'. The Outlook is Stable.

The rating affirmation reflects Fitch's expectation that KCE should be able to maintain its leading position in the automotive printed circuit board (PCB) business. We expect its financial profile to remain strong, despite weaker earnings in 2018, with funds from operations (FFO) adjusted net leverage below 1x over the medium-term.

KEY RATING DRIVERS

Slow Revenue Recovery: Fitch expects KCE's revenue growth to remain weak, rising by only 1%-3% in 2019, compared with a 1.5% drop in 2018. This is based on our expectation that automotive sales could remain soft in 1H19 and will only recover in 2H19. Weak revenue growth in 2019 is due partly to slow orders from automotive suppliers since 4Q18 as the new EU testing rules on the automotive industry reduced the number of car sales. A drop in revenue in 2018 was also due to the strengthening of the Thai baht against the US dollar, which resulted in lower revenue recognition in the local currency. KCE reported revenue in US dollars increased by 3.7% in 2018 (2017: 6.7%).

Margin Pressure to Alleviate: We believe KCE should be able to maintain its operating EBITDAR margin at around 20% in 2019 in light of Fitch's expectation that the average 2019 copper price will remain subdued compared with 2018. A ramp up of KCE's new capacity and increasing high-margin, multi-layered automotive PCB product sales should help support the margin improvement in the medium term. KCE is exposed to changes in raw material costs, particularly copper (including copper foil and copper anode), which accounted for around 19% of the cost of goods sold in 2018. KCE's operating EBITDAR margin declined to 20% in 2018 from 24% in 2017 and 29% in 2016, due largely to a surge in the copper price since 2017.

Prices are agreed with customers annually, allowing KCE to propose price rises at the next round of negotiations if the medium-term outlook is for higher raw-material prices. However, the extent to which the company can pass on higher costs will depend on the market-power dynamics between the company and its customers.

Strong Financial Profile: Fitch expects KCE to continue to generate strong operating cash flow and maintain moderate financial leverage in the medium-term despite weaker earnings and higher capex. We expect the company's low financial leverage (0.5x at end-2018) to provide flexibility to support an increase in investment. KCE's FFO adjusted net leverage is likely to rise due to higher capex for a new production plant, but we expect it to remain below 1.0x over the next three years.

Leading Auto PCB Producer: KCE's rating reflects its leading position in the automotive PCB business, which offers wider margins and has higher barriers to entry than consumer electronic PCBs. The company is one of the world's top-10 automotive PCB makers, with revenue market share of around 5%. Its profit margins are higher than the average of PCB producers, supported by a competitive cost structure due to efficient manufacturing and Thailand's low labour costs.

Growth Opportunities: We expect KCE's sales volume to increase by about 4%-6% a year over the medium term, as the company benefits from automotive PCB market's long-term growth prospects. This is underpinned by global expansion in vehicle production, particularly electric vehicles, and higher electronic content in automobiles.

Customer Concentration; Foreign-Exchange Risks: KCE has a concentrated customer mix and faces price competition and technology risks associated with the electronics segment. In addition, the appreciation of the Thai baht against the US dollar during the manufacturing cycle could lower revenue in local currency terms.

DERIVATION SUMMARY

KCE's business profile is moderate relative to nationally rated Thai peers, but its financial profile is stronger. KCE's business and financial profiles are comparable with those of Polyplex (Thailand) Public Company Limited (PTL; A-(tha)/Stable), which is one of the top-10 polyester film producers in the world by revenue. PTL operates in a higher-risk industry, with the majority of its products being standard films that are commodities and face high competition. KCE focuses on the niche segment of automotive PCBs, which has higher barriers to entry. However, PTL has more geographically diversified operations and a broad customer base. KCE generates a wider EBITDA margin, but both companies have low financial leverage with total adjusted net debt/operating EBITDAR of below 1.5x. The ratings are therefore the same.

Siam City Cement Public Company Limited (SCCC; A(tha)/Negative), the second-largest cement producer in Thailand, is significantly larger than KCE, with comparable operating EBITDAR margins. Competition is lower in the cement business than the PCB business. SCCC's stronger business risk profile warrants the one-notch difference in ratings, despite higher financial leverage. However, there are risks associated with SCCC's deleveraging to a level consistent with its rating, which is reflected in the Negative Outlook.

KEY ASSUMPTIONS
Fitch's Key Assumptions Within Our Rating Case for the Issuer
  • Revenue growth of about 1%-3% in 2019 and increase to 4%-5% over 2019-2021
  • Average 2019 copper price to be around 2% lower than 2018
  • EBITDAR margin of about 20%-22% in 2019-2021
  • Higher capex for capacity expansion during 2019-2021 (2018: THB750 million)
  • 65% dividend payout ratio (2018: 58%)
  • No major acquisitions
RATING SENSITIVITIES
Developments That May, Individually or Collectively, Lead to Positive Rating Action
  • A substantial increase in size and a more diverse customer mix, and an increase in operating EBITDAR margin above 25%, while maintaining FFO-adjusted net leverage below 1.5x over a sustained period.
Developments That May, Individually or Collectively, Lead to Negative Rating Action
  • Lower cash flows or higher investments than Fitch expects, or acquisitions leading to FFO-adjusted net leverage above 1.5x over a sustained period.
  • Decline in operating EBITDAR margin below 20% over a sustained period if the competitive position or the ability to pass-on increased costs weaken.
  • A weakening in the company's market position or loss of key customers.
LIQUIDITY

Manageable Liquidity: KCE had THB2.4 billion of debt due within one year as of end-2018. Most short-term debt is packing credits (bank loans for financing export activities), while a THB168 million long-term loan is due in 2019. The company has a cash balance of THB1.4 billion, while its liquidity needs for working capital are supported by uncommitted revolving facilities of THB18.0 billion and USD80 million at end-2018.


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