The credit ratings on Korean companies were already squeezed before COVID-19 shuttered cities and toppled supply chains, and matters are deteriorating quickly. The World Health Organization on March 11, 2020, defined the outbreak as a pandemic, noting there were 118,000 infections in 114 countries. Korea is unusually exposed. It is a coronavirus hotspot and its companies are highly dependent on global trade. S&P Global Ratings has a negative outlook on almost one-quarter of the Korean companies we rate, and we expect COVID-19 will have far-reaching ratings implications for Korean firms.

Table 1

Tourism, Leisure, And Airline Sectors Take Biggest Hit

The outbreak is most directly hitting Korea's tourism, leisure, and airline industries. International passenger traffic declined about two-thirds, year on year, in the last week of February 2020, according to the Korea Civil Aviation Association. As of March, daily passenger traffic at Incheon International Airport was about 10%-20% of the average, and at the lowest level since the SARS outbreak in 2003.

On March 7, 2020, we placed Hanjin International Corp. (HIC) on CreditWatch with negative implications. HIC is a subsidiary of Korean Air Lines Co. Ltd. (KAL). This reflects a rising credit risk due to its significant debt maturity in the second half of 2020, operational disruptions in its hotel business, and rising earnings pressure on KAL.

Unravelling Supply Chains And Production Halts Knock Auto Sector

Production halts triggered by COVID-19 have hurt Korean manufacturing companies, which typically rely heavily on global supply lines. Hyundai Motor Co. (BBB+/Stable/--) and Kia Motors Corp. (BBB+/Stable/--) have slowed production in Korea since end-January after China temporarily stopped supplying a single auto part: wiring harnesses. This supply chain issue has disrupted production of roughly 120,000 cars at Hyundai Motor and Kia combined, equal to about 2% of annual sales for both groups. However, a demand slowdown may exert a greater hit on the companies' earnings and creditworthiness.

Disruptions to the technology industry are less severe. COVID-19 cases at Samsung Electronics Co. Ltd.'s (AA-/Stable/A-1+) plant in Gumi, central Korea, has disrupted production. If the supply chain outages persist much longer, this may disrupt the overseas facilities of Samsung and LG Electronics Inc.(BBB/Stable/--) in Vietnam and other countries.

Chart 1

The Bigger Threat: Weak Demand

COVID-19 has reduced demand in many countries. Given that Korean firms are highly export-oriented, the decline in global demand for major sectors has greater implication for their creditworthiness than production disruptions. The industries most exposed to likely decline in demand include refining and chemical, steel, retail, automotive, and technology.

Refining and chemical:   Refining margins and spreads of major chemicals are weakening due to sluggish economic activity and reduced demand. Singapore's oil refining margin in 2019 averaged US$3.0-US$3.5 per barrel, down about 40% from 2018. The year-to-date average margin, which has dropped to below US$1.0 per barrel, reflects an even greater weakening.

The recent significant drop in oil prices will create inventory losses. We expect Western Texas Intermediate crude oil prices to be US$35 per barrel in 2020 and US$40 in 2021, compared with US$55 in 2019. Since 2019, we have taken downward rating actions on refining and chemical companies such as SK Innovation Co. Ltd., GS Caltex Corp., and LG Chem Ltd.. We expect further credit pressure on these companies given their subdued profitability and aggressive investment policies.

Steel:   We expect Korean steelmakers' earnings to deteriorate in the first half of 2020 given sluggish demand from the auto and construction sectors. The current price of Chinese exports of hot rolled coil at China's Tianjin port is 8.5% lower than it was in early January 2020. On Feb. 5, 2020, we revised the outlook on Hyundai Steel Co. to negative, reflecting worsening operating performance and financials.

Retail:   Korean 2020 GDP will grow 1.1%, almost half our pre-outbreak forecast of 2.1%. Retailers' earnings should also drop steeply in the first half of 2020 due to reduced consumer discretionary spending.

The rating on E-MART Inc. has been strained over the past several years due to profit deterioration and the heavy use of debt to fund investment. Even as we expect its low-margin online retail business will grow, the COVID-19 outbreak will likely exacerbate the decline in its operating profit given its high reliance on offline retail channels.

On Feb. 19, 2020, we revised our outlook on E-MART to negative to reflect earnings pressure and aggressive investment.

Autos:   The drop in auto demand is also noticeable, with auto sales dropping by about 15% in Korea and about 80% in China year on year in February. We expect this negative trend to continue in March for the Korean auto market. In addition, as the coronavirus spreads across the U.S. and Europe, which are the major markets of Hyundai Motor and Kia, we see increased downside risk for the companies' first-half earnings.

Given that the buffer on Hyundai Motor's and Kia's 'BBB+' ratings is narrow, a prolonged outbreak may strain the ratings on these companies. Nonetheless, we expect Hyundai Motor and Kia to outperform their peers on the back of model launches.

Technology:   We expect demand for major electronic products such as smartphones and home appliances to decline, and that this will affect demand for components such as semiconductors and display panels. Smartphone global unit sales will decline about 7% year on year in 2020, according to Strategy Analytics, a researcher. This reflects a 10% cut to 2020 sales projections set before the COVID-19 outbreak.

Samsung's vast net cash (about US$80 billion as of end-2019) and conservative financial policies should protect the ratings on the firm during the outbreak.

Companies such as LG Electronics do not have a large buffer at the current rating level. A drop in profit amid the demand slide may create downward ratings pressure on the firm.

Most Major Korean Firms Have Sufficient Liquidity To Maintain Ratings

We expect most of our rated Korean companies will have ample opportunity to raise funds for refinancing. That's because of the strong liquidity of the domestic capital markets and the sound banking relationships of the firms.

In addition, for exporters such as Samsung, LG Electronics and Hyundai Motor, we believe the depreciation of the Korean won will boost their operating results, which are in the local currency.

Things May Pick Up In The Second Half

While there continues to be high uncertainty about the rate of spread and the timing of the peak of the COVID-19 disease, modeling by epidemiology experts indicate a likely range for the peak of up to June 2020. For the purpose of assessing the economic and credit implications, we assume the global outbreak will subside during the second quarter of 2020, and currently forecast Korea's GDP growth for 2021 to rebound to about 3.2% from 1.1% in 2020.

A number of Korean companies will likely report earnings declines in the first half of 2020. In particular, companies with narrow ratings headroom will face greater downward pressure. Under these circumstances, the flexibility of financial policies, such as reducing capital investment and shareholder returns, will be important in determining ratings. Currently, about 23% of Korean companies rated by S&P Global Ratings have a negative outlook.

Chart 2

Related Research

• Hanjin International Corp. Ratings Placed On CreditWatch Negative Due To Worsening Liquidity, March 6, 2020
• COVID-19 Now Threatens More Damage To Asia-Pacific, March 5, 2020
• Global Credit Conditions: COVID-19's Darkening Shadow, March 3, 2020
• E-MART Inc. Outlook Revised To Negative Due To Weak Profitability And Rising Debt; 'BBB-' Rating Affirmed, Feb. 19, 2020
• SK Innovation Outlook Revised To Negative On Aggressive Financial Policy; 'BBB' Rating Affirmed; Issue Rating Lowered, Feb. 10, 2020
• Supply Chain Disruptions Threaten Hyundai Motor, Kia Performance, Feb. 5, 2020
• Hyundai Steel Outlook Revised To Negative On Weak Operating Performance; 'BBB' Rating Affirmed, Feb. 5, 2020
• LG Chem Ltd. Downgraded To 'BBB+' On Rising Leverage; Outlook Stable, Dec. 11, 2019
• GS Caltex Outlook Revised To Negative On Weakening Operating Conditions; 'BBB+' Rating Affirmed, Sept. 16, 2019