Taiwan's leading corporates could see their credit profiles strengthen further over the coming year on the back of still-strong export demand. Taiwan Ratings Corp. forecasts corporate profitability and cash flow will hover near their current historical highs for several more quarters. This is thanks to the positive effect of vaccination programs on demand recovery in developed markets.

Significant bottlenecks in global production and logistics as well as a shortage of key raw materials and components could provide some headwind against revenue growth into early 2022. However, we believe Taiwan's top performing corporates will maintain prudent financial policies that provide sufficient leverage headroom for a reversal in the supply-demand dynamic, while simultaneously increasing their capital spending over the coming year.

Our annual review of Taiwan's leading enterprises shows an unexpected strengthening in their financial performance in 2020, despite global economic volatility and trade headwinds. The average credit profile of the 50 select corporates has strengthened moderately since our last review. The most significant factors underlining this improvement are surging demand for electronic goods to support remote working and learning, and the growth in e-commerce and other business amid pandemic-induced consumption changes. Relatively strong virus containment measures in Taiwan helped to prevent material disruption to manufacturing and construction activities over the past year and at the same time sustain domestic demand.

In addition, the strategic confrontation between the U.S. and China on technology tariffs provided significant unexpected tail wind for Taiwan's semiconductor and tech hardware firms. This was also aided by slower expansion in China's semiconductor sector and China's diminishing presence in the global networking and 5G telecommunications market. However, the risk of more contagious COVID-19 variants and faster output increases following aggressive capacity additions by semiconductor firms in 2021-2022, could rapidly reverse the currently favorable business conditions.

Business Outlook Is Generally Stable With Reduced Downside Risk

We see the following factors as key risks for Taiwan's corporates over the next 12 months:

• Severe economic disruption from a potential resurgence in the pandemic including more potent variants;
• Aggressive global investments to increase semiconductor capacity;
• Still-strong competition and technology evolution risk for the technology sector;
• Rising competition from China's tech supply chain;
• Spillover from further escalation in trade and technology tension between the U.S. and China;
• Significant capacity additions by China and the U.S. could worsen supply and demand dynamics for the chemical sector; and
• Volatile commodity prices.

We assume that the global vaccination push will prevent worsening disruption to global economic activity, particularly in developed markets. That's despite the recent emergence of new and more potent COVID-19 variants along with rising infection numbers. We also believe that adequate travel and social restrictions and accelerating inoculation could prevent a worsening of Taiwan's recent outbreak and avoid disruption to business activities, particularly for key exporters.

Strong demand for products and services used in remote working and learning as well as from other consumption changes during the pandemic could gradually decline from the fourth quarter of 2021. However, recovering consumption following the reopening of developed markets could sustain Taiwan's robust economic growth for even longer. We base this on S&P Global Ratings forecast for global GDP to rebound by 5.9% in 2021 after contracting 3.4% in 2020. Growth will gradually normalize to 4.3% in 2022 and 3.7% in 2023. Nonetheless, pent-up demand could be completely fulfilled in 2022, which could slow revenue growth slightly for Taiwan's key exporters.

Taiwan's technology sector is likely to see more sustainable growth over the coming year. That's because of a structural shift driven by new technologies including 5G, cloud computing, and electric vehicles, digital transformation, and strategic competition between the U.S. and China that has slowed the development and expansion of China's semiconductor sector. The U.S. is unlikely to lift its blockade of Chinese telecommunications suppliers such as Huawei Technologies Co. Ltd. and ZTE Corp. anytime soon, which should reduce competition for Taiwan's tech companies over the next two to three years.

China's aggressive environmental targets on pollution and greenhouse gas emissions are also key to the future performance of Taiwan's commodities sector. Such targets will increasingly cap output and exports for energy intensive commodities such as cement, steel, oil refining, and commodity chemicals through various measures including the retirement of inefficient capacity, market consolidation, and export taxes. This could reduce supply risk for non-tech sectors in Taiwan and throughout Asia.

Credit Quality To Improve Across All Sectors

High-tech companies lead our assessment of the top 50 corporates. Tech firms account for almost half of our selection, followed by commodity chemicals companies (see Appendix A and B). We forecast the tech sector will represent a growing proportion of the top 50 over the next one to two years, given the likelihood of higher growth for this sector over the period.

Average creditworthiness has improved slightly across major corporate sectors over the past 12 months. This is mostly attributable to lower debt leverage as measured by the ratio of debt to EBITDA. Companies' surging cash flows have largely been sufficient to meet their spending on investments and dividends over the period. This is despite no significant net change in our assessment of the stand-along credit profiles (SACPs) of the top 50 corporates. This year we lowered our assessment of eight SACPs while at the same time we raised nine. Upward adjustments in the tech sector moderately outnumber those of the non-tech sector by a five-to-four ratio, which reflects how weaker tech companies have benefited more from surging growth in remote working and remote learning during the pandemic.

We now assess the median SACP of the top 50 corporates at 'bbb' according to S&P Global Ratings' global rating scale, compared with 'bbb-' last year. We assess 33 of the top 50 corporates have SACPs at 'bbb-' or above, up from 32 in 2020 (see chart 1). Weaker companies have seen the greatest improvement in their credit quality which reflects significant growth in their capacity utilization, margins, and ultimately cash flow as these companies stepped in to meet the supply gap amid surging demand.

Chart 1

The overall financial position of the top 50 corporates has improved slightly from 2019, with cyclical sectors experiencing the most significant improvement in cash flow and debt leverage. By contrast, the business risk profiles of the top 50 have held largely stable. We made only one downward adjustment and one upward adjustment, both in the tech sector which partly reflect the impact of rising demand for 5G telecommunications, the U.S.-China tech war, and intensifying competition from companies in China. The tech war helped lift our assessment of MediaTek Inc.'s business risk profile while rising competition risk lowered our assessment of the business risk profile for Catcher Technology Co. Ltd.

Strong Profitability Will Largely Sustain Into 2022

We forecast the aggregate EBITDA for the top 50 will grow 16.6% year on year in 2021, slightly down on 19% growth in 2020. Over the same period, the average EBITDA margin will likely improve to 16.2% from 15.1% in 2020 (see chart 2). EBITDA and EBITDA margins are at their highest levels since we began tracking Taiwan's top corporates over ten years ago. Improvement in profitability is broad based in 2021 with all key sectors experiencing tight supply or undersupply.

Chart 2

The shortage of upstream materials such as steel and chemicals as well as electronics components, including semiconductors and display panels, have sharply increased product prices at a speed unseen over the past few years. This in turn has sharply expanded producers' margins. Price increases have also inflated the input costs of downstream companies in the supply chain. However, capacity constraints have also strengthened the ability of these companies to pass through incremental costs to downstream clients and consumers in 2021.

Profitability could diverge among key sectors in 2022, resulting in an about 5% annual decline in aggregate EBITDA for the top 50. Commodity sensitive sectors such as commodity chemicals, steel, and container shipping could experience a decline in EBITDA and EBITDA margins due to a likely decline in commodity prices and less favorable supply and demand dynamics (see chart 3). Extreme weather events and the pandemic have disrupted some supply and capacity additions in 2021. However, we expect these to catch up gradually and along with fading pent-up demand will dampen product prices. Nonetheless, profitability in non-tech sectors could remain above the mid-cycle level in 2022. S&P Global Ratings forecasts the price of Brent crude oil will drop to US$60 per barrel in 2022 and US$55 per barrel in 2023 from around US$70 currently, which could bring some cost relief to commodity sensitive sectors.

Chart 3

Meanwhile, tech companies are more likely to sustain their EBITDA in 2022, despite the potential for moderate margin erosion over the period. This is because shifts in technologies such as 5G, digital cloud, electric vehicles, and Internet of Things will continue to drive demand growth. This growth could significantly offset a likely decline in demand from remote working and learning from the fourth quarter of 2021. Semiconductor and electronic components manufacturers are likely to pursue aggressive capex and capacity expansion over the coming year. However, we don't expect this to cause material oversupply over the next three to four quarters, given the wide supply gap and long construction periods required to ramp up capacity. Nonetheless, oversupply risk could rise in the second half of 2022 or 2023 once additional capacity begins to come online.

Mostly Prudent Capital Structures Support A Stable Credit Outlook

We forecast aggregate debt for the top 50 corporates will grow slightly in 2021-2022 (see chart 4). Nonetheless, we believe corporates' strong operating cash flows will moderate the impact of more aggressive capex and cash dividend payments. Leading industry players are likely to increase their cash dividends, given their strong profitability.

Chart 4

At the same time, strong margins, high utilization, and a shortage of materials and components has prompted some corporates, particularly semiconductor companies, to raise their capital expenditure significantly in 2021-2022. We believe this is absorbable, given that continued strong profitability will enable stronger cash flow protection measures over the period. We forecast the aggregate ratio of debt to EBITDA for the top 50 could remain stable at about 1.5x in 2021-2022, down slightly from 1.7x in 2020. Improvement in debt leverage is more prominent for leveraged companies in shipping and display panel sectors. However, their debt leverage is likely to remain unpredictable due to very high business volatility in these sectors.

We forecast that capex will only begin to slow in 2023 after annual growth of 4%-5% in 2021-2022. Several factors are behind the rise in aggregate capital expenditure, including:

• Semiconductor companies, particularly Taiwan Semiconductor Manufacturing Co. Ltd. (TSMC), raising capital spending to reduce current supply shortages while also preparing for anticipated strong demand growth for its advanced technology nodes;
• Tech companies seeking to diversify production capacity away from China in response to trade tension, tech security concerns, and business disruptions caused by COVID-19;
• Telecom operators maintaining high capex for the construction of 5G networks;
• Container shipping companies sharply expanding their order books amid strong freight rates and anticipated strong demand as the global economy rebounds post pandemic; and
• Chemical companies for facilities expansion and maintenance such as the Formosa Plastics Corp. group in the U.S. and other markets.

Acquisitions are also likely to grow, given the current low funding costs and high equity valuation of Taiwan's leading corporates, particularly for tech and consumer nondurable product companies. However, we expect the top 50 to maintain relatively prudent financial policies and avoid aggressive debt-funded acquisitions and capex over next one to two years. Companies are also likely to increase cash dividend payments over the same period, but we are unlikely to see firms materially exceed their average free operating cash flow.

The Tech Sector Will Remain The Bright Spot In 2022

Below, we look at the key factors weighing on the business risk and financial risk profiles of individual corporate sectors in 2021-2022. In the tables that follow, red highlights a downward revision and blue an upward revision to business or financial risk assessments since our last review in 2020.

Robust Growth And Generally Sound Capital Structures Mitigate Capex Risk For Tech Firms

Table 1

Key assumptions

• Accelerating investments in 5G mobile communications and shifting consumer demand toward electronics and e-commerce under the pandemic have supported strong demand growth. This should help sustain revenues and margins for the tech sector in 2021-2022.
• Nonetheless, the ongoing component shortage and retreating demand for remote working and remote learning could slow revenue growth by the end of 2021, as the rollout of COVID-19 vaccines allows most aspects of life to return to previous norms.
• Competition facing Taiwan's semiconductor and communications firms could ease slightly due to the U.S. government's restriction on exports of semiconductor manufacturing equipment to China and a blockade by Western countries on Chinese 5G technologies.
• Smaller operating scale and weaker technology capability could see thin-screen-transistor liquid-crystal display (TFT-LCD) companies and branded IT companies experience pricing and margin pressure as pandemic-induced demand recedes.
• Generally low debt leverage and still-strong operating cash flow can absorb higher capex levels without materially affecting tech firms' creditworthiness.

Key risks

• Uncertain COVID-19 trajectory, the pace of shifting technology, rising production costs for capacity diversification, and supply chain disruption during the pandemic could all cause the tech sector's performance to fall below our current assumption for 2021-2022.

Economic Reopening And Extreme Weather Lift Chemical Companies' Fortunes

Table 2

Key assumptions

• COVID-19 induced demand, the global economic reopening and extreme weather in Texas sharply expanded product margins since the fourth quarter of 2020, greatly improving margins and cash flow for Taiwan's chemical companies in 2021.
• Recent extraordinary margins will gradually normalize in the second half of 2021 but could remain above mid-cycle levels in 2022.
• Most large chemical companies have strengthened their financial capacity to sustain stable credit outlooks. Strong cash flow could largely fund elevated capex levels and maintain low debt leverage within our current assessment range for 2022-2023.

Key risks

• Rising feedstock costs, supply recovery, and faster capacity additions in China and North America could hasten normalization in 2022 at a faster and deeper rate than under our current forecast.

Outlooks Diverge For Container Shipping Companies And Airlines

Table 3

Key assumptions

• Port congestion in major harbors and strong demand for physical goods will constrain global shipping service supply and support higher freight rates in 2021.
• Soaring freight rates will outweigh elevated operating costs, including bunker costs and charter hire payments, and underpin carriers' profitability in 2021.
• Supply constraints due to port congestion and container shortages should ease gradually in late 2021 and a consumption shift to services from physical goods could weaken container shipping companies' profitability in 2022.
• For airlines, booming air cargo services cannot fully offset a delayed recovery in passenger traffic. A slow recovery in passenger traffic could drag the weak performance of Taiwan-based airlines into 2022.
• Operational challenges persist amid an ongoing domestic outbreak of the pandemic in Taiwan while more stringent quarantine restrictions could constrain service capacity.

Key risks

• A slower local vaccination rate and resurging case numbers worldwide from more potent COVID-19 variants could postpone recovery further.
• Airlines' debt leverage could weaken further if a recovery in passenger traffic is again delayed.
• Aggressive capex and returning business volatility could weaken debt leverage for container shipping companies if freight rates normalize at a faster pace than we currently expect.

Credit Outlook Is Slightly Positive For Steel And Cement Companies

Table 4

Key assumptions

• China's intensifying green push will continue to cap output and exports of energy intensive commodities such as cement and steel through various measures including the retirement of inefficient capacity, market consolidation, and export taxes.
• A severe curb on the housing market, slowing infrastructure investments, and higher coal prices could partly offset tight production controls and slightly weaken the profitability of Taiwan cement makers in 2021-2022.
• Still-strong operating cash flows are sufficient to meet capex and dividend needs while improving the capital structure of major cement companies.
• Strong demand following the economic reopening in developed economies along with China's curbs on domestic steel production could sustain strong steel profitability in 2021 before softening gradually in 2022.
• Steel makers could take advantage of soaring product spreads and use their strong cash flow to deleverage at a faster pace, thus increasing their financial buffer for the next downcycle.

Key risks

• A slower global economy, material increases in China's steel exports, or rising iron ore prices could dampen steel makers' margins more than we currently assume.
• More aggressive capital spending and merger and acquisition activity could materially weaken the debt leverage of cement companies.

High Capex On 5G Infrastructure And Tepid Adoption Of 5G Services Slow Efforts By Telecom Operator To Deleverage

Table 5

Key assumptions

• High capex on 5G infrastructure, together with continued price pressure on 4G services and limited contributions from 5G services, have weakened operators' debt leverage more than our earlier forecast.
• Continued spending on 5G infrastructure along with price erosion on legacy services will limit operators' cash flow and capacity to lower debt in 2021.
• 5G price plans among large operators coupled with increasing adoption rates could bring more visible uplift for operators' average revenue per user in 2022.
• Relatively stable and strong cash flows underpin stable credit outlooks after credit profiles weakened materially over the past 12 months; however, rapid improvement in operators' debt leverage is unlikely.

Key risks

• Slower acquisition of new 5G subscribers and further price erosion of 4G and 5G services could further weaken operators' profitability.

Taiwan Corporates Are Better Prepared For The Next Downturn

We believe the top 50 corporates, particularly tech firms, will continue to perform better than their regional peers over the coming year, just as they did in 2020 and the first half of 2021. We attribute this stronger performance to better epidemic controls in Taiwan and China which have preserved relatively greater normality in consumption and production activities in areas where the top corporates have most of their capacity located.

In addition, we see accelerating vaccination and continued vigilance on virus control will prevent a resurgence of case numbers in Taiwan. The continued strategic confrontation between the U.S. and China, particularly in the technology field, will continue to provide tailwind for Taiwan's semiconductor and hardware sector in 2021-2022. China's ambitious target for carbon neutralization by 2050 could also lower chronic oversupply in steel, cement, and some chemicals and provide some margin relief.

That said, the relative credit strength of Taiwan corporates could diminish if more overseas supply chains recover and bottlenecks in global production and logistics are resolved. Conflict between the U.S. and China has triggered global anxiety over the security of the tech supply chain and threatens to cause breaks in it, resulting in rising competition for Taiwan's tech firms that have made aggressive long-term investments.

In our view, aggressive capex, particularly in the wake of severe shortages in mid-2021, could lead to significant oversupply from late 2022. Moreover, the current surge in demand for physical goods is unlikely to continue as consumption shifts to services and governments taper fiscal stimulus programs in developed markets. This in turn could quickly reverse the favorable business conditions of 2021 as we move in to 2022. Nonetheless, we believe the leading 50 corporates will use their strong cash flows to enhance their business positions and more importantly, maintain prudent capital structures. This would provide an additional business and financial buffer to better withstand a potential recession than many regional peers over the next two to three years.

Appendix A

Appendix B

Chart