The risk of Asia-Pacific corporate issuers falling into speculative grade remains elevated through 2024. The culprits include high legacy leverage and expansionary financial policies. Flagging earnings, especially for exporters, and governance considerations are also potential triggers.

S&P Global Ratings estimates that as many as 26 issuers with about US$204 billion of reported debt could become either speculative grade, or potential fallen angels, over the next 12 months.

Chart 1

Credit polarization has been growing within Asia-Pacific 'BBB' rated nonfinancial entities. At the higher end of the 'BBB' category, financial discipline appears to be more entrenched.

Investors are asking many questions about the state of 'BBB' rated companies. Interest is highest for companies and sectors that are most at risk of falling into speculative grade. We define fallen angels as issuers rated 'BB+' and below that were downgraded from investment grade (rated 'BBB-' and above). We define potential fallen angels as issuers rated 'BBB-' with either a negative outlook or on CreditWatch with negative implications.

What Is The State Of Play For Asia-Pacific Companies In The 'BBB' Category?

We identify five credit highlights:

Downside and upside rating movements or outlook revisions have slowed over the past 12 months, especially at the higher end of the 'BBB' category.   So far in 2023, the share of upside and downside movements is broadly similar (see chart 2). Fewer rating actions also suggests transitions tend to be more company-specific (earnings, leverage, financial policies) rather than the broader macroeconomic or industry trends that influenced transitions in 2020 and 2021.

Chart 2

Growth aspirations and shareholder distributions are resuming despite slowing global growth and earnings headwinds.   Discretionary spending picked up in 2022--and seems to be gaining momentum. We estimate that:

• Nearly 60% of 'BBB' rated companies will post negative discretionary cash flows in 2023, an increase of nearly 10 percentage points compared with 2020 and 2021.
• Capital spending for the group will grow about 13% on average in 2023 in our forecasts, up from nearly 10% in 2022 and a single digit decline over 2020-2021.

The erosion in rating headroom has been more pronounced at the lower end of the 'BBB' rating category.   The share of companies on negative outlook is over 3x higher at the 'BBB-' level (about 18%, see chart 3) than at the 'BBB' and 'BBB+' levels (about 5%). This for three main reasons discussed later in the article: earnings headwinds; legacy leverage from the pandemic and uncertain forward-looking financial discipline; and company-specific governance or ownership considerations.

Some 14 companies face potential fallen angel risk, while over one in four of the companies rated 'BBB-' with a stable outlook have limited headroom under our downside rating triggers.

Chart 3

The negative outlook bias on 'BBB' nonfinancial issuers is converging across regions but with different regional trends.  It has been falling in Europe but increased in the U.S. and Asia-Pacific over the past six months (see chart 4). In all three major regions, the main watch point is at the lower end of the 'BBB' category, where a growing number of companies have limited rating headroom. This could add to the number of potential fallen angels in the coming months.

We estimate the amount of debt associated with U.S. nonfinancial fallen angel downgrades could reach about US$68.9 billion (about 1.9% of rated 'BBB' debt) over the 12 months to March 31, 2024. For Europe and the Middle East combined, this is about $29.1 billion (1.4% of 'BBB' rated debt). Those figures would be about three times higher than compared with the previous year, but in line with the average annual level of the past 15 years.

Chart 4

Credit trajectories vary across sectors. 

Among companies rated in the 'BBB' category in the Asia-Pacific, those in the technology, infrastructure, automotive/capital goods, and power/utilities are the most exposed to credit deterioration (see chart 5). This downside risk is generally due sustained capital spending that reduce deleveraging prospects (technology, infrastructure, automotive and capital goods, power and utilities); slowing domestic or export demand (automotive and capital goods, some infrastructure firms); or persisting cost inflation (automotive and capital goods, power and utilities).

Two sectors stand-out for relative strengths: commodities and consumer/media/telecom (CRT).

• About 13% of rated commodity producers are on positive outlook, largely due to industry considerations, namely over two years of elevated prices and profits and disciplined spending since 2021. Significant headroom has built against our assumption that commodity prices will revert to mid-cycle levels as the global economy slows.

• Rating outlooks have sharply improved over the past 12 months for CRT companies, and 11% of rated sector companies are on positive rating outlooks. The lifting of the last COVID-related restrictions has gradually improved consumer sentiment and mobility, especially for small ticket discretionary products and services, restaurants and retailing.

Chart 5

Could More Corporate Angels Fall In Asia-Pacific Over The Next 12 Months?

Yes. We have a negative outlook on 14 (roughly one in five) companies rated 'BBB-'. These 14 issuers had about US$113 billion in aggregated reported debt (about US$19 billion in rated debt) and limited rating headroom. They could become fallen angels in the next 12 months barring a sustainable pick-up in profits, slowing capital spending or credible balance sheet consolidation measures (table 1).

Table 1

Interestingly, the number is the same as in our previous potential fallen angel article in August 2022. That does not mean the potential fallen angel risk has stabilized, however. The list of current potential fallen angels features eight new newcomers, while ratings of some previous potential fallen angels were either lowered to speculative grade or withdrawn.

Since August 2022:

Eight companies became new potential fallen angels,  generally because of weaker operating prospects, high leverage, reduced financial discipline or governance considerations (see table 2): Adani Electricity Mumbai Ltd.; Adani Ports and Special Economic Zone Ltd.; Zhejiang Geely Holding Group Co. Ltd., and its subsidiary Geely Automobile Holdings Ltd.; GLP Pte. Ltd. and its subsidiary GLP China Holdings Ltd.; SK Hynix Inc. and Port of Newcastle Investments (Financing) Pty Ltd.

We lowered the ratings on four companies to speculative grade,  generally because of reduced profit prospects (Nissan Motor Co. Ltd. and Nexteer Automotive Group Ltd.), reduced cash flow stability (Li & Fung Ltd.); or ownership considerations (One Rail Australia Holdings Ltd.). The ratings on Nexteer were withdrawn at the issuer's request.

We affirmed our 'BBB-' rating with a stable outlook on three companies--   NHPC Ltd., Beijing Capital Group Co. Ltd., and Meituan--because of profit recovery, stabilizing working capital or expectations of improving financial discipline and leverage.

We withdrew the 'BBB-' rating with negative outlooks on two companies:  on E-Mart Inc. and Energy Australia Holdings Ltd.

What Are The Three Top Triggers For Potential Downgrades To Speculative Grade?

In Asia-Pacific, companies would most likely slip to speculative grade for three reasons:

• Reducing revenue and profit prospects;
• Legacy COVID- or expansion-induced leverage and uncertain forward-looking financial discipline;
• Company-specific governance or ownership considerations.

Table 2

1: Reducing revenue and profit prospects

This is the main watch point for about 40% of potential fallen angels, due to a mix of company-specific and broader macroeconomic drivers.

The global slowdown, oversupply, and elevated inventory levels, along with a spike in debt, is weighing on the profitability of chips manufacturer SK Hynix Inc., eroding its rating headroom.

The pace of the recovery momentum in a re-opened China is a main watch point for two potential fallen angels : Guangzhou-based Yuexiu Real Estate Investment Trust (with a focus on the pace of improvement in occupancy rates, rentals, and the progress on asset disposals); and hotel, travel, and logistics operator Jinjiang International Holding Co. Ltd.

Other idiosyncratic operating considerations underpinning the negative outlooks include potential profitability compression (for China-based automobile producer Zhejiang Geely); weather-related operating disruptions for Australia-based Port of Newcastle Investments; and uncertainties over U.S. export restrictions and falling demand from customers reducing their inventories for China-based Semiconductor Manufacturing International Corp.

2: Legacy leverage and financial discipline

The steepening of leverage during COVID has left a wide trace on corporate balance sheets in Asia-Pacific. In that context, financial discipline, spending and shareholder distributions have come back to the front as a focus of our credit analysis for 'BBB-' entities in Asia-Pacific.

About half of the potential fallen angels in Asia-Pacific are at risk of slipping to speculative grade due to high legacy leverage, discretionary spending choices, uncertainties regarding their financial policies, or a combination of the three.

For example, spending to expand electric-vehicle battery production and losses in the battery business have spiked leverage at SK Innovation Co. Ltd., the Korean chemical and electric vehicle battery producer. Aggressive financial policies with consistently heavy capex and steady shareholder returns have substantially narrowed the rating headroom of Korea-based power company SK E&S Co. Ltd.

Amid reducing rating headroom, most of the potential fallen angels have put in place measures to strengthen balance sheets, including adjusting discretionary spending, or planned asset sales or rights issues. The implementation and timeliness of these plans are the watch points for the following issuers: GLP (timely monetization of logistics assets, the collection of related-party receivables, and willingness to pace its capital spending relative to its asset-disposal plan), Jinjiang International, Yuexiu REIT, and SK Innovation.

3: Governance or ownership

Governance considerations are relevant for three companies. The negative outlook on Adani Electricity and Adani Ports factors the risk of an adverse impact in the credit profile of these two entities due to governance risks and funding challenges for the larger Adani Group. There is a risk that investor concerns about the group's governance and disclosures are larger than we have currently factored into our ratings. This could affect funding access and increase funding costs for group companies. The growing frequency of material related party transactions at GLP Pte. Ltd. and limited disclosure on related-party transactions have compounded the company's persistently high leverage.

The stabilization of credit ratings affected by governance considerations often takes time. This is because it is often contingent upon issuers demonstrating two things. First, stronger governance practices, such as the reduction of related party transactions outside the normal course of business and improving transparency and proactive communication with market participants. Second, the absence of tangible effect from the lingering negative governance headlines on profits and funding access in the medium term.

In the case of Adani Ports and Adani Electricity we will need to be convinced that governance practices in the group and funding access will improve in line with an investment-grade credit profile to revise the outlook to stable. Both entities have to demonstrate they are not significantly exposed to reputational and governance risks of the larger Adani group. Indicators could include successful fund raising, particularly in offshore markets, at competitive rates while refraining from significant related-party transactions outside the normal course of business. For GLP, this would include using less of its own balance sheet to fund material related-party transactions and the collection of advances it has made to related parties.

The downside pressure on Geely Automobile, SK Geo Centric, and GLP China reflect the strains on their parent companies. We view these three subsidiaries as instrumental to their parent's operations, finances, brand recognition, with the ratings and outlooks matching those on their parent companies.

How Are The Other 'BBB-' Rated Companies Holding Up?

Our sensitivity analysis shows that more 'BBB-' rated companies in Asia-Pacific could become potential fallen angels. Some 46 companies in the region have 'BBB-' ratings with stable outlooks. After screening for financial headroom they have against their downside rating triggers, we put them into three buckets (see table 3 for the buckets; see table 4 for financial projections against financial ratio triggers). The classification also reflects the structural volatility in earnings of the sector.

• 12 companies (about one-quarter of firms rated 'BBB-' on stable outlook) have limited rating headroom over the next 12 months. That proportion is similar to our exercise last year. These entities are more at risk of becoming potential fallen angels or fallen angels, barring a sustainable pick-up in their operations or a more credibly conservative financial policy. We estimate that companies in this category had aggregate reported debt (rated and unrated) of about US$91 billion.
• 28 companies (about 60%) have moderate rating headroom in 12 months. We believe these companies can absorb moderate declines in revenues and profits (for example, from slowing export markets in Europe and the U.S.) or have built sufficient rating headroom amid accelerating capital spending.
• 6 companies (about 15%) have significant rating headroom. This is generally because their conservative balance sheets affords them significant flexibility against falling earnings or more aggressive capital spending, acquisitions or shareholder distributions.

Table 3

Table 4

Companies in the "limited headroom" bucket face the higher risk of becoming potential fallen angels over the next 12 months given their limited financial headroom. For these 12, our analytical focus will be:

• Financial discipline, either linked to issuers' commitment to pay down debt with asset sales (Beijing Capital Group Co. Ltd.) or to manage leverage by controlling discretionary spending or acquisitions (telecom tower companies Profesional Telekomunikasi Indonesia PT and Summit Digitel Infrastructure Ltd., gold producer Zijin Mining Group Co. Ltd., investment holding company First Pacific Co. Ltd.). High capital spending and downturn industry conditions have substantially narrowed the rating headroom of China chemical producer Shanghai Huayi Holdings Group Co. Ltd. with any downside pressure translating into downside rating pressure for its subsidiary Huayi Group (Hong Kong) Ltd.
• Revenue and profit prospects, for Australian transportation company Pacific National Holdings Pty Ltd. and China real estate company China Jinmao Holdings Group Ltd. For the latter, weak contracted sales over the past two years are likely to affect future revenue recognition and leverage, with measured capital spending a key offsetting factor underpinning our stable outlook on the company.

Table 5

Angels Could Always Keep Their Wings

None of the companies we discuss in this report will automatically become fallen angels or potential fallen angels. In general, negative outlooks reflect at least a one-in-three risk that we will lower the rating. While four nonfinancial companies fell into speculative grade between August 2022 and June 2023, 'BBB-' rated issuers often have discretionary levers they can implement to shore up their financial position. The credit question then becomes how solid is their commitment to investment-grade.

Editor: Cathy Holcombe

Digital designer: Halie Mustow

Related Research

• Credit Trends: 'BBB' Pulse: Rising Stars And Fallen Angels Pick Up Amid Economic Uncertainty, May 18, 2023
• Bulletin: SK Hynix's Weak First Quarter Narrows Rating Headroom, April 27, 2023
• Research Update: Meituan Outlook Revised To Stable From Negative On Lower Investment Losses; 'BBB-' Rating Affirmed, April 6, 2023
• Research Update: SK Innovation, And SK Geo Centric Ratings Placed On CreditWatch Negative On Higher Capex And Rising Leverage, March 20, 2023
• Credit FAQ Explores Reasons For Nissan Motor Downgrade, March 8, 2023
• Bulletin: Zijin Mining's High Spending To Push Debt Up, March 28, 2023
• Credit FAQ: Adani Group: The Known Unknowns, March 22, 2023
• Research Update: SK Hynix Inc. Outlook Revised To Negative From Stable On More Severe Memory Market Conditions; 'BBB-' Rating Affirmed, Feb. 3, 2023
• Research Update: Port of Newcastle Investments (Financing) Pty Ltd. Outlook Revised To Negative; 'BBB-' Ratings Affirmed, Dec. 1, 2022
• Research Update: China Auto Manufacturer Zhejiang Geely Holding And Subsidiary Geely Auto Outlooks Revised to Negative On Margin Pressure, Nov. 22, 2022
• Credit FAQ: A Look At The Reasons For Our Outlook Revision On GLP, GLP China To Negative, Nov. 9, 2022
• Research Update: Li & Fung Downgraded To 'BB+' From 'BBB-' On Divestment Of Logistics Unit; Outlook, Sept. 2, 2022