With prospects for profits low, Japanese electronics manufacturers are reshuffling their auto-related operations, with many spinning off underperforming businesses.
Omron Corp. (A/Stable/A-1) was the first to make a move, selling its auto-related business to Nidec Corp. in October 2019. The trend is gathering pace again having stalled during the COVID-19 pandemic. In April 2023, Mitsubishi Electric Corp. (A/Stable/A-1) announced plans to restructure and spin off its automotive equipment business, while Hitachi Ltd. (A/Stable/A-1) deconsolidated its automotive parts business in October. In November, Panasonic Holdings Corp. (A-/Stable/A-2) revealed it would convert its automotive equipment business (excluding the automotive battery business) into an equity-method subsidiary.
We believe that fierce competition in auto-related sectors and the changing business environment have prompted Japanese electronics manufacturers to reorganize their auto-related businesses. South Korean electronics giants Samsung Electronics Co. Ltd. (AA-/Stable/A-1+) and LG Electronics Inc. (BBB/Stable/--), in contrast, still position auto-related business as a growth area.
In response to inquiries from market participants, we have summarized our views on the impact of this trend on our credit ratings on Japanese electronics makers.
Frequently Asked Questions
How do you assess the risks of auto-related business?
We see high volatility in sales and profitability in the auto-related business. The sector is greatly affected by vehicle sales trends. As autos are high-priced products, the number of sales depends largely on the economy and consumer confidence. Moreover, we believe that the continuous need for capital investment and constant heavy pressure from automakers to lower prices increase the risk of profits fluctuating. In the auto-related business, we also believe there is severe pressure on earnings because of the high quality and safety performance requirements of automakers and the need to spend large amounts on research and development (R&D) to keep up with innovation in the industry.
We assess the risks in the auto-related business (the auto parts supplier industry) as moderately high based on our criteria. This assessment is the same as that on the technology industry (electronics and semiconductors) but is one notch higher than our intermediate risk assessment for the capital goods and consumer electronics businesses managed by many electronics companies.
Why are Japanese electronics manufacturers restructuring their auto-related businesses?
We believe that this is due to a decline in capacity and incentives to continue investing in low-profit auto-related businesses as the competitive environment becomes increasingly challenging.
Continuing to invest in auto-related businesses while also increasing revenue is a huge challenge, in our view. Auto-related operations are a key area for Japan's electronics makers, accounting for 15%-20% of total sales. However, we believe that operating profit ratios for these businesses remain under 5% or even in deficit. This is very low compared with total earnings, and it is also unlikely to improve significantly any time soon.
Hitachi, Mitsubishi Electric, and Panasonic all have strengths in terms of market position and competitiveness in their auto-related businesses, such as electric power steering and in-vehicle cameras, in our assessment. However, we believe that the earnings environment has been challenging in recent years, as the pandemic hit auto production. Auto-related business as a whole needs to keep pace with technological innovations in the auto industry, such as electrification and autonomous driving, if it is to expand. Meanwhile, businesses such as automotive batteries, information technology (IT) services, and semiconductors, which companies have also positioned as growth areas, require significant investment, which limits the ability to invest in auto-related businesses, in our view. In addition, we believe electronics makers may be hesitant to invest large amounts in auto-related businesses, given the delays at some automakers in shifting to electrification and incorporating electronic technology.
In addition, we believe that pressure from the stock market is also affecting the decision to restructure. In March 2023, the Tokyo Stock Exchange asked listed companies on the Prime Market and Standard Market to run their businesses in consideration of capital costs and stock prices. In response to this trend, we believe that there is a strong incentive for Hitachi, Mitsubishi Electric, and Panasonic to reorganize the low-profit businesses.
Does keeping auto-related businesses in portfolios hurt creditworthiness?
We still believe that Japanese electronics manufacturers' focus on auto-related businesses is a somewhat positive factor for their creditworthiness. However, this is based on the assumption that they can secure sufficient profits from such businesses. There are many elements they have developed for consumer goods that can be repurposed for the auto industry. This potentially brings down development costs and timeframes. Since auto-related business is conducted over long timeframes with contracts spanning a number of years, it can mitigate fluctuating short-cycle earnings of electric appliances. In addition, there are potential benefits from growth in the automobile market, where the incorporation of electronic technology is accelerating. Electronic components and semiconductor manufacturers such as TDK Corp. and Renesas Electronics Corp. have been able to generate sufficient profits in their auto-related businesses. Sharp Corp. and Sony Group Corp. are also exploring new business opportunities in the sector.
However, the pace of electrification and incorporating electronic technology in vehicles at automakers is slower than some of them had expected. This could slow the electronics industry's ability to generate new revenue. We also believe that electronics manufacturers are spending more money and time than anticipated to meet customer quality demands. For these reasons, we believe that the risks to the auto-related business of electronics manufacturers have risen slightly.
Chart 1
What is the impact of reorganization on creditworthiness?
We believe that unbundling underperforming businesses will benefit overall creditworthiness. Reorganizing low-profit businesses will strengthen overall portfolios and earnings will improve to some extent. Also, since we believe that electronics makers will conduct their financial operations in a disciplined manner, it is unlikely that they will use funds from the sale of their auto-related businesses for extensive shareholder returns. Therefore, while investment in growth areas is accelerating, obtaining funds will improve their investment capacity.
We believe that electronics companies will be able to remain competitive in the next two to three years in areas other than auto-related business. In growth areas such as IT services, automotive batteries, and semiconductors, Japanese companies have relatively high global market shares. In the latter two, the financial impact of increased investment can be tempered with government subsidies aimed at strengthening energy and economic security. In IT services, there is likely to be high growth and strong profitability thanks to increased demand for digital transformation, in our view. Moreover, the core areas of capital goods and home appliances have lower business risk than the auto-related business, and the companies can maintain market position and competitiveness for the time being.
Is the ongoing reorganization of auto-related businesses detrimental to the benefits of diversification?
The impact of restructuring auto-related businesses on the benefits of diversification varies from company to company, in our view. Having multiple uncorrelated businesses as revenue sources is a positive factor in our credit rating analysis because it reduces default risk for operating companies. On the other hand, we believe that Panasonic's divestiture of its automotive equipment business will have only limited impact. We believe that spinning off the business will not dent the benefit of a diversified portfolio immediately as the automotive battery business remains in place.
In general, in the process of reviewing business portfolios, there is a possibility that the positive effects of diversification will be lost as development becomes concentrated in certain areas. If the competitiveness of the remaining businesses is not strengthened, the loss of diversification benefits would have a negative impact on the rating. In Hitachi's case, the sale of various businesses, including the deconsolidation of the auto parts business, eliminated the positive effects of diversification. However, the disadvantage of narrowing scope by selling multiple businesses can be fully offset by strengthening a company's portfolio and improving profitability.
What is your view on Panasonic's automotive battery business?
We expect risks from Panasonic's automotive battery business to remain within limits for our rating on the company. Risks in this business remain relatively high due to its capital intensity and collaboration with Tesla Inc. (BBB/Stable /--), a company with an aggressive growth strategy, despite Tesla's strong position in the global electric vehicle(EV) market. However, given the company's production and sales record in the U.S., its strategy of avoiding head-on competition with major battery manufacturers, and the benefits of the U.S. Inflation Reduction Act (IRA), the company is able to mitigate these risks, in our view.
Why do you think Korean electronics manufacturers can persevere in this field?
Korean electronics makers Samsung Electronics Co. Ltd. and LG Electronics Inc. are also engaged in the auto-related businesses. We believe both companies have the financial capacity to invest into the sector. Their diversified business portfolio, with good positions in other areas, have generated high companywide revenues and cash flows. In addition, both companies form part of conglomerates that have positioned the auto-related business as a growth area, including EV battery manufacturing. That said, we expect that slowing growth in EV demand will likely cast a shadow on the profitability of their auto-related over the next one to two years.
What are the growth prospects for the auto-related businesses of Samsung Electronics and LG Electronics?
In March 2017, Samsung Electronics acquired Harman International Industries Inc., a U.S. auto parts company that focuses on audio technology, for about US$8 billion. Harman's sales account for about 5% of consolidated sales as of fiscal 2023. Harman's EBITDA margin has remained close to the industry average at around 11%, but this is low compared with Samsung Electronics' consolidated figure of around 25%. We anticipate Samsung Electronics will further strengthen its auto-related business, considering the strong long-term growth prospects in auto-related business and high volatility in its core semiconductor business. However, we do not expect Samsung Electronics to adopt a highly aggressive expansion strategy into the EV space, given the group's conservative risk management and financial policy.
LG Electronics also bolstered its auto-related business in August 2018 with the acquisition of ZKW Holding GmbH, a car lights company based in Austria. LG Electronics' auto-related business posted operating losses for six consecutive years from the fiscal year ended December 2016, but returned to the black in 2022 thanks to increased sales of EV products. In addition, LG Electronics formed a joint venture with Canadian auto parts giant Magna International Inc. in July 2021, mainly to strengthen its EV powertrain business. We expect the auto-related business' top line to grow steadily over the next one to two years, supported by a large backlog of orders(worth approximately ¥10 trillion as of Dec. 31, 2023). However, it could take longer for the margin to rebound significantly, given the current sluggish growth in EV sales volume.
Chart 2
How will reorganization of Japanese electronics manufacturers' auto-related businesses affect automakers and component manufacturers?
The impact on suppliers of automobiles and parts is limited in the short term from the point of view of commercial flow, in our opinion. This is because most of the spin-offs seem to be based on the assumption of business continuity. However, Mitsubishi Electric has announced plans to withdraw from certain products such as car navigation, and it is possible that each company will reconsider its product lineup as it reorganizes its auto-related business.
On the other hand, we believe that Japanese electronics manufacturers are likely to take significant measures to improve earnings under new shareholders, including investment funds, in our view. This will likely lead to even tougher negotiations on sales and procurement prices with automakers and parts manufacturers. However, given the multi-year sales and procurement contracts in the automotive industry, we expect a limited short-term impact on automakers and component manufacturers following the reorganizations.
Related Research
- Panasonic Holdings' Auto Solutions Deal Boosts Portfolio, Nov. 21, 2023
- Hitachi Ltd. 'A/A-1' Ratings Affirmed On Strengthening Business Portfolio; Outlook Remains Stable, Oct. 23, 2023
- Japanese And Korean Electronics Companies Are Catching A Lift--At Some Risk--With Carmakers, July 21, 2017
This report does not constitute a rating action.
| Primary Credit Analyst: | Hiroshi Nagashima, Tokyo (81) 3-4550-8771; hiroshi.nagashima@spglobal.com |
| Secondary Contacts: | Makiko Yoshimura, Tokyo (81) 3-4550-8368; makiko.yoshimura@spglobal.com |
| JunHong Park, Hong Kong + 852 2533 3538; junhong.park@spglobal.com | |
| Yuta Misumi, Tokyo +81 3 4550 8674; yuta.misumi@spglobal.com |
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