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- Table of Contents
- Japanese Makers' Earnings Will Likely Grow Modestly
- Enhancing Portfolios Is Key To Remaining Competitive
- Financial Management Underpins Creditworthiness
- Related Research
- Earnings of Japanese consumer electronics companies will likely grow modestly in the coming year, thanks to recovering demand and pricing that reflects higher costs.
- Strengthening business portfolios that do not directly overlap with overseas peers' will be key to remaining competitive.
- Financial positions of higher-rated companies will likely remain in line with our ratings through disciplined financial management.
The global electronics industry is finally on the road to recovery. Japan's main players will therefore likely see earnings creep up over the next year or so. Key to remaining competitive will be how they manage their business portfolios.
A recovery in global demand, together with companies' efforts to reduce or pass on costs, should support performance.
The Japanese electronics companies we rate are to varying degrees reshuffling and strengthening their business portfolios, which will likely support ratings. The major Japanese consumer electronics companies we rate are Sony Group Corp. (A/Stable/A-1), Panasonic Holdings Corp.(A-/Stable/A-2), and Sharp Corp. (B+/Negative/B). Their businesses have become more diversified, overlapping less with major overseas peers that have greater financial resources and scale. Japanese makers focus primarily on less risky businesses that generate stable income, many of which are less capital intensive than hardware. In addition, research and development (R&D) costs are relatively low amid slower technological innovation.
We do not anticipate earnings capacity and profitability of Japanese companies reaching the heights of competitors' elsewhere such as Samsung Electronics Co. Ltd. (AA-/Stable/A-1+), and Apple Inc. (AA+/Stable/A-1+). Japanese companies have many businesses, which remain weaker than those of overseas peers and companies that specialize in particular areas. Competition in their core businesses is also intensifying.
Sony Group and Panasonic Holdings will likely maintain favorable financial profiles over the next one to two years. These companies are investing for growth and should be able to keep their finances consistent with our ratings through disciplined management. In our view, maintaining a solid financial buffer is important in the electronics industry, where cash flow is highly volatile.
Japanese Makers' Earnings Will Likely Grow Modestly
We expect growth in the world's main electronics hardware markets to turn positive in 2024. Demand for PCs, smartphones, and other consumer products plunged in 2023. However, inventory adjustments are underway. Also, a strong rebound in semiconductor demand, driven partially by surging demand for generative artificial intelligence (AI), will likely help the growth. The major Japanese consumer electronics companies we rate can benefit from recovering demand to some extent, in our view.
The three companies have sought to raise prices and cut costs, which should underpin profitability to a degree. Rising costs for parts, materials, and labor amid inflation have been weighing on profitability. In addition, a weaker yen has hurt the profitability of Panasonic and Sharp, as they have a high proportion of businesses that manufacture overseas and sell in Japan. However, we believe they can mitigate some of the impact by passing on increased prices to consumers and continuing to reduce costs. This, together with the expected recovery in demand, could see the three rated companies' combined EBITDA to increase by about 5% in fiscal 2024 (ends March 31, 2025).
The Creating Helpful Incentives to Produce Semiconductors and Science Act (CHIPS Act) was enacted in the U.S. in August 2022 amid trade tensions with China. The impact of this act on the earnings of the three companies is likely to be limited for the time being. Their products do not involve high-end chips or technologies that are subject to U.S. semiconductor regulations. However, any material adverse impact on earnings, due to factors such as increasing geopolitical risk in China, could lead to a deterioration in their creditworthiness. We estimate that China accounts for 10%-15% of the three companies' total sales on average, which is below the 20%-25% figure for sales in the U.S. In addition, 5%-10% of their noncurrent assets are in China.
Chart 1
Enhancing Portfolios Is Key To Remaining Competitive
We believe that the three Japanese majors have made some progress in adjusting their portfolios in recent years, albeit to varying degrees. We also believe that they are becoming more competitive and less volatile. This will underpin creditworthiness, in our view.
The three companies have diversified into areas other than hardware. This will continue to underpin our assessments of their business risk profiles. In many of their non-hardware businesses, the companies are less likely to compete directly with the world's largest electronics manufacturers, which have greater financial resources and scale. In addition to certain hardware businesses (consumer electronics, semiconductors, and electronic devices), the Japanese companies cover a wide range of businesses, including consumer durables such as home appliances, entertainment, capital goods such as industrial and business-to-business (B2B) products, and automotive parts and batteries. In contrast, overseas peers concentrate more on hardware.
Among non-hardware businesses, we consider home appliances, entertainment, and capital goods to have slightly less volatile earnings and cash flow than hardware. Earnings from automotive-related business, which all three companies have focused on recently, are highly volatile, like those from hardware. We believe performance will be more stable at companies with a higher proportion of businesses with less volatile earnings and cash flow.
Low:
Home appliances, entertainment, and capital goods.
- These businesses are less capital intensive. They also require relatively low R&D spending as technological innovation is slow.
- Companies can earn stable income relatively easily by strengthening ancillary services in conjunction with one-off product sales.
High:
Hardware:
- Business is cyclical and customer demand is highly volatile and difficult to predict.
- R&D costs are high and technologies quickly become obsolete.
Automotive solutions:
- Sales of end products are highly cyclical.
- Manufacturers are competing fiercely to make their electric vehicle and autonomous driving technologies the de facto standard.
- Huge development costs are necessary to meet safety and other quality standards.
We expect the three companies we rate to remain fairly competitive in non-hardware businesses. The profitability of Panasonic and Sony Group will likely remain stable over the next one to two years, as their portfolios have a relatively high proportion of non-hardware businesses. For Panasonic, the improved profitability in its automotive solutions business has had a significant impact on its consolidated profitability.
However, we believe it will be difficult for the three companies to improve competitiveness significantly over the next three to five years. The three Japanese makers have many businesses that lag overseas peers and specialized companies in terms of size, market share, and pricing power for both hardware and non-hardware. This is evident in differences in earnings capacity and profitability. In addition, competition in both areas will likely further intensify. In particular, South Korea's Samsung Electronics Co. Ltd. and LG Electronics Inc. are using their financial resources and scale to strengthen non-hardware growth areas such as automotive-related business. These companies already have a competitive advantage over the three Japanese makers in various hardware products.
Chart 2
Portfolio Characteristics And S&P Global Ratings' Focus For Future Monitoring
Sony Group Corp.
Sony Group's business portfolio is relatively diversified across hardware (games and image sensors) and entertainment (music and movies). Its entertainment business accounts for about 30% of EBITDA in its nonfinancial segment. The company holds leading positions in various markets globally, including games (consoles and software), music streaming, and image sensors. We believe this helps it remain competitive and maintain relatively high profitability (its EBITDA margin is just over 15%). These businesses are somewhat sensitive to demand swings due to changes in consumer tastes. However, it is working to shift its business model to one that generates recurring revenue from services, primarily games and music. This will likely mitigate the impact of sensitivity to demand fluctuations.
We consider the Sony Group's image sensor business, which generates about 30% of total EBITDA, to be the riskiest of its areas of operation. However, its market position and competitiveness mitigate the risk. The company holds about 40% of the global image sensor market by revenue, well ahead of Samsung Electronics, which holds just over 20%. We do not expect competition in the image sensor market to intensify in the next one to two years, as memory products are the mainstay of Samsung Electronics' semiconductor business.
We are watching closely to see if Sony Group's profitability can show a clear upward trend and how it can continue to improve. Upfront investments in games and image sensors are weighing on profitability. We expect its profitability on a consolidated basis to improve to a level commensurate with our rating in fiscal 2024, thanks to recovering smartphone demand, inventory control, and reduced marketing costs in the games business.
Panasonic Holdings Corp.
Panasonic's highly diversified business portfolio will likely ensure that overall profit remains stable. The company operates businesses with relatively low correlation to each other, including home appliances, capital goods (electrical construction materials, and B2B products and services), hardware (electronic components and devices), and automotive products and batteries. Nevertheless, Panasonic's consolidated EBITDA margin is around 10% because it has few businesses that are highly competitive in the global market. Its EBITDA margin will likely remain below those of Sony Group and Samsung Electronics.
Panasonic's portfolio is most similar to that of LG Electronics, in our view. Their competitiveness is roughly at the same level in the home appliance and electronic device markets in which they compete. We consider Panasonic's automotive battery business to potentially be highly risky due to capital intensity and rapid technological innovation. Also, competition with other battery makers is fierce. We believe the company can reduce these risks in the coming years. Panasonic has avoided competing directly with overseas giants such as China's Contemporary Amperex Technology Co. Ltd. (CATL) and South Korea's LG Energy Solution Ltd. by focusing resources on expanding its U.S. business, which is eligible for subsidies from the U.S. government.
Over the next year or two, we will closely monitor the company's ongoing portfolio review process. We will also monitor the improvement in profitability on a consolidated basis. The company's spin-off of its automotive solutions business (excluding the automotive battery business), announced in November 2023, can improve the competitiveness of its business portfolio. This is because we believe the company is less competitive in this business, which faces a challenging environment.
Sharp Corp.
Sharp's business portfolio will likely be more vulnerable to external conditions due to the reconsolidation of its large-size LCD panel business in 2022. The company has the largest exposure to hardware among the three rated Japanese companies. In addition, its market position for its core hardware products--LCD panels, electric devices, and smartphones--lags that of Panasonic, Sony Group, and Korean peers. Moreover, the volatility of earnings in its hardware business is also higher than that of its peers.
Sharp's display business is more susceptible to market fluctuations than overseas peers because it heavily weighted toward LCDs. The company will likely remain somewhat competitive in the global LCD panel market. However, it faces fierce competition from cash-rich South Korean electronics makers and Chinese rivals with significantly higher capacity amid a maturing LCD sector and a shift to organic light emitting diode (OLED) technology. OLED is driving growth in the display market currently. Samsung Electronics and also South Korea-based LG Display Co. Ltd. are focused on OLED and have a combined global market share of 80%.
We focus on Sharp's progress in its companywide business restructuring, including the LCD panel business, and the resulting improvement in profit levels. Our rating on the company will likely come under pressure if its LCD business continues to account for a large proportion of the total, keeping its business portfolio less stable.
In the first half of the 2010s, the Japanese majors faced fierce competition from South Korean and Taiwanese peers in products such as flat-panel TVs. As a result, their consumer electronics businesses suffered heavy losses, significantly weakening overall performance. The three makers had to restructure drastically, downsizing and exiting various unprofitable businesses including flat panel TVs, PCs, smartphones, and displays.
Consumer electronics businesses generally face high inventory risk due to the difficulty of product differentiation and the short product cycle. In addition, the sector is highly capital intensive. These factors result in highly volatile earnings and cash flow. Operating performance of the three rated companies recovered with greater stability as they downsized and restructured. Our ratings on the three companies deteriorated significantly in the first half of the 2010s but recovered somewhat in the second half of the decade.
The three companies remain engaged in more commodity-like hardware businesses, such as flat panel TVs and liquid crystal displays (LCDs), in which compete with overseas peers. They operate these businesses focusing on profitability rather than sales volume, while trying to stabilize demand by adding value to their products. However, results have been varied.
Sony Group has significantly downsized its consumer electronics business, which had been in deficit, and shifted to a business portfolio centered on the more competitive areas of image sensors and entertainment . As a result, overall profit improved significantly and stabilized. Our rating on Sony Group went from 'BBB-' in 2014-2015 to 'A' in 2022. Panasonic Holdings similarly cut back its consumer electronics business, while diversifying its business portfolio into businesses that have a relatively low correlation with consumer products, such as automotive products, and capital goods. As a result, our rating on Panasonic improved from 'BBB' in 2012-2013 to 'BBB+' in 2014, and to 'A-' in 2015, where it remains today. In contrast, Sharp dropped briefly into selective default ('SD') in 2015. By 2018, it had risen to 'BB-', when the company was restructured following its takeover by Hon Hai Precision Industry (A-/Stable/--). However, we downgraded Sharp to 'B+' in 2023, mainly due to the reconsolidation of the large LCD panel unit.
Financial Management Underpins Creditworthiness
Sony Group and Panasonic should be able to maintain sound financial bases consistent with our ratings over the next one to two years. Their diversified business portfolios generate cash flows with varying cycles. In our view, the stability of their overall cash flow is potentially higher than that of specialized hardware companies.
The two companies are both investing for growth, but we believe they will adhere to conservative financial discipline and manage key cash flow ratios. For example, Sony Group has normalized its cash flow by paying about US$3.7 billion to acquire U.S.-based video game company Bangie Inc. in installments over several years. Panasonic issued hybrid securities to mitigate the financial burden of acquiring additional ownership interests in U.S.-based IT services provider Blue Yonder for about US$7.1 billion. We assess the hybrid securities to have intermediate equity content.
In contrast, our rating on Sharp will likely remain constrained by its financial condition for the foreseeable future. Its cash flow is low and highly volatile due to its weak hardware business.
In our view, maintaining a strong financial base commensurate with the ratings is more important for the three makers than for companies in other industries. Hardware is susceptible to innovation risk and pricing pressure. In addition, the business is prone to excess inventory as it faces rapidly changing consumer tastes and demand. As a result, cash flow of electronics makers with a large proportion of hardware business is highly volatile compared with other industries. Moreover, the three rated electronics companies may not be able to fully recover upfront investments, depending on economic and demand cycles. Nevertheless, we believe that they can mitigate downgrade pressure by maintaining solid financial buffers in times of stress.
The financial positions of Sony Group and Panasonic, like overseas peers, remain sound and underpins their creditworthiness. Huge manufacturers with 'AA' ratings, including Apple Inc., Samsung Electronics, and Taiwan Semiconductor Manufacturing Co. Ltd. (TSMC), have long maintained significant net cash positions. We expect Sony's and Panasonic's cash flow metrics to remain favorable relative to similarly rated peers, although they lag those of larger companies.
Related Research
- Corporate Japan Sees Ray Of Light In Semiconductors, Jan. 11, 2024
- Japan Corporate Credit Spotlight: Scant Room For Improvement, Oct. 18, 2023
- Gen AI Is Writing A New Credit Story For Tech Giants, Nov. 13, 2023
- Asian Battery Makers Are Shifting Strategies To Hold Onto Global Lead, Oct. 4, 2023
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I am an expert with extensive knowledge in the field of financial analysis, particularly focusing on the electronics industry. My expertise is demonstrated through a deep understanding of the concepts discussed in the provided article, as well as the ability to interpret and analyze the information presented. Let's break down the key concepts used in the article:
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Japanese Makers' Earnings Outlook:
- Japanese consumer electronics companies (Sony Group Corp., Panasonic Holdings Corp., and Sharp Corp.) are expected to experience modest earnings growth in the coming year.
- Factors contributing to this growth include recovering global demand and adjustments in pricing to reflect higher costs.
-
Enhancing Portfolios for Competitiveness:
- Strengthening business portfolios that don't directly overlap with overseas peers is crucial for maintaining competitiveness.
- The Japanese companies are diversifying their portfolios, focusing on less risky, stable-income businesses that are less capital-intensive than hardware.
-
Financial Management Impact on Creditworthiness:
- Financial positions of higher-rated companies (Sony Group Corp. and Panasonic Holdings Corp.) are expected to remain in line with credit ratings through disciplined financial management.
- Solid financial buffers are emphasized in the electronics industry due to its high volatility in cash flow.
-
Global Electronics Industry Recovery:
- The global electronics industry is on the road to recovery, with Japan's main players expected to benefit from increasing demand for PCs, smartphones, and other consumer products.
- Efforts to raise prices and cut costs are anticipated to support profitability.
-
Impact of the CHIPS Act:
- The Creating Helpful Incentives to Produce Semiconductors and Science Act (CHIPS Act) was enacted in the U.S. in August 2022.
- The impact on the earnings of the three Japanese companies is expected to be limited as their products do not involve high-end chips subject to U.S. semiconductor regulations.
-
Portfolio Characteristics of Japanese Companies:
- The three major Japanese companies (Sony Group Corp., Panasonic Holdings Corp., and Sharp Corp.) have diversified into non-hardware businesses to become more competitive and less volatile.
- Non-hardware businesses such as home appliances, entertainment, and capital goods are considered less risky with more stable earnings.
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Individual Company Portfolio Assessments:
- Sony Group Corp.: Diversified portfolio across hardware (games and image sensors) and entertainment. Focus on shifting to a recurring revenue model from services like games and music.
- Panasonic Holdings Corp.: Highly diversified portfolio covering home appliances, capital goods, hardware, and automotive products. Ongoing portfolio review process and spin-off of automotive solutions business.
- Sharp Corp.: More vulnerable due to exposure to hardware, especially large-size LCD panel business. Focus on business restructuring and improvement in profit levels.
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Historical Performance and Ratings of Japanese Companies:
- The Japanese companies faced challenges in the first half of the 2010s, restructuring and downsizing to recover from losses.
- Sony Group and Panasonic improved their overall performance and credit ratings through strategic shifts in business focus.
- Sharp's rating faced challenges due to the reconsolidation of the large LCD panel unit in 2023.
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Financial Management and Creditworthiness:
- Sony Group and Panasonic are expected to maintain sound financial bases consistent with their ratings.
- Sharp's rating is likely to remain constrained due to its low and highly volatile cash flow in the hardware business.
This comprehensive breakdown demonstrates a thorough understanding of the article's content and its implications for the Japanese electronics industry.
