Hyundai Rotem is writing a 'reversal drama'. Hyundai Motor Group was branded as a 'financial inferior' due to the contraction of its core business, the railway sector, and massive losses from overseas plant projects.
There are many forecasts that the credit rating, which has been downgraded due to a large earnings rebound, will soon find its way back. However, there are opinions that we should wait and see as the uncertainty of overseas business is still intensifying as competition for orders in the Korean market is intensifying.
Despite being BBB-level, the popular ‘Captain’
In June of this year, there was a lot of controversy inside and outside the market over Hyundai Rotem, which appeared in the public offering corporate bond market. Many view that it will be difficult to attract institutional investors due to the expected interest rate hike and low credit rating. On the other hand, given the business and financial prospects and attractiveness of investment, some expect that it will be a successful box office success.
Established in 1999, Hyundai Rotem focuses on the production of railway vehicles. The railroad business divisions of three companies, Hyundai Precision Industry Co., Ltd., Daewoo Heavy Industries, and Hanjin Heavy Industries, were merged to form the current shape. It was incorporated into Hyundai Motor Company in 2001, and as of March of this year, Hyundai Motor is the largest shareholder with a 33.8% stake.
Its main business is the railway sector, which produces trains and carriages, but it is also engaged in the defense industry, which produces ground weapons such as tanks and armored vehicles, and the plant business, which manufactures automobiles and steel facilities.
It is not unusual for affiliates of large conglomerates to raise funds in the public offering corporate bond market. However, Hyundai Rotem is a little different. It is the first time in two years since 2019 that it appeared in the publicly traded corporate bond market.
At the time of the last corporate bond issuance two years ago, Hyundai Rotem's credit rating was A-. Although it was placed at the bottom of Class A, it did not have much difficulty in securing demand from institutional investors due to its semi-monopoly market position in the railroad sector and sales stability due to large-scale order backlog.
But in March of last year, the mood changed. The railway division, the main business, suffered an operating loss of 259.5 billion won in 2019 due to additional costs due to design changes in domestic and overseas projects, recognition of sales of low-priced projects, and delays in the process. Due to the nature of the order-taking business, it is not easy to raise financial stability in a short period of time due to the burden of working capital due to the progress of the project. At the end of 2019, the debt-to-equity ratio soared to 362.6%, shaking financial stability.
Korean credit rating agencies were forced to downgrade Hyundai Rotem's credit rating to BBB+. A- and BBB+ are one step apart, but there is a big difference in the level of credit risk perceived by the bond market. As a result, companies whose credit ratings have been downgraded from A- to BBB+ have no choice but to bear the expanded financial burden as the interest rates on corporate bonds have risen significantly in a short period of time.
Recognizing this situation, Hyundai Rotem has not appeared in the corporate bond market for the past two years. This is because if institutional investors' investment demand cannot be secured or the competition rate for demand forecasting is remarkably low, it will not only damage their reputation but also make it difficult to implement financial strategies.
It is for this reason that there was a lot of concern both inside and outside the market over Hyundai Rotem's return to the corporate bond market.
However, when the lid was opened, the market's concerns were nothing but false. 258 billion won was poured into the forecast of 50 billion won corporate bond issuance demand. This means that there were that many institutional investors who wanted to invest in Hyundai Rotem corporate bonds, and it was possible to raise funds at the lowest interest rate ever. Due to the high demand, the issuance of corporate bonds also increased by 68 billion won from the original estimate.
Of course, the recent boom in the public offering market is also a factor. This is because high-yield funds contain BBB grade corporate bonds, which are competing to receive more public offering shares of companies that are going public.
However, the prevailing view is that Hyundai Rotem's high investment attractiveness has attracted institutional investors. This is because the company's financial condition improved rapidly as it successfully turned to the black last year. This year, Korean credit rating agencies are evaluating Hyundai Rotem's credit rating outlook as 'positive'. In the future, we can expect an increase in investment profit following the credit rating upgrade.
The favorable market response allowed Hyundai Rotem to take a breather. The issuance of corporate bonds has a special meaning for Hyundai Rotem. In addition to the one-dimensional goal of raising funds, it was an opportunity to gauge the market's perception and trust in Hyundai Rotem, which underwent intensive restructuring.
Changed order quality... Further improvement is 'well'
Market participants are cautiously predicting that Hyundai Rotem will regain its A-grade credit rating as early as this year. Since 2015, sales have continued to decline due to a sharp decline in orders in the railway sector and a slowdown in orders in the plant sector, but new orders have been revived and earnings have been growing since 2019.
As of the end of last year, the order backlog was about 9 trillion won. Although there are differences by year, on average, new orders worth 3 trillion won are received every year, which is equivalent to the size of sales.
It is also evaluated that the quality of the order backlog is improving. Jaeho Choi, a research fellow at Nice Credit Ratings, said, “The ratio of the railroad sector, which has relatively low business risk, to the order balance has risen from 58% in 2014 to 80% since 2018. The percentage is gradually increasing.”
In the plant sector, which suffered large-scale operating losses due to high business risk, selective orders were made centered on related projects or projects with a lot of business experience, and the ratio of the order balance decreased from 21.2% in 2014 to less than 4% last year. As delivery to the railroad and defense divisions is expected to increase in the future, sales growth is expected to continue.
Operating profitability is also on the rise. Hyundai Rotem's fixed cost burden increased due to sales slowdown in 2018-2019, and its profitability deteriorated significantly due to accidental losses in the railway and plant divisions. Hyundai Rotem's profit before interest and tax (EBIT) compared to sales in 2018 was minus 8.1%. In 2019, it recorded minus 11.4%.
To overcome the difficulties, Hyundai Rotem carried out high-strength restructuring. By entering into an emergency management system, the number of executives was reduced and the cost was reduced by consolidating the organization. It sold part of the site in Uiwang, Gyeonggi-do to Hyundai Mobis, and also sold its stake in Green Air, a subsidiary of industrial gas supplier, to Hyundai Steel. As a result of such self-rescue efforts, EBIT as a percentage of sales increased to 3.9% as of the first quarter of this year.
Financial stability is also expected to gradually improve. As of March of this year, Hyundai Rotem's debt ratio stood at 218.3%, and its dependence on net debt stood at 14.6%. The debt ratio, which had risen to 362.6% in 2019, has been significantly reduced. Total borrowings, which exceeded 1.8 trillion won in 2016, were also reduced to 1.189 trillion won in March this year due to the implementation of the self-rescue plan.
However, there are still many challenges to be solved. Some analysts say that it is not easy for Hyundai Rotem to stably expand its ability to generate profits and maintain operating profitability. This is because the industry itself has entered a mature stage and conditions for order receipt are deteriorating due to intensifying competition.
Although Hyundai Rotem is expanding exports to secure growth potential, it is in a situation where it has no choice but to bear risk factors such as the burden of new designs, preference for quality standards different from those of Korea, and local circumstances.
Kwang-Hoon Ji, a senior researcher at Korea Enterprise Ratings, said, “We have to compete in technology and reputation with global leading companies such as Siemens and Alstom, and price competition with Chinese companies is inevitable.” “There is always a structural risk depending on the exchange rate of the national currency,” he said.
