Key Takeaways
- Korean corporates are embracing more risk for the purpose of expansion and diversification into new businesses. Such efforts could strengthen business fundamentals, while weakening financials.
- Rating actions on Korean corporates year-to-date are tracking slightly negative; while earnings are rising, so are debt levels due to high investment needs.
- We believe sectors contending with increased supply from China (chemicals and steel) and with high debt-funded investment needs (EV battery) may be pressured in the next 12 months.
- The semiconductor and auto sectors will likely sustain solid earnings momentum on the back of strong market positions.
Korean corporates embrace risk. They operate in a midsize market that is export-focused and fully exposed to trade wars and disrupted supply chains. This exposure encourages Korean corporates to seek opportunities; they may invest heavily to capitalize on these opportunities.
S&P Global Ratings believes the embrace of risk is a key theme running across Korean corporate sectors. Bond investors are exposed: our net rating bias is trending in a modestly negative direction. We are seeing firms increase debt and leverage. Often this is paired with raising profits as entities push into new product categories or sectors.
Sometimes the gains are substantial (as is the case with SK hynix Inc.) and sometimes firms experience bumps during the ramping up (SK Innovation Co. Ltd. and LG Energy Solution Ltd.). But if Korea Inc.'s risk stance could be summed up simply, it would be: strengthening business fundamentals, weakening financials.
China's Industrial Push Is Squeezing Korea
The Chinese petrochemical sector is rapidly adding capacity, and its steelmakers are creating oversupply in the market. This increases competitive pressure on their Korean counterparts, hurting the profitability of LG Chem Ltd., Posco and Hyundai Steel Co.
Chinese petrochemical companies have pursued aggressive expansion, installing new capacity at a rate far faster than the global average (see chart 1). This was spurred by Chinese government initiatives and industrial polices supporting domestic production. Spreads on key chemical products have dwindled amid increased competition from Chinese players seeking exports to offset a significant increase in output.
In our view, market overcapacity is an ongoing structural issue that will persist over the next two to three years. Korean petrochemical companies such as LG Chem, SK Geo Centric Co. Ltd. and Hanwha Totalenergies Petrochemical Co. Ltd. will likely continue to face significant margin pressure.
We see a similar situation in the steel sector. An influx of cheap Chinese steel into the global market has squeezed steel product prices, hitting the profitability of Korean steelmakers such as Posco and Hyundai Steel (see chart 2).
Chart 1
Chart 2
EVs are the future, just not yet
The electric vehicle (EV) related sectors are at a tricky juncture. The long-term growth outlook remains strong. However, sales growth for BEVs (battery electric vehicles) and their batteries has undershot firms' projections, exactly as they ramp up capital expenditure (capex) (see chart 3).
This dynamic will likely drive up leverage for LG Energy Solution Ltd. and LG Chem Ltd. Both firms have invested heavily in making batteries and battery materials for BEVs, and have been caught out by the global sales growth slowdown. We have a negative ratings outlook on both entities (see "LG Chem, LG Energy Solution Outlook Revised To Negative On Aggressive Expansion Investments; 'BBB+' Ratings Affirmed," May 28, 2024).
The Korean EV battery firms are also in competition with Contemporary Amperex Technology Co. Ltd. (CATL). The world's biggest Chinese EV battery maker has a more disciplined investment policy and a stronger balance sheet. Such differences have meant that LG Energy Solution's free operating cash flow is negative, while CATL's net cash balance is rising (see chart 4).
Chart 3
Chart 4
Posco group is also pushing into the EV battery value chain, partly to achieve growth outside its core steelmaking business. The diversification is costly: Posco Holdings Inc.'s capex in 2023 was more than double that of three years prior. As a result, its adjusted debt has grown over 50% in the same period (see chart 5).
Chart 5
Posco group's increased capex is largely about the group's plans to expand production of EV battery materials, particularly in upstream materials and EV battery materials. The significance of this expansion to the group is captured in the name of the unit undertaking the EV battery material investment: Posco Future M. (see "Posco Holdings And Posco 'A-' Ratings Affirmed On Likelihood Of Disciplined Financial Policy; Outlook Stable," June 24, 2024).
SK Group Flies The Flag For Aggressive Expansion
Korean entities are generally assertive in their approach to risk, but SK Group is a notch above most. That is partly because the conglomerate is putting a lot of its focus on EV batteries and EV battery materials, in addition to large investments required for semiconductors. The leverage of SK Group's main units is rising quickly.
The group's battery-making business has an advantage over Chinese battery makers: its access to the U.S. market. The Inflation Reduction Act (IRA) in the U.S. and other trade hurdles have kept Chinese battery makers from investing in the U.S. Into that void has come the likes of SK Innovation, which plans to increase its global EV battery production capacity to more than 199 gigawatt hours (GWh) in 2025, from 88GWh in 2023.
Most of this expansion will be in the U.S., where they are eligible to receive policy benefits. These include advanced manufacturing production credits, a federal tax credit under the IRA to incentivize manufactures to produce in the U.S. (see "Korea Is On The Brink Of A Battery Boom," Dec. 6, 2022).
Unfortunately for SK Innovation, growth in demand for BEVs has slowed globally (see chart 3), while their immediate investment burden remains high. We downgraded the firm to 'BB+' in March 2024, reflecting rising leverage amid weaker EV growth (see "SK Innovation And SK Geo Centric Downgraded To 'BB+' On High Investments Amid Slack Battery Demand; Outlook Stable," March 19 , 2024).
SK Innovation's adjusted debt balance almost quadrupled over 2018-2023. Its leverage has spiked largely because of the steep upfront investment burden of pushing into EV batteries (see chart 6). The company and the broader SK group are working on ways to improve their financial position through restructuring and tighter cost management.
Chart 6
Other bets have paid off for the group. For example, the Korean chipmaker SK hynix took a big gamble on high bandwidth memory (HBM), a niche component that has recently proven integral to AI systems.
The firm has established a leading sales position in the latest generation of HBM chips. Largely on the back of its strong HBM sales, we assume SK hynix (BBB-/Stable/--) will likely lower its leverage below our upside trigger of 1.0x for 2024 (see "From Bust To Boom: How AI Is Uplifting The Korean Memory Makers," July 2, 2024).
Chart 7
Hyundai-Kia: The Exception That Proves The Rule
Hyundai Motor Co. and Kia Corp. have both recently demonstrated more disciplined investments. This coupled with their improved business fundamentals over the past couple of years is boosting the group's net cash positions, which are positive and rising.
The entities take a fast-follower approach--while not necessarily the first to pioneer the segment, they are well positioned to adapt to fluctuations in market demand, as they did during the recent slowdown in the BEV segment.
For example, Hyundia-Kia have solid hybrid sales, while Stellantis N.V. and Volkswagen AG do not (see chart 8). Toyota Motor Corp. does make very good hybrids, but is hardly present in the BEV category, while Hyundia-Kia do make BEVs.
We assume Hyundia-Kia's profitability will be strong over 2024 largely due to their better product and geographic mix. They have credible offerings across the internal combustion engine (ICE), hybrid and BEV categories.
This has helped the entities navigate the carmaking industry during its transition. For example, when BEV sales growth faltered over the year, the firms were able to capture rising interest in hybrids, which many consumers viewed as a good bridge between ICE and BEVs (see chart 9).
Chart 8
Chart 9
A Urge To Diverge
The credit picture of Korea Inc. at midyear is very much a moving target. The solid performance of semiconductor firms and carmakers should persist over the next 12 months. However, the credit metrics for entities in the chemical, EV battery, and steel sectors will likely be under pressure.
This reflects the ebb and flow of sales in different segments. The semiconductor sector 12 months ago was in a steep cyclical downturn; demand for AI systems has only recently put the sector into high growth. The thread connecting many of these entities is an appetite for risk, in our view.
Korean corporates lack few of the defensive advantages of some of their global peers. They don't have a large domestic market to fall back on. Also, Korea's high dependance on external markets limits the government from implementing strong protectionist policies such as high import tariffs.
For many of these entities the best defense is offense, and that translates into capex and related investment that often outpaces competitors. For investors in Korean firms this often means greater volatility, and steeper swings both upside and downside.
Writer: Jasper Moiseiwitsch
Digital Designer: Evy Cheung
Related Research
- From Bust To Boom: How AI Is Uplifting The Korean Memory Makers, July 2, 2024
- Posco Holdings And Posco 'A-' Ratings Affirmed On Likelihood Of Disciplined Financial Policy; Outlook Stable, June 24, 2024
- LG Chem, LG Energy Solution Outlook Revised To Negative On Aggressive Expansion Investments; 'BBB+' Ratings Affirmed, May 28, 2024
- Krakatau Posco Assigned 'BBB-' Rating With Stable Outlook, May 17, 2024
- Hanwha TotalEnergies Petrochemical Outlook Revised To Negative On Weak Profitability; 'BBB' Ratings Affirmed, April 30, 2024
- Doosan Bobcat Upgraded To 'BB+' From 'BB' On Robust Profitability And Solid Financial Metrics; Outlook Stable, April 29, 2024
- GS Caltex Upgraded To 'BBB+' On Ongoing Debt Reduction With Disciplined Investment; Outlook Stable, March 25, 2024
- SK Innovation And SK Geo Centric Downgraded To 'BB+' On High Investments Amid Slack Battery Demand; Outlook Stable, March 19, 2024
- KCC Corp. 'BB+' Rating Affirmed Despite Narrow Headroom; Outlook Stable, Feb. 28, 2024
- Hyundai Motor Co. And Kia Corp. Outlook Revised To Positive On Strong Profitability; Ratings Affirmed, Jan. 24, 2024
- Korea Is On The Brink Of A Battery Boom, Dec. 6, 2022.
This report does not constitute a rating action.
| Primary Credit Analysts: | JunHong Park, Hong Kong + 852 2533 3538; junhong.park@spglobal.com |
| Jeremy Kim, Hong Kong +852 2532 8096; jeremy.kim@spglobal.com | |
| Secondary Contacts: | Ji Cheong, Hong Kong +852 25333505; ji.cheong@spglobal.com |
| Taehee Kim, Hong Kong +852 25333503; taehee.kim@spglobal.com |
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