For Japanese corporate entities, uncertainty is growing.

S&P Global Ratings believes that the outlook for the operating performance of Japanese corporate entities for fiscal 2024 has been clouded by a number of factors. Over the summer, the Japanese yen appreciated sharply against the U.S. dollar. The Japanese stock market has also experienced significant volatility over the past couple of months.

Having said that, the impact on the creditworthiness for Japanese corporate companies we rate will be limited for the time being. These corporations are breaking performance records and of sound financial standing.

We expect improvement in the operating performance of Japanese companies to lose momentum to a degree. A slowdown in the global economy, particularly in the U.S., is one factor behind the recent sharp appreciation of the yen. Overseas sales account for about 40% of total sales for Japanese corporations; the U.S. accounting for about 20% as the largest export market for Japan. Therefore, a weaker U.S. economy is a drawback for the performance of Japanese corporates. In addition, since 2023, Japanese corporate issuers we rate have resumed acquisitions of foreign companies, mainly in the U.S. A slowing economy increases the risk of delayed recovery of acquisitive investments.

Significantly higher currency volatility could obscure the business prospects of Japanese companies. Moreover, it could affect their growth and financial strategies. Operating performances of many export-oriented Japanese corporations, such as automakers and electronics companies, have generally benefited from factors such as the weaker yen over the past two years. Even so, benefits from a weaker currency have faded in recent years. This is in part because the companies have increased overseas production to try to control the impact of currency fluctuations.

In addition, for general trading and investment companies and investment holding companies, the main business is investment. Significant volatility in domestic and overseas stock markets could lead to a decline in the price of the shares of the companies they invest in. If the decline in stock prices leads to deteriorations of their financial soundness, it would have a negative impact on their creditworthiness.

Here, S&P Global Ratings presents frequently asked questions from investors about the impact of the slowdown of the global economy, in addition to volatility in the value of the yen and stock prices, on the performance and creditworthiness of Japanese companies.

Frequently Asked Questions

What is the impact of the yen's appreciation since July 2024 on the performance of Japanese issuers you rate?

Continued yen appreciation would weaken Japanese companies' ability to boost operating performance, in our view. Many manufacturers, which accounted for about 27% of total sales of all Japanese companies in 2022, export. Their overseas sales have reached almost 40% of overall sales. A weaker yen can benefit sales and profit for exporters. There were similar superficial benefits for companies that produce and sell overseas through currency translations. Contrarily, a stronger yen would depress their operating performance.

For companies that import and sell their products in Japan, or import fuel materials, yen appreciation would be beneficial. A strong yen reduces the prices of goods, raw materials, and fuels imported from overseas, meaning these companies can reduce costs.

Against the U.S. dollar, the yen has depreciated by about 40% since 2021. At the end of that year, the dollar exchanged for slightly more than ¥115. In early July 2024, the dollar traded upward of ¥160. Since the middle of that month, the yen has strengthened; the dollar now exchanges for about ¥146-¥147, about 10% less than it did two months earlier. Having said that, the yen remains weaker than it was in 2021. This weakness underpins the performance of issuers we rate in Japan that primarily export or produce and sell overseas.

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What other external factors could affect the operating performances of Japanese corporate entities over the next one to two years?

In addition to yen volatility, the performance of the Japanese and global economies will have a significant effect on Japanese corporate entities. The ratio of overseas sales is close to 40% for Japanese manufacturers. They are therefore susceptible to not only the Japanese economy but also major overseas economies such as the U.S. and China. Moreover, domestic demand-oriented entities, including retailers and consumer goods companies, have expanded overseas as a growth strategy as the domestic market matures. Their earnings have thus become more susceptible to economic and consumption trends in major overseas countries.

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Japanese companies are particularly vulnerable to the economic slowdown in the U.S., Japan's largest export market. In the U.S. market, Japanese companies have not only increased exports but also increased direct investment as demand recovered rapidly after the pandemic. In the U.S., we expect that policy rate cuts will begin in September 2024, several months earlier than we had previously assumed, as the slowdown in employment demand intensifies.

The slow recovery in China, the second largest export market after the U.S., also makes the outlook for some sectors more uncertain. China accounted for 17.6% of Japan's exports in 2023. Weaknesses in the Chinese economy are conspicuous in various areas, including real estate, and sluggish consumer sentiment is tightening purse strings. In addition, Chinese manufacturers have enhanced competitiveness in various fields, including automobiles, electronics and appliances, and machinery. We expect Japanese companies to continue to face tough competition with Chinese manufacturers at home and abroad.

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What does growing uncertainty over earnings forecasts mean for the credit outlooks for Japanese companies you rate?

We generally expect stability. For now, we don't expect to revise down our expectations for the creditworthiness of Japanese companies we rate despite uncertainty over performances. We assume the somewhat increased uncertainty about operating performance will not have a significant impact for now. For Japanese companies we rate, 90% of our long-term issuer credit ratings are stable, compared with 77% for U.S. corporate issuers.

About 87% of Japanese corporations we rate have investment-grade ratings ('BBB-' or higher), with stronger business bases and sound financial standing. The median debt to EBITDA ratio for the investment-grade companies remained at a healthy level of slightly less than 1.4x in fiscal 2023. While we expect the improvement in EBITDA for these companies to be slow, we assume that debt is likely to increase moderately due to increases in growth investment, through capital expenditures and mergers and acquisitions (M&A), and shareholder returns. Nevertheless, we expect the ratio to remain at a favorable level of slightly more than 1.6x in fiscal 2024.

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For Japanese companies as a whole, mounting pressure from shareholders through various channels will continue to weigh on their financial standing for the time being. To improve shareholder value and capital efficiency, if Japanese companies make excessive growth investments, large M&A, or hefty shareholder returns, such measures will worsen the financial standing and exert pressure on creditworthiness. In fact, major Japanese listed companies' free cash flow after shareholder returns has been significantly negative. If free cash flow after shareholder returns, which is used to repay debt, continues to decrease over the long term, or if companies incur extreme financial burdens more often, financial headroom as a buffer for potential future deterioration of the external environment will shrink. Accordingly, we consider this a negative factor in our assessment of creditworthiness.

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What are the prospects of operating performance for major sectors?

The prospects for the automotive and electronics sectors are as follows:

Automotive

• Global vehicle sales growth is likely to slow to 1%-3% in 2024 and 2%-4% in 2025 from 2023 levels as supply and demand normalize.
• Japanese automakers need time to improve operations in China, but we expect moderate sales growth in other regions, continued cost reductions, and strong sales of hybrid vehicles to support performance and profitability.
• Despite continued high levels of investment in next-generation technologies such as electrification and autonomous driving, Japanese automakers' strong financial positions relative to global peers will support creditworthiness.

Electronics

• Globally, major companies will benefit from the generative AI boom. Sales of semiconductor makers and server suppliers for data centers, both of which are essential for generative AI, have been expanding. Stock prices of those companies and others providing cloud platforms, large language models, and services have been soaring. Beneficiaries include Taiwan Semiconductor Manufacturing Co. Ltd. (TSMC), Nvidia Corp., SK Hynix Inc., Samsung Electronics Co. Ltd., Cisco Systems Inc., and Foxconn Industrial Internet Co. Ltd.
• In Japan, there are very few competitive semiconductor and server manufacturers that can benefit from generative AI.
• IT services companies NEC Corp. and Fujitsu Ltd., as well as telecom companies Nippon Telegraph and Telephone Corp. and Softbank Corp., have tried to provide services using generative AI. However, their focus is domestic and contributions to earnings are likely to be limited for the time being.

If Japanese interest rates increase further, how will this affect companies that you rate in the country?

For Japanese companies we rate, we do not expect increases in interest expenses due to rising interest rates to lead to significant decreases in profit. In March 2024, the Bank of Japan (BOJ) began paring back from large-scale monetary easing, including ending its negative interest rate policy. The central bank raised interest rates for the first time in 17 years on the grounds that it could confirm the beginning of a virtuous cycle of wages and prices. In July, the BOJ decided to again raise its policy interest rate, to around 0.25%, but this remains significantly lower than rates in other countries. According to a simulation analysis we published in October 2023, we assumed a rise in fixed long-term borrowing rates of +0.4 percentage point (ppt) and +0.2 ppt for floating short-term borrowing, with 25% long-term and 75% short-term borrowings. We then estimated only a slight decline of 2% in corporate sector operating profit (see "Japan Is Robust Enough For Rising Yen Rates," published Oct. 12, 2023).

Moreover, the Japanese corporates we rate 'BBB-' or above (investment grade) have an average funding interest rate of about 1.2%. Debt maturities are well diversified, and the ratio of fixed interest rates is sufficiently high. Therefore, if interest rates rise, the pace of increase in interest expenses is likely to remain moderate. On the other hand, in industries that rely heavily on debt, such as railways and electric utilities and gas, a further rise in interest rates could depress interest coverage ratios. In addition, in cases of companies rated 'BB+' or lower (speculative grade), or with large amounts of debt funded in foreign currencies, such as U.S. dollars and euros, an increase in interest expenses could weigh on profits.

Will stock price volatility in Japan and elsewhere affect the performance of Japanese companies?

We expect the direct impact on the performance for most Japanese companies to be small. This is because profits and cash flows of companies are basically generated from business, not investments in stocks. Having said that, a large decline in the stock market would indicate an economic slowdown or recession, which may increase uncertainty on the future performance of companies, as they are closely linked to the economy. In addition, we think that companies would be more cautious in making decisions on growth investments, tempering future business expansions.

After reaching a record high in July 2024, the Nikkei 225 experienced a historic crash in August, falling about 25% within two weeks from a peak. Then, it fluctuated wildly, rising about 20% within a week.

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In the case of companies with large holdings of listed stock, including cross-shareholdings, a significant decline in stock prices could push down accumulated other comprehensive income (under Japanese generally accepted accounting principles, other components of equity under International Financial Reporting Standards), which is part of its equity. In the case of a stronger yen, foreign currency translation adjustments will decrease and, as a result, equity will also decrease.

When analyzing financial conditions of corporate entities, we basically focus their ability to repay debt through cash flow from business. We do not pay significant attention to assessments of equity ratios. However, we think in some cases, a company's creditworthiness will likely be under pressure if stock prices are volatile and currency exchange rates would make financial bases less stable. Such cases include:

• Companies with weak competitiveness in their core businesses and little accumulation of profits in equity;
• Those likely to record impairment losses;
• Companies in which the proportion of valuation items such as stocks and foreign exchange in equity is high.

In addition, for companies whose main business is investment, such as general trading and investment companies and investment holding companies, a decline in stock prices leads to a deterioration in the valuation of business investees (risk assets) or investment portfolio. For general trading and investment companies, a decline of capital adequacy ratio, which serves as a buffer to risk assets, has a negative impact on our creditworthiness assessments. This is also the case for investment holding companies if their loan to value ratios rise. We define this ratio as adjusted debt divided by our estimated portfolio value.

Related Research

• Japanese Companies Hear Shareholders: Reverberations For Ratings, Aug. 12, 2024
• Credit FAQ: Japanese Business And Yen Weakness, June 6, 2024
• Asia-Pacific Corporate Credit in 2024: Taking The Slow Road, Jan. 30, 2024
• Japan Is Robust Enough For Rising Yen Rates, Oct. 12, 2023