OREANDA-NEWS. Fitch Ratings has affirmed South Korea-based Hyundai Motor Company's (HMC) and its subsidiary Kia Motors Corporation's (Kia) Long-Term Foreign-Currency Issuer Default Ratings (IDR) at 'BBB+' with a Stable Outlook. Fitch has also affirmed the companies' senior unsecured ratings at 'BBB+' and their Short-Term Foreign-Currency IDRs at 'F2'. The ratings on notes issued by HMC's subsidiary, Hyundai Capital America, have also been affirmed at 'BBB+'.

The ratings and Stable Outlooks on HMC and Kia are supported by their solid financial profile and status as low-cost mass-market auto producers with high capacity utilisation and a well-diversified sales and product portfolio. Fitch has also taken into account the companies' near-term profitability pressure, higher capex and rising competition.

KEY RATING DRIVERS

Mixed Operating Performance: HMC reported a 16% decline in its operating profit from non-financial operations in 2015, with slower sales growth and rising costs, including depreciation and amortisation. Operating profit fell by a further 5% in 1H16. Kia posted similar trends in its 2015 performance, but reported a 21% yoy operating profit improvement in 1H16 (2015: -9%), due to a better product-mix, especially in its more profitable domestic market. However, the near-term outlook remains uncertain, with potential slowing of key markets, such as the US and Korea. We expect a slight rise in EBITDA in 2016-2017 for both companies, reflecting modest revenue growth, but operating profit is likely to remain mostly flat due to higher depreciation and amortisation costs.

Near-Term Industry Outlook Uncertain: Fitch expects global light-vehicle sales to show low-single-digit growth in 2016, with growth to remain robust in Western Europe and China, which has recovered after slowing in 2015. This is offset by slower growth in the US, as sales have now surpassed pre-2008 financial crisis peaks, and weakness in emerging markets, including Brazil and Russia. Sales in the domestic market are also expected to slow due to the expiry of a temporary excise tax-cut in June 2016. Furthermore, we expect higher competition and increased capacity to weigh on pricing and potentially increase incentives in various markets.

Declining FX Exposure: Foreign-Exchange (FX) volatility remains an important factor in HMC's and Kia's profitability due to their reliance on exports. Around 40% of HMC's manufacturing capacity was in Korea at end-2015, with the country accounting for about 15% of total global sales. About 55% of Kia's capacity is from its Korean facilities, as it started overseas production later than HMC. Both companies have expanded their overseas manufacturing capacity in the previous decade, which has reduced the effect of currency fluctuations on earnings. Exports out of their Korean facilities have also continued to fall. Most recently, Kia completed a new plant in Mexico, which should lower shipments from Korea and support sales in North and South America. We expect further overseas capacity expansion, which should continue to lower volatility in the companies' earnings due to FX movements.

Increasing Capex: Lower profitability and higher capex due to increasing R&D expenses are likely to squeeze FCF. We expect HMC and Kia's capex to gradually rise over the medium-term due to increased investment in power train improvement, expanding green-car line-ups and the build-up of HMC's new Genesis luxury brand.

Solid Financial Profiles: We expect HMC and Kia to revert back to positive FCF generation in 2016, after a large one-off land purchase resulted in negative FCF in 2015. The combined net-cash position of the companies' non-financial operations rose to KRW13.7trn in 1H16 (2015: KRW12.9trn). We expect continued improvement over the next two to three years, albeit at a modest pace, and a resulting combined adjusted net-debt/EBITDAR ranging around -1.0x to -1.1x (2015: -1.1x)

Linked Ratings: Fitch believes Kia is integral to HMC's long-term growth strategy as a global auto-maker as well as to its group structure and as such, Kia's ratings are equalised with HMC's ratings. The two companies share strong strategic and operational ties, including platform integration, shared R&D and procurement and the same senior management team led by Hyundai Group chairman. Fitch does not see a change in the strong linkages between the two companies, even though Kia's financial statements are no longer consolidated into HMC's. Fitch assesses Kia's standalone credit profile at 'BBB'.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for HMC and Kia include:

- KRW/USD of 1,150 in 2016 and 1,120 after 2016

- nearly flat retail sales volume in 2016, with 2%-3% growth in 2017-2018

- capex of KRW4.6trn for HMC and KRW2.6trn for Kia in 2016, increasing gradually afterwards.

RATING SENSITIVITIES

Negative: Future developments that may, individually or collectively, lead to negative rating action include:

HMC

- HMC's and Kia's combined adjusted net-debt/EBITDAR (industrial operations) sustained above 0.5x (2014: -1.1x)

- Sustained negative FCF

- A major reversal of market recovery or sustained market-share erosion in key markets

Kia

- A downgrade in HMC's rating

-Weakening of linkages between HMC and Kia

Positive: Positive rating action is not envisaged for either HMC or Kia over the next two to three years due to the concentration of the companies' products on the volume segment.