Fitch: STMicroelectronics's Ratings and Outlook Weighed By Nokia Exposure
Fitch Ratings says that it expects Switzerland-based STMicroelectronics' ratings to remain under pressure throughout 2012, following earnings calls last week by ST and its wireless chipset joint venture, ST-Ericsson (STE).
"The surprise in ST's results was the degree to which the wholly owned businesses are suffering, seemingly as a result of what is happening at Nokia," says Stuart Reid, a Senior Director in Fitch's TMT team. "In addition to STE, two of the wholly owned divisions were loss making in Q112, with most of the company's difficulties stemming from the weakness of sales to Nokia, still the company's single largest customer in 2011."
Better visibility throughout 2012, over the revenue value that Samsung and other key vendor relationships is likely to drive, both at STE and within the wholly owned businesses, will be key to ST's ratings remaining at their current level.
ST's Q1 results highlighted the degree to which its fortunes have been affected by the travails at the former mobile handset market leader. The agency expects the conclusion of the strategic review and announcement of further restructuring at STE to help mitigate the ongoing weakness of revenues at the JV. However, the extent to which the wholly owned businesses are also suffering Nokia related weakness, suggest a wider revenue contagion to this customer and was not expected.
Fitch's downgrade guidelines for ST include operating margins at the wholly owned businesses falling below 9% (11.4% in 2011) and pre-dividend free cash flow (adjusted for 50% of EBITA losses attributable to Ericsson, below 5%. Fitch's current forecast model now indicates both metrics potentially being breached in 2012. Rating actions in sectors as cyclical as semiconductors are typically based on underperformance over more than one year, with Fitch's forecast model predicting a recovery in the metrics from 2013. However, the company-specific nature of Fitch's concerns imply that rating action is likely if weakness in the metrics is likely to persist once visibility over 2013 is clearer, which is more likely once H212 results are reported.
The fact that both ST's Power Discrete and Digital divisions were loss making in Q1 raises concerns about the exposure of the overall group to Nokia. In Fitch's view, the 340bp erosion in gross margin due to fab under-utilisation, is in large part due to the company's exposure to the handset vendor. The agency notes that another key customer, Sony (formally SonyEricsson) has also seen volumes contract dramatically since the STE JV was formed in 2009.
STE also announced the results of its strategic review and new business plan
last week. This includes restructuring 25% of the workforce, transferring the
R&D for application processors to ST, and lowering opex by USD320m a year by
end of 2013 vs the end of 2011 base. USD130m-USD150m of restructuring charges
are to be absorbed by 2013, in efforts to lower the quarterly sales breakeven
point to approximately USD600m compared with the previous management's target of
around USD770m-USD780m. However, there is no indication of when the USD600m
quarterly sales rate might be achieved. While the breakeven target is more than
twice STE's Q112 USD290m revenues, the first quarter is always the seasonally
weakest and with Q112 reportedly now the bottom for STE.
The plan to leverage the group's capabilities in integrated modem plus application processor solutions (ModAp) for smartphones and tablets will encompass a transitional cost sharing model followed by a royalty scheme whereby the chipset JV will license ModAp technologies from ST.
Ongoing efforts to resize the cost base at STE, as well as take advantage of sales and R&D synergies within ST's Digital division, are positive. A further positive factor is that Samsung is now STE's single largest customer, noting the momentum that the South Korean vendor is enjoying, particularly in its smartphones business. STE's management has noted that the JV's viability/business model is no longer predicated on the success of the Nokia relationship.