Debt Increases but Performance Slumps... Growing Financial Warning Signs for SK, Lotte, and CJ

Hankyung Ratings and Hanshin Ratings Point Out Deterioration in Financial Structure of Top 3 Groups
Poor Performance in Core Businesses...Increase in Short-Term Borrowings
If Trend Continues, High Possibility of Credit Rating Downgrade

Warning signs about the deterioration of the financial structures of SK, Lotte, and CJ groups are growing louder. The three groups share the commonality of worsening overall financial conditions due to poor performance while continuously increasing borrowings for investment and operating fund procurement. If the performance normalization of key businesses and financial improvement are not achieved, concerns about credit rating deterioration must be considered. Korea Ratings (KR) pointed this out during an online seminar on corporate group credit ratings on the 6th. Korea Investors Service (KIS) also presented a similar analysis earlier in its group analysis report.

SK Group: Rapid Increase in Borrowings Due to Investments in Secondary Batteries and Semiconductors

SK Group has been continuously increasing its debt over recent years to invest in semiconductors and secondary batteries. According to KIS, the net borrowings (total borrowings minus cash equivalents) combined from the consolidated financial statements of SK Inc., SK Hynix, and SK Discovery reached approximately KRW 82 trillion as of the end of March this year. This rose from KRW 56 trillion at the end of 2021 to KRW 75 trillion at the end of last year, and then increased by an additional KRW 7 trillion in just one year and three months. This means net borrowings increased by about KRW 26 trillion over two years and three months. KR analyzed that SK Group's net borrowings, aggregated by its own standards, rose from about KRW 22 trillion at the end of 2017 to about KRW 87 trillion at the end of March 2023.

Despite increasing borrowings to expand investments, performance has rather deteriorated. SK Hynix's consecutive large-scale losses and delayed performance improvement in the secondary battery sector coincided. According to the KIS report, SK Group's EBITDA was KRW 3.7231 trillion in 2021 and KRW 3.8292 trillion last year, maintaining cash-generating capacity. However, EBITDA for Q1 this year plunged to KRW 372.4 billion, about one-third of KRW 1.1663 trillion in the same period last year. As a result, the net borrowings to EBITDA ratio, indicating borrowing burden relative to cash generation, increased from about 1.9 times annually at the end of last year to 5.4 times in Q1 this year.

The shortening maturity structure of borrowings was also pointed out as a problem. The proportion of short-term borrowings with maturities of one year or less in SK Group's total borrowings across major sectors rose to 36.6%, up 11.4 percentage points from the end of 2021. This proportion has been gradually increasing this year. By the end of Q1 this year, out of total borrowings of KRW 116 trillion, KRW 40 to 50 trillion must be repaid or refinanced within one year.

Jang Su-myung, Senior Analyst at KR, said, "SK Group will have to bear a high level of financial burden while continuing large-scale investments to secure new growth engines such as semiconductors, batteries, and renewable energy," adding, "If the cash-generating capacity of key business units continues to weaken, it will act as a burden on financial flexibility." He advised, "A review of the expansionary investment policy or more proactive implementation of financial improvement measures is necessary."

Lotte Group: Increased Investments but Cash Cow ‘Chemicals’ Performance Plummets

Lotte Group is also analyzed to be facing an increasing borrowing burden. According to KIS, the combined net borrowings of Lotte Group’s major business sectors such as distribution, food and beverage, chemicals, and tourism and leisure increased from KRW 26.7 trillion in 2020 to KRW 34.5 trillion in Q1 this year. While borrowings had significantly increased in the past due to global investments in hotels and distribution sectors, recently Lotte Chemical has also increased borrowings through large-scale investments, continuously raising the group's overall borrowing burden. Financial support for Lotte Construction has also contributed to increasing financial burdens.

With sluggish performance in the distribution and hotel sectors, and operating losses continuing in the group’s cash cow chemical sector, the group’s combined sales and operating profit in Q1 this year recorded KRW 15.5 trillion and KRW 300 billion respectively, down 7.4% and 15% from the same period last year. EBITDA decreased from KRW 625.5 billion at the end of 2021 to KRW 162.2 billion in 2022, with profitability slightly declining again in Q1 this year.

Lotte Chemical, the cash cow of Lotte Group, saw its credit rating downgraded by one notch from AA+ to AA in June due to increased financial burdens from facility expansions and the acquisition of Iljin Materials (Lotte Energy Materials), coupled with deteriorating performance. During this process, Lotte Group’s integrated credit rating also declined. Among other affiliates, Lotte Himart (AA-), Korea Seven (A+), and Lotte Construction (A+) currently have credit rating outlooks assessed as ‘negative.’ If performance deterioration continues, credit rating downgrades will be inevitable.

Choi Han-seung, Head of Evaluation Team 2 at KIS, said, "The poor performance of Lotte Himart and Korea Seven is expected to continue," adding, "We plan to reflect this in credit ratings while monitoring financial trends such as performance." He also said, "We will monitor the construction sector’s new project starts, sales performance, collection of sales proceeds, and reduction of project financing (PF) contingent liabilities." He assessed, "Although the possibility of an immediate further downgrade of the group’s integrated credit rating is low, the overall group’s investment burden is expected to remain high for some time, so efforts to improve financial conditions are necessary."

CJ Group: Performance Deterioration in Media and Entertainment after Large-Scale M&A

According to KR, CJ Group’s combined net borrowings increased from KRW 6.7 trillion at the end of 2015 to KRW 14.9 trillion at the end of last year. Excluding about KRW 4.7 trillion of lease liabilities converted into borrowings due to accounting standard changes in 2019, net borrowings stood at around KRW 11.5 trillion at the end of Q1 this year. Financial burdens have continued to grow due to ongoing capital needs from overseas equity investments, logistics facilities, and equipment investments. Recently, the acquisition of Fifth Season in the U.S. and operating fund burdens from rising raw material prices have led to increased borrowings.

The outstanding balance of KRW 2.836 trillion from hybrid capital securities and redeemable convertible preferred shares issued by affiliates to defend debt ratios is also a burden. Hybrid capital securities and preferred shares are generally classified as equity in accounting. However, most of the securities issued by CJ Group affiliates have strong redemption obligations under their agreements, making them effectively equivalent to borrowings.

Deterioration in profitability of key business units is expected to further increase financial burdens. Sales in the food and food service business, centered on CJ CheilJedang, have continued to grow, but operating profit has stagnated. In Q1 this year, operating profit even declined. The operating profit margin, which was in the mid-5% range, fell to the mid-3% range.

The biotechnology sector’s profitability sharply worsened from Q4 last year due to sluggish livestock industry conditions caused by China’s economic downturn, weak amino acid market conditions, and poor demand for nucleotides. Logistics and new distribution businesses, led by CJ Logistics, have maintained solid performance supported by recovery in cargo volume after the COVID-19 endemic, but the entertainment & media business centered on CJ ENM has been suffering losses as profit realization from Fifth Season and TVING has been delayed.

Due to increased borrowings and deteriorating performance, the net borrowings to EBITDA multiple on a consolidated basis for CJ Corporation, the group’s holding company, rose from about 2.8 times at the end of last year to 3.8 times. Gu Jung-won, Senior Analyst at KR, said, "With the increase in borrowings due to several large-scale mergers and acquisitions (M&A), and planned investments in key sectors this year, it seems difficult to reduce capital expenditures (CAPEX) scale," adding, "Efforts to improve financial conditions through asset sales and measures to expand profit generation are necessary."

Kim Kyung-hoon, Researcher at KIS Evaluation Team 2, said, "Group sales are expected to continue rising due to price increases in the food and bio sectors and recovery of CJ CGV, but short-term profitability improvement will be difficult due to delayed recovery in the entertainment and media sectors," advising, "It is necessary to improve financial stability by utilizing asset sales and other measures."

This content was produced with the assistance of AI translation services.