Hon Hai Precision Rating Raised to 'twAA' On Strong Operating Performance, Outlook Stable

Taiwan Ratings Corp. today raised its long-term corporate credit rating on Hon Hai Precision Industry Co. Ltd. (Hon Hai) and its issue rating on the company's senior unsecured bonds to 'twAA' from 'twAA-'. At the same time, Taiwan Ratings revised the outlook on the corporate credit rating to stable from positive. Hon Hai is one of the world's largest electronic contract manufacturers, with estimated total revenue of NT$540 billion (about US$16 billion) in fiscal 2004 (ended Dec. 31 2004).

The rating action reflects Hon Hai's consistent sales and profit growth, and successful customer and product diversification. The ratings also reflect the company's strong competitive position, consistent operational execution, and prudent financial policy. Counterbalancing factors include extremely competitive industry conditions and a business model that subjects the company to strong customer bargaining power and margin pressure.

Hon Hai's strong competitive position is underpinned by several key success factors, including strong mechanical engineering expertise, a vertically integrated production process, reliable production quality, and global logistics capability. As a result of consistent execution of these factors, Hon Hai has been able to meet customer demand by supplying components, modules, and system assembly services in a timely manner, and has also successfully expanded its product range to cover computing, consumer electronics, networking, and handset products.

Hon Hai targets first-tier global brand-name original equipment manufacturers (OEM) customers. This strategy, however, has resulted in a relatively concentrated customer base, but this is not uncommon in the global electronic manufacturing service sector. Moreover, these customers tend to have considerable bargaining power in negotiating purchases that, in turn, put pressure on Hon Hai's margins. Nevertheless, this risk factor has not had a material impact on the company's operating and financial performances to date. Hon Hai has well-established customer relationships with leading OEMs, including Apple Computer Inc., Cisco Systems Inc., Dell Inc. (rated A/Stable/-- by Standard & Poor's Rating Services), Hewlett-Packard Co. (A-/Stable/A-1), Intel Corp. (A+/Stable/A-1+), Motorola Inc. (BBB/Positive/A-2), Nokia Corp. (A-/Negative/A-1), and Sony (A/Negative/A-1). The company's consistent operational execution has enabled it to robustly grow its revenue from existing customers, while at the same time adding new customers by offering a wider product range. As a result, Hon Hai's level of customer and product concentration degree has improved.

Hon Hai's low-cost, highly integrated production process has also contributed to the company's improving market position. Consolidated sales grew by 45% year-on-year to an estimated NT$540 billion in fiscal 2004, after rising 44% to NT$371.5 billion in fiscal 2003. Hon Hai's operating performance has remained consistently strong in recent years. Its return on net capital averaged about 30% in the 2002-2004 period, supported by robust volume growth that helped offset margin pressure resulting from strong customer bargaining power. Further strong sales growth is expected over the medium term as a result of continued outsourcing in the global high-tech industry. Taiwan Ratings expects Hon Hai to maintain a return on net capital of more than 25% and EBITDA interest coverage exceeding 50x in the 2005-2006 period.

Hon Hai has a prudent financial policy. Despite strong sales growth that has resulted in heavy working capital requirements in recent years, Hon Hai maintained its ratio of total debt to total capital below 30% in the 2000-2004 period. It also had a net cash position in 2002 and 2003, and reported a ratio of net debt to capital of 7% at the end of 2004. Taiwan Ratings expects Hon Hai to maintain a prudent financial policy, which is a critical factor supporting the current rating on the company given the inherently high risk of the global high tech industry.

Liquidity.
As of Dec. 31, 2004, Hon Hai had about NT$43 billion (US$1.3 billion) in cash and short-term investments, compared with short-term debt of about NT$30 billion. At the same date, the company had unused uncommitted credit facilities of NT$38 billion, which are provided by local and foreign banks and renewed every year under normal business conditions.

OUTLOOK: STABLE
The outlook reflects Hon Hai's ability to consistently grow sales and profits as well as diversify its customer base and product range. While continuing robust sales growth will require higher levels of working capital and capital expenditure, Taiwan Ratings expects Hon Hai to maintain a prudent financial policy and to hold its ratio of total debt to capital to below 30% over the medium term.

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