OREANDA-NEWS. Fitch Ratings has affirmed South Korea-based LG Electronics Inc.'s (LGE) Long-Term Foreign- and Local-Currency Issuer Default (IDR) ratings at 'BBB-'. The Outlook is Stable. Its senior unsecured rating has also been affirmed at 'BBB-'.

The ratings reflect LGE's well-established global market positions in its core products, its diverse product portfolio and its relatively stable financial structure. We believe that LGE's competitive strength in consumer electronics and flat-panel displays will support its overall operating performance amid expected global economic slowdown and soft demand. The Stable Outlook reflects our view that LGE's financial profile - including proportional consolidation of 37.9%-owned LG Display (LGD) - will remain commensurate with the lowest investment grade. However, weaker-than-expected margins have lowered the company's rating headroom.

KEY RATING DRIVERS
Lower Rating Headroom: LGE's credit profile will deteriorate in the short term - leaving narrower rating headroom - because of weakness in the consumer electronics industry and the wider economy. However, its strong market presence and product diversification may provide stability to LGE's cash flows to some extent. LGE holds strong positions in the global flat panel TV and home appliance markets. LGD is the largest flat panel display manufacturer with a 25% share of the global market in terms of area.

Thin Margins: The modest handset business, which has yet to achieve a scale that contributes meaningfully to earnings, and a saturated TV market will drag LGE's EBIT margin down in the short term. The decline, though, will be mitigated by its solid market positions in home appliances and air-conditioners. The margin in the display business will also come under pressure from the bleak industry outlook, but this could be partly offset by faster-than-expected adoption of premium products such as Ultra-High-Definition (UHD) and Organic-Light-Emitting Diode (OLED) displays.

Solid Appliances Business: We expect LGE to maintain its strong market positions in refrigerators, washing machines and air conditioners. In addition, LGE has increased investments to diversify and expand its business-to-business (B2B) operation. We expect steady profitability for its home appliance and air-conditioning operations over the long term. However, slower economic growth in developed markets and volatile currency movements may constrain their short-term profitability.

Oversupply Persists in Display: Capacity expansion in China and the delayed adjustment in utilisation rates will result in prolonged oversupply of display panels globally. While there will also be fragile demand for TV and IT display panels, we believe LGD's dominance in high-end products, which is underpinned by advanced technology such as OLED, will protect margins to some extent. The company held around 78% of the OLED market by area in 2015.

Strength in TVs: LGE's position in the global TV market is likely to remain solid, but significant margin improvement is unlikely after a dismal 2015. LGE's margin in the TV business will remain fragile given slowing demand, fierce competition and volatile currency movements in the short term. However, low panel prices and faster-than-expected penetration of OLED TVs may lead to a modest rebound in LGE's profitability.

Intense Competition in Handsets: We expect LGE to continue to face keen competition in the handset business, which will generate just a margin of just 1%-1.5% in the medium term. We believe LGE's market position will be under threat because of a lack of hardware differentiation amid growth of Chinese manufacturers. Its newly launched flagship model "G5" may boost sales, although the increase in marketing spending and persistent pricing pressure will limit margin improvement.

KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
- LGE's 2016 revenue to be comparable to that in 2015 due to stiffer competition and slower economic growth.
- LGE's operating margin to improve slightly from that in 2015. Cost control measures, gradual shift to premium products and lower commodity costs likely to help offset pricing pressure in key markets.
- Supply glut in LCD panel industry to push LGD's margin down to low-single digits.
- LGE's capex to remain similar to previous levels while LGD to increase its spending to around KRW4.5trn in the short term
- Free cash flow generation to remain minimal

RATING SENSITIVITIES
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- Sustained operating EBIT margin below 2.0% (2015:2.8%)
- total adjusted debt/EBITDAR is sustained over 3x (2015:2.3x)

Positive: Future developments that may, individually or collectively, lead to positive rating action include
- Sustained operating EBIT margin above 4%
- Total adjusted debt/EBITDAR is sustained below 2x

These financial metrics are based on a proportional consolidation of LGD.