LG Energy Solution's Global Ambitions Hit by Credit Rating Downgrades

[Korea Financial Times, Kim JaeHun] Various factors affect corporate value. Objective evaluation requires considering diverse variables. Korea Financial News aims to view a company's current situation, response, and financial soundness three-dimensionally through the 'Altman Z-Score' and examine the meanings hidden within in depth. [Editor's Note]

Since entering the stock market in early 2022, LG Energy Solution has executed aggressive annual facility investment (CAPEX) worth trillions of won for growth. In this process, borrowings increased, highlighting financial burden risks. Financial risks further emerged as profitability declined due to temporary slowdown in electric vehicle demand (chasm) immediately after listing.

This is why global credit rating agencies successively downgraded LG Energy Solution's credit rating this year. With domestic credit rating agencies' year-end regular evaluations remaining, the industry is closely watching the results.

Korea Financial Times calculated and analyzed LG Energy Solution's 'Altman Z-Score' from after listing to recently. The Altman Z-Score is an indicator that checks corporate financial risks based on financial statement items, with scores above 3 generally considered relatively stable for manufacturing businesses, and scores below 1.8 viewed as high risk.

LG Energy Solution's Z-score fell from 4.5 in 2022 immediately after listing to 3.99 in 2023 and 2.22 last year. While not reaching risk levels, it has been continuously declining since listing.

Looking at performance, in 2022 (consolidated basis) revenue was KRW 25.5986 trillion and operating profit was KRW 1.2137 trillion. Subsequently in 2023, revenue was KRW 33.7455 trillion and operating profit was KRW 2.1632 trillion, the highest ever, due to policy effects including the IRA (Inflation Reduction Act).

However, despite these results, the Z-score declined, analyzed as due to insufficient conversion to profit and cash generation compared to large-scale CAPEX and borrowing increases.

LG Energy Solution has executed large-scale CAPEX of around KRW 10 trillion annually since its 2022 listing. Total borrowings increased from approximately KRW 2.19 trillion in 2022 to approximately KRW 3.82 trillion in 2023, and total liabilities grew from KRW 17.7057 trillion to KRW 21.0636 trillion during the same period. Cash and cash equivalents decreased from KRW 5.938 trillion to KRW 5.0688 trillion.

Generally, the battery industry tends to aggressively expand facility investment to expand market share due to its order-based characteristics. Manufacturers sometimes engage in aggressive orders while accepting losses to secure market share.

LG Energy Solution also showed aggressive investment behavior while accepting financial burdens. However, even increasing profitability deteriorated. This was as the electric vehicle chasm that started in the second half of 2023 reached its peak in 2024.

Last year, LG Energy Solution's consolidated annual revenue was KRW 25.6196 trillion and operating profit was KRW 575.4 billion. These are figures decreased 24% and 74% respectively year-over-year. Despite deteriorating performance, LG Energy Solution continued investment, executing CAPEX at a record high level of approximately KRW 12 trillion. This was a bet to enhance technological competitiveness and production capacity in preparation for after the chasm.

As a result, financial burdens worsened further. As of last year, LG Energy Solution's total borrowings were approximately KRW 7.9 trillion, about double compared to 2023. Cash and cash equivalents evaporated by KRW 1.5722 trillion, decreasing to KRW 3.8987 trillion.

LG Energy Solution succeeded in rebounding with cumulative Q1-3 revenue of KRW 17.5302 trillion and operating profit of KRW 1.4681 trillion this year. However, excluding U.S. IRA subsidies, actual operating profit earned is around KRW 154.2 billion.

As declining profitability and increasing borrowings overlapped, global credit rating agencies successively lowered LG Energy Solution's ratings. Rating downgrades can negatively affect actual business, such as rising fundraising costs including corporate bond interest rates and worsening order judgments by some ordering parties.

Standard & Poor's (S&P) downgraded LG Energy Solution's credit rating from 'BBB+ (negative)' to 'BBB (stable)' in March.

This was about 10 months after lowering the rating outlook to 'negative' in May last year. At the time, S&P lowered the rating citing expanded financial burden due to large-scale CAPEX and poor battery industry conditions.

Another global rating agency Moody's also recently lowered LG Energy Solution's credit rating from 'Baa1' to 'Baa2'. This was a second downgrade in less than a year after lowering from A3 to Baa1 at the end of last year. Moody's explained, "This reflects debt increases from battery facility expansion in recent years and profitability pressure from electric vehicle battery market oversupply, the main revenue source."

However, these rating agencies maintained the rating outlook as 'stable'. This is due to expectations for future profitability improvement as large-scale investments including gradual recovery of the global electric vehicle market and ESS expansion are completed.

In fact, LG Energy Solution has been continuing efforts such as reducing CAPEX scale from over KRW 10 trillion to approximately KRW 7 trillion this year, emphasizing cost efficiency.

Attention is focused on how year-end domestic regular credit evaluations will turn out following global credit rating agencies' credit rating adjustments.

Korea Ratings Corporation forecast in a report last month that the battery industry's overall negative business environment will continue beyond Q4 this year due to sluggish downstream electric vehicle demand and intensifying competition with Chinese companies.

NICE Credit Rating also diagnosed through its secondary battery industry inspection report that credit burden continues due to sluggish operating performance and heavy investment factors despite increasing global electric vehicle sales.

The industry views ESS (Energy Storage System) as a breakthrough for the time being, as recovery of electric vehicle battery demand is expected to take time.

Reflecting this, LG Energy Solution also focused on enhancing ESS competitiveness in year-end regular personnel appointments. Representatively, Kim Hyung-sik, Head of ESS Battery Business Division, was promoted to Executive Director, and the ESS Battery Business Division organization size and capabilities were significantly reinforced to proactively respond to the ESS market.

An LG Energy Solution official explained, "This is part of strategic and efficient personnel management to respond nimbly to market changes including electric vehicle chasm and tariff agreements and maximize organizational execution capability."

Prospects for existing ESS global orders are also positive. Particularly, activity restrictions on Chinese companies that have held ESS dominance in the largest market, the United States, are most welcome.

LG Energy Solution is the only non-Chinese company with an ESS LFP battery mass production system. It started producing ESS LFP batteries at its Nanjing, China plant last year, and also started product production at its Michigan, U.S. plant from June this year.

Based on the de-China trend in the U.S. and local LFP product production capabilities, it signed a 6-year supply contract totaling 13GWh with a U.S. residential ESS company in Q3. It also signed large-scale project contracts with multiple power grid ESS customers.

Current ESS business order backlog is 120GWh, more than double compared to the previous quarter. The company explained that additional order backlog increases are expected in the future as there are multiple projects currently under discussion with customers.

Recently, it is even utilizing domestic bases, such as declaring 'domestic production of ESS LFP batteries' at the Ochang Energy Plant. LG Energy Solution plans to begin production line construction at year-end and commence full-scale operation from 2027. Initial production will start at 1GWh scale, with plans to gradually expand production scale according to future market demand.

Kim JaeHun (rlqm93@fntimes.com)