Fitch Ratings-Colombo-26 February 2018: Fitch Ratings has affirmed Sri Lanka-based conglomerate Richard Pieris & Company PLC’s (RICH) National Long-Term rating at ‘A(lka)’ with a Stable Outlook.
Fitch has also affirmed the National rating on RICH’s outstanding senior unsecured debentures at ‘A(lka)’.
The affirmation of RICH’s ratings reflects our view that the improvement in the group’s adjusted net leverage was offset by the underperformance in its tyre business and some segments in the plastics sector over the last 18 months, and the risks around their recovery prospects over the medium term, limiting any positive rating action. RICH’s leverage improved to 1.9x by the financial year ended 31 March 2017 (FY17) and 1.7x by 30 December 2017 from 2.5x in FY16, which compares well with the 2.0x level below which we may take positive rating action on
RICH. The leverage improvement was also underpinned by a major increase in global tea prices over the last 12 months, which has helped to offset the high cost structure in the plantation business, although current price levels may not be sustainable over the longer term.
RICH’s rating also reflects the group’s diversified cash flows, market leadership in several of its segments, and the company’s well-established operating history. We also expect the company to increase capex in the next two years in a bid to expand production capacity in the retail, rubber and palm oil segments, which may also keep leverage from improving materially below in that period.
KEY RATING DRIVERS
Retail to Drive Growth: We expect store expansion and a shift in consumer preference towards
hypermarkets and supermarkets to lead to double-digit revenue growth for the company’s retail
segment in the medium term. RICH’s retail revenue growth slowed in 1HFY18 amid a weak
macroeconomic environment and higher indirect taxes but these pressures eased in 3Q18 as
consumers adjusted to higher costs and we expect the moderate improvement to continue in
the next 12-18 months. We believe the sector’s EBITDA margin will contract slightly to around
7.3% in the medium term, from 8.0% in FY17, as the opening of new stores and the introduction
of a smaller-store format could weigh on costs.
Sri Lanka’s supermarket penetration, which is only around 15%, indicates growth potential for
the industry. Over the longer term, increasing per capita income and rising urbanisation will
help make the modern grocery retail concept more affordable and accessible to a larger portion
of the population.
Risks in Plastics and Tyres: We do not expect a near-term recovery in the company’s plastics
business as domestic demand for its key products, polyurethane (PU) mattresses and water
tanks, may remain sluggish amid weak economic conditions. Margin pressure in the PU mattress
segment stemming from raw material shortages could also take time to resolve. The company is
investing to expand export revenues in this sector but we believe potential risks over
establishing its brand name and penetrating distribution networks in new markets could prevent
the company from realising substantial returns in a short period of time.
We think the domestic retreading business, which accounts for the majority of the tyre
business’s operating profit, will undergo a structural decline amid stiff competition from
Chinese imports. Steps taken by the management to penetrate export markets may take time to
generate returns that are sufficient to offset the pressures in the domestic market.
Capacity Expansion in Export Business: We expect RICH’s export revenue to maintain its growth
momentum, helped by the capacity expansion in its value-added rubber export segment. New
market opportunities and the introduction of more value-added products are likely to help
absorb the extra capacity coming online in the next few years. We expect growth in export
revenue to also help offset the volatility in some of the other segments, such as plastics and
tyres, due to the slowdown in the domestic market.
Increasing Share of Palm Oil: Fitch believes the volatility in the plantation segment will decline
in the medium term with increased contribution from a more stable palm oil business. We
expect the segment’s EBIT from palm oil to increase significantly in the next few years, helped
by the improving maturity profile of the plantations, which will drive yields higher. We have
assumed that global palm oil prices will remain at USD665/tonne in FY18 and USD675
RICH’s tea segment has seen a strong rebound recently, helped by rising global prices, but we
expect the performance to moderate in the next 12-18 months on the back of more muted
prices and rising operating costs. However, the palm oil segment, which benefits from strong
domestic demand and regulated pricing, should help to iron out the volatility in other crops.
Stronger Holding Company Balance Sheet: We expect leverage at the holding company (2x as at
FYE17) to improve over the next few years due to higher dividend income from subsidiaries and
a decision to cut borrowings at the holding company level. Subsidiaries will fund their own
expansion, reducing dependency on the holding company. However, an increase in subsidiaries’
leverage could weigh on the rating due to the structural subordination of the holding company’s
debt. Currently, the structural subordination is minimal due to low subsidiary debt and the
holding company’s strong ownership of most of the operating subsidiaries, which provides for a
high degree of cash fungibility within the consolidated group.
RICH has diversified cash flows similar to Hemas Holdings PLC (AA-(lka)/Stable) and Sunshine
Holdings PLC (A-(lka)/Stable). RICH is rated two notches below Hemas to reflect its large
exposure to the cyclical plantation sector, which increases business risk, as well as RICH’s higher
RICH is rated one notch higher than Sunshine due to its stronger business risk profile from a
lower exposure to the cyclical plantation segment compared with Sunshine, as well as
substantially higher cash flows from its defensive grocery retail business and larger operating
scale. Both companies have similar financial risk due to Sunshine’s latest acquisition.
Lion Brewery (Ceylon) PLC (A+(lka)/Negative) is rated higher than RICH on the basis of Lion’s
market leadership in Sri Lanka’s protected beer market.
RICH is rated one notch above consumer durables retailer Singer (Sri Lanka) PLC (A-(lka)/Stable)
to reflect RICH’s stronger business risk profile, which is reflected in its cash flow diversity and
Fitch’s Key Assumptions Within Our Rating Case for the Issuer
– Revenue growth to average in the low teens from FY19-FY21 due to expansion in the retail and
rubber sectors and strong contributions from the palm oil sector.
– EBITDAR margin to contract and stabilise at around 10%-10.5% in the next two to three years
amid cost pressures, competition and higher fixed costs stemming from capacity expansion.
– Annual capex to increase to about LKR2.8 billion on average to support the planned expansion.
– Dividend payout ratio of about 40% of net income to be maintained over FY18-FY21.
– No M&A activity or further equity infusions to the financial sector assumed in the next two to
Developments that May, Individually or Collectively, Lead to Positive Rating Action
– A sustained improvement in RICH’s adjusted net debt/EBITDAR (adjusted for finance
subsidiary) to below 2.0x (FY17 1.9x).
– A sustained improvement in the holding company’s net debt/EBITDAR to below 3.0x. (FY17:
Developments that May, Individually or Collectively, Lead to Negative Rating Action
– A sustained increase in RICH’s adjusted net debt/EBITDAR (adjusted for finance subsidiary) to
– RICH’s adjusted EBITDAR coverage of gross interest and rent (adjusted for finance subsidiary)
falling below 2.5x on a sustained basis (FY17: 4.8x).
– Significant investment in non-core business activities, which could adversely impact the
profitability or cash flow generation of the group.
Comfortable Liquidity Position: As at end-December 2017, RICH had about LKR5.4 billion of
unrestricted cash and LKR4.3 billion in unutilised credit facilities to meet LKR3.2 billion of debt
(excluding finance subsidiary obligations) maturing in the next 12 months. We do not expect
RICH to generate positive free cash flow in the next 12 months due to high capex and
shareholder returns. RICH has another LKR4 billion of short-term working capital-related debt,
which we expect to be rolled over by lenders in the normal course of business.