Fitch Ratings has assigned Sri Lanka based cable manufacturer Sierra Cables PLC (Sierra) a National LongTerm Rating of ‘BB+(lka)’. The Outlook is Stable.
Sierra’s rating reflects its established core business, which has an extensive product portfolio, modest but expanding market share and stable EBITDA margins. This is counterbalanced by exposure to cyclical endmarkets, risks associated with international expansion and losses at subsidiaries.
The rating is also supported by Fitch’s expectation that the company will maintain net leverage, measured as net adjusted debt/operating EBITDAR, at less than 2.5x over the medium term, despite planned capacity expansions.
Leverage was 2.4x in the financial year ended 31 March 2016 (FY16).
KEY RATING DRIVERS
Recovery in End Markets: Sierra’s customers are mostly in cyclical industries, including construction and infrastructure development, which substantially slowed down in the past 1218 months.
However, the government’s decision to resume work on many of the suspended projects and to launch a few new largescale developments in 2016 will boost demand for the cable industry. Growth in construction of housing due to rapid urbanisation in Sri Lanka and gradual expansion in the manufacturing sector should also drive demand for cables.
Modest but Increasing Market Share: Sierra is the thirdlargest cable manufacturer in Sri Lanka based on revenue. Its market share has increased steadily to 22%. The company has an extensive product portfolio that is similar to that of much larger peers to meet the needs of domestic industrial and retail customers.
Strong EBITDA Margins: Sierra’s EBITDA margin improved steadily over the past few years due to increases in highmargin sales to institutional customers, low rawmaterial prices and use of efficient machinery in the production process. Aluminium and copper account for about 70% of the company’s cost of goods sold, and Sierra can pass on any price increases to its customers if necessary, which allows the company to maintain stable margins. Strengthening Balance Sheet: Sierra’s net leverage improved to 2.4x at FYE16 from 5.1x at FYE13 due to significant improvements in its core operations.
We expect the company to maintain net leverage below 2.5x over the medium term, despite planned expansions both domestically and internationally, which we expect to be primarily funded through internally generated funds. Drag from Unprofitable Subsidiaries: Sierra’s two subsidiaries Sierra Industries Limited (SIL) and Sierra Power Limited (SPL) are still unprofitable.
The potential divestment of the power business during FY17 and a possible turnaround in SIL’s profitability in the next 1218 months as a result of significant contract wins from institutional customers should have a positive impact Sierra’s margins and leverage in the medium term.
Risky International Expansions: Sierra will invest LKR375m to set up cable manufacturing plants in Kenya and Fiji in the next couple of years. Kenya provides strong growth potential for the company given electrification is below 30% but the investment carries high political and economic risk. Disruptions to production, delays in payments or additional capital calls could adversely impact Sierra’s future cash flows. In Fiji, Sierra has tied up with the two largest hardware product distributors in the country, which mitigates risks associated with foreign expansion.
Fitch’s key assumptions within our rating case for the issuer include: Annual revenue growth to average 20% from FY17FY18, partly due to a low base and partly due to international expansion and new contract wins from institutional clients.
Annual revenue growth to stabilise in the highsingledigit range in the medium term. EBITDA margins to expand by 100bps over FY17FY20 due to a bigger proportion of institutional and international sales in the sales mix, and due to the restructuring of unprofitable subsidiaries.
Average capex of LKR150m a year over FY17FY20 Dividend payout ratio to average 30% over FY17FY20
Positive: An upgrade is not anticipated in the short to medium term due to Sierra’s current size and scale of operations, however future developments that may, individually or collectively, lead to positive rating action over the longer term include: An improvement in company’s size and scale of operations while maintaining the current credit profile Negative: Future developments that may, individually or collectively, lead to negative rating action include: Adjusted net debt/EBITDAR over 3.5x on a sustained basis EBITDAR coverage (as measured by EBITDAR to (Gross Interest + Rent)) reducing below 3.0x on a sustained basis Delays or disruptions in its planned Kenyan of Fiji expansion, which could result in additional capital calls or reduce profitability LIQUIDITY Manageable Liquidity Position: As at endMarch 2016, Sierra had LKR73m of unrestricted cash and LKR840m in unutilised credit lines to meet LKR945m of shortterm debt falling due in the next 12 months, placing the company in a tight but manageable liquidity position. The planned divestments of the power subsidiary should also boost cash.