Fitch assigns first-time A to Richard Pieris and Company

ARPICO

Fitch Ratings has assigned Sri Lanka-based conglomerate, Richard Pieris & Company PLC (RICH), a National Long-Term ‘A(lka)’ rating. The Rating Outlook is Stable. Fitch has also assigned RICH’s outstanding senior unsecured debentures National Long-Term Ratings of ‘A(lka)’ as they represent senior unsecured obligations of the company and would rank equally with the company’s other senior unsecured debt.

RICH’s rating reflects the diversified nature of its business, strong market leadership in most product categories and its well-established operating history. The rating is supported by Fitch’s expectation that the group is likely to maintain leverage, measured by net adjusted debt/operating EBITDAR (excluding its finance company subsidiary, Richard Pieris Finance Limited), at less than 3.0x over the medium term, compared with 2.04x in the financial year ended 31 March 2015 (FY15). High debt at the holding company level, challenges in the tea and rubber sectors and plans for aggressive growth in the financial services sector constrain the rating in the medium term.

KEY RATING DRIVERS

Growth in Retail Business: RICH’s strategy of adopting a larger store format that sells grocery items, merchandise and consumer durables, compared to stores that sell mainly grocery items operated by its peers, has enabled the company to generate higher revenue per customer and also maintain better margins. We believe rising disposable income levels, rapid urbanisation and currently low supermarket penetration in Sri Lanka provide strong growth opportunities for the company to expand this segment. Intense competition among peers remains a key risk.

Expansion in Latex Mattresses, Tyres: In the medium term, RICH aims to almost double its capacity in the natural foam latex mattress segment to meet growing demand from key export markets in the US and Europe. RICH has a competitive advantage in this segment because it sources quality rubber from its sister company Kegalle Plantation PLC. RICH also plans to enter into production of tyres for two- and three-wheeler vehicles to tap the significant demand for tyres from both the replacement market and vehicle manufacturers in the medium term.

Stable Group Balance Sheet: Fitch expects the group to maintain adjusted net leverage (excluding financial subsidiary) at less than 3.0x over the medium term, supported by strong EBITDAR contributions from most segments despite higher than historical capex spend over FY16-FY19. We do not expect any significant M&A activity in FY16-FY19 and expect most of the capex to be spent on expanding its palm oil plantations and retail chain.

High Debt at Holding Company: RICH is dependent on dividends from its operating subsidiaries to service debt at the holding company level, which was high with net debt at 3.5x of EBITDAR at end- March 2015. Leverage at the holding company could remain at high levels due to continued debt-funded investments. However, this is mitigated by the holding company’s ability to influence the dividend payout decisions of the subsidiaries, given its strong ownership and control over the majority of the dividend paying subsidiaries.

Challenges in Plantation Sector: We do not expect a significant recovery in the tea and rubber sectors in the foreseeable future due to weak demand in key export markets, depressed global oil prices and escalating operating costs due to regular wage increases. RICH is focused on expanding its palm oil operations, where long-term demand is robust due to rising domestic demand for palm oil and margins are wider compared with the rubber and tea sectors.

Aggressive Financial Services Growth: RICH’s management expects its financial services segment, which mainly consists of a finance company and an insurance arm, to grow at a rapid pace over the medium term by using the group’s extensive customer, supplier and employee network. Fitch believes the financial services segment would require additional capital support from the holding company to meet its targeted growth.

KEY ASSUMPTIONS
Fitch’s key assumptions within the rating case for the issuer include:
– Revenue growth to average in the low double digits from FY16-FY19, driven by demand growth across
most sectors and new capacity expansions
– EBITDAR margins to settle at around 11% in the medium term due to higher costs stemming from new
capacity additions, which will be partly offset by cost efficiency measures.
– Capex for the group to total around LKR9.0bn over FY16-FY19
– Capital of LKR2.0bn to be provided to the financial services segment over FY16-FY19

RATING SENSITIVITIES
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
– A sustained improvement in RICH’s adjusted net debt/EBITDAR (excluding finance subsidiary) to below
2.0x
– A sustained improvement in the holding company’s net debt/EBITDAR to below 3.0x.
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
– A sustained increase in RICH’s adjusted net debt/EBITDAR (excluding finance subsidiary) to over 3.0x
– RICH’s adjusted EBITDAR coverage of gross interest and rent (excluding finance subsidiary) falling below 2.5x on a sustained basis (FY15: 3.75x).
– Significant investments in non-core business activities, which could adversely impact profitability or cash flow generation of the group
– Significant capital calls from the financial services sector over and above what is assumed by Fitch

LIQUIDITY
Strong liquidity position: As at end-September 2015, RICH had about LKR3.9bn of unrestricted cash and LKR5.7bn in unutilised credit facilities to meet LKR5.6bn of debt (excluding customer deposits) falling due in the next 12 months, placing the company in a strong liquidity position. We believe the company will also benefit from positive FCF in FY16 due to lower capex in the plantation sector.