Fitch assigns Sunshine Holdings first time ‘A’ rating

Fitch Ratings Lanka has assigned Sri Lanka-based Sunshine Holdings PLC (Sunshine Holdings) a National Long-Term Rating of ‘A(lka)’ with a Stable Outlook.

Sunshine Holdings’ rating reflects the defensive nature of its key operating subsidiaries, their leading market positions and strong free cash flow (FCF) generation. The rating also takes into account Sunshine Holdings’ low group leverage, which Fitch expects to remain intact despite significant expansion. Sunshine Holdings, however, is exposed to the weak tea sector and its investments in ventures that are outside the company’s core competencies could increase the business risk of the group as a whole.

KEY RATING DRIVERS

Strong Group Balance Sheet: Fitch expects Sunshine Holdings to maintain leverage – the ratio of gross adjusted debt to operating EBITDAR – at less than 3.0x over the medium-term (1.34x at end of the financial year to 31 March 2015 or FY15). The holding company benefits from strong EBITDAR contributions from the palm oil and fast-moving consumer goods (FMCG) sectors and the defensive healthcare sector. Fitch consolidates 33.15% of the financials of Estate Management Services Pvt Ltd (EMSPL), the holding company of agriculture and FMCG subsidiaries in its calculations of Sunshine Holdings’ ratios.

We expect the company to maintain leverage at these levels despite higher than historical capex and spending on growth opportunities over FY16-FY19, which will be partly funded by strong internally generated funds.

Healthcare to Provide Stability: Fitch expects the healthcare segment to remain the largest contributor to dividends received by Sunshine Holdings’ given stable FCF generation and low capex requirements. We expect growth in the healthcare segment over FY16-FY19 to be driven mainly by the expansion of the pharmacy chain, with growth in the high-margin diagnostic and wellness segments also contributing. Risks to the pharmacy chain include changes to regulated pricing for the drugs sold and volatility in foreign-currency rates as the company imports almost all the products it distributes.

Growth from FMCG and Palm Oil: Sunshine Holdings should continue to benefit from strong growth prospects in the palm oil and FMCG segments, which are driven by favourable macroeconomic trends that increase demand for the segments’ products. Furthermore increased contributions from these segments should translate to improved group EBITDAR margins given both FMCG and palm oil carry high margins compared with rest of the group.

Continued Losses from Tea: The unprofitable tea business will continue to weigh on the rating as Fitch does not expect the segment to turn around in the foreseeable future. This view reflects the low global tea prices and escalating operating costs due to regular wage increases, which are not linked to any productivity measures.

New Project Risk: Sunshine Holdings is undertaking various projects across different sectors that we believe will increase the company’s business risk. Even though new investments are supported by equity partnerships and Sunshine Holdings’ strong balance sheet, any delays in construction of the projects or delays in breaking even could adversely impact the company’s profitability and cash flow generation, and weigh on the rating.

Structural Subordination Not Material: Claims of creditors at the holding company level are structurally subordinated to creditors of the operating subsidiaries. Consequently, an increase in leverage at operating subsidiaries would weigh on Sunshine Holdings’ rating. As of end-FY15 the ratio of Sunshine Holdings’ prior ranking debt to proportionally consolidated EBITDA was 1.60x, which is below the 2.0x level at which Fitch would notch down the rating.

KEY ASSUMPTIONS

Fitch’s key assumptions within the rating case for the issuer include:

– Revenue growth to recover to low double-digit levels from FY17 driven by organic growth in existing businesses and contributions from new business ventures.

– EBITDAR margins to broadly settle in the low-double digit range in the medium term.

– Capex and growth-opportunity investments of LKR6bn during the rating horizon, including investments in the power, packaging and healthcare sectors

– Sunshine Holdings to maintain its current dividend policy

RATING SENSITIVITIES

Positive: No positive rating action is expected in the next 12-18 months given the cyclical risks of commodity-based business segments and risks associated with new investments.

Negative: Future developments that may, individually or collectively, lead to negative rating action include:

– A sustained increase in Sunshine Holdings’ adjusted gross debt/EBITDAR (considering only a 33.15% consolidation of EMSPL) to over 3.0x

– Sunshine Holdings’ consolidated EBITDAR coverage (considering only a 33.15% consolidation of EMSPL), reducing below 2.5x on a sustained basis (8.40x as at end FY15).

– Significant delays or protracted break even period of new projects/investments which could adversely impact profitability or require additional capital calls

LIQUIDITY

As at end-September 2015, Sunshine Holdings’ unrestricted cash on hand and committed but unutilised credit lines comfortably covered short-term debt falling due in the next 12 months.