Hayleys MGT’s credit profile slips, as it opts for a debt finance drive to expand capacity and sets aside extra cash for working capital

Hayleys MGT’s credit metrics has weakened somewhat recently, as it embarks on a debt finance drive and steps up its working capital requirements to keep pace in the quota free arena. Hayleys MGT’s credit metrics has weakened somewhat recently, as it embarks on a debt finance drive and steps up its working capital requirements to keep pace in the quota free arena. The fabric maker retained its BBB+ (sri) status during a recent credit rating evaluation by Fitch Ratings Lanka, which translates to low credit risk with the capacity to honour payments on time.

The firm comfortably rubs shoulders within the top four local fabric knit makers, keeping competitors at bay by being the only knitted fabric player making 100 percent polyester fabric and polar fleece.

Over the last few months, production capacity increased by 50 percent at a cost of US$ 6.2 mn. The firm is expected to invest another US$ 700 mn during latter part of this year to widen its knitting and dyeing/finishing capacity, notes Fitch Analyst Buddhika Piyasena in a report released Monday.

The firm is cruising pretty well so far in the quota free era, as its key local buyers are not restricted to quotas but maintain their edge by forging stronger relationships with large retailers.

Moves to court trade deals with key markets of United States and European Union are paying off, with both blocks keen to unlock few barriers to help Sri Lanka recover during the post-tsunami phase.

The EU’s GSP+ (Generalised System of Tariff Preference) scheme, which relaxes rules of origin, kicks off from April 1 and is expected to swell apparel export industry’s order books by as much as eight to ten percent this year.

Hayleys MGT’s indirect exposure is tipped largely towards the EU, but the firm is not dependent on any one buyer/few buyers and hence has low customer concentration risk.

Piyasena says working capital requirements in the quota free era is expected to rise as fabric makers are forced to carry higher inventories to meet shorter lead-times and retain semi-finished stocks for longer periods to satisfy last-minute customisations.

Lead times for Sri Lankan apparel makers have fallen over a five year period from 72 weeks to 38 weeks at present. Pressure will build up in the months ahead as lead times are expected to crash to 16 weeks by mid 2006.

A bigger focus on more polyester-based fabrics would mean that the working capital requirement of the firm will increase as typically it enjoys less credit from suppliers of polyester yarn.

For instance, despite stronger earnings in FY04 (up 44 percent to US$ 24.5 mn), the net cashflow from operating (NCFO) activities deteriorated to – US$ 572,614 from – US$ 385,058 as a result of higher inventories increasing the working capital requirement.

In addition, the company has been maintaining a high dividend payout policy based on positive earnings, despite weak operating cashflows slowing equity build-up.

The net free cash flow (NFCF) before dividends was – US$ 2.1 mn compared to – US$ 1.5 mn in FY03. The company made a dividend payment of US$ 1.26 mn (FY03:US$ 0.885 mn).

Gross debt at 1H05 stood at US$ 16.2mn, with broadly 85 percent of the long-term loans raised in US dollars. The firm had committed, undrawn credit facilities of US$ 1.8mn as at end-1H05. Gearing measured by Debt/Equity has increased to 147 percent (from 105 percent at FYE03) due to the largely debt-funded capital expenditure and short-term borrowing to fund the increased working capital requirement.

But, Fitch expects the credit metrics to improve over the medium-term with increased sales and gradual repayment of the debt taken on to fund the recent capital expenditure. Fitch also does not expect significant capital expenditure in the short-to medium-term.

Looking ahead, cotton yarn prices are expected to fall, easing pressure on profitability. The management expects the top-line to be US$ 34 mn for the full financial year 2005.

Hayleys MGT started off in 1993 as a joint venture between Hayleys Limited and Australia’s MGT Samor Knitting Mills of Melbourne. In 2003, the firm was quoted on the Colombo Stock Exchange by way of an introduction.

The Hayleys Group controls 41.2 percent, Australian promoters maintain their interest through Shantiro Proprietary Ltd, Ocean Faith International Limited and Mr. Oaul Edward Paradisco with 15.83 percent, 3.15 percent and 0.70 percent of equity ownership respectively. The balance share are owned by National Development Bank and MAS Holdings.

-LBO Newsdesk: LBOEmail@vanguardlanka.com