Sri Lanka Lankem ‘A-‘ rating confirmed: RAM

Mar 13, 2013 (LBO) – RAM Ratings Lanka said it had confirmed an ‘A-‘ rating on Lankem Ceylon Plc, with a ‘stable’ outlook. Its short-term ‘P2’ rating was also confirmed. “The ratings are supported by its diversity in business operations, dominant market positions in most of its business lines, the resilient demand for agrochemicals, and above average
debt-protection metrics,” RAM Ratings said in a statement.

“However the ratings are pressured by its exposure to the volatility in the plantation segment and its vulnerability to fluctuations in raw material prices as well as the below-average liquidity profile.”

The full statement is reproduced below:

RAM Ratings Lanka reaffirms Lankem Ceylon PLC’s
A-/P2 ratings

RAM Ratings Lanka has reaffirmed Lankem Ceylon PLC’s (“Lankem” or “the
Company”) long- and short-term corporate credit ratings of A- and P2
respectively. The outlook on the long-term rating is stable.

The ratings are
supported by its diversity in business operations, dominant market positions in
most of its business lines, the resilient demand for agrochemicals, and aboveaverage
debt-protection metrics. However the ratings are pressured by its
exposure to the volatility in the plantation segment and its vulnerability to
fluctuations in raw material prices as well as the below-average liquidity profile.

Lankem and its subsidiaries are collectively referred to as “the Group”.
Lankem, through its subsidiaries, is mainly engaged in the manufacture and
distribution of agrochemicals as well as the cultivation of tea and rubber, with a
presence in the consumer goods and paints sectors. Its other business ventures
include interests in hotels, agriculture, construction and trade. The diversity has
enabled the Group to better withstand downturns in a particular sector, as weaker showing
in one sector can be offset by the better performance in another.

The ratings are upheld by the Group’s good market position in its key business
lines. Lankem is one of the top 3 players in the agrochemicals industry.
Furthermore, Lankem is also among the top 3 players in the paint industry while
controlling 60% of the thinner market owing to its exclusive dealership
agreements and distribution fleet.

Elsewhere, Lankem is a major player in the
bitumen industry aided by its established brand name and distribution network.
Meanwhile, the ratings are also upheld by the resilient demand for agrochemicals.
Lankem’s agrochemicals division has been one of the main contributors to the
Group’s revenue and profits; its revenue is largely derived from its herbicides,
which are a crucial input in paddy cultivation. Since rice is the country’s staple
food, the demand for herbicides is anticipated to remain relatively resilient.

We note that the Group’s performance deteriorated significantly in fiscal 2012, in
line with a drop in revenue of its plantation segment and sluggish sales growth in
chemicals and hardware; as such, its operating profit before interest and tax
(“OPBDIT”) contracted 34.99% year-on-year (“y-o-y”). This coupled with heavier
borrowings, resulted in its funds from operations debt coverage (“FFODC”)
halving to 0.25 times as at 31 FYE March 2012 (“end-FY Mar 2012”); lower than
RAM Rating Lanka’s expectations.

Although Lankem’s debt protection metrics are
still opined to be above average, the deterioration is viewed with concern. Moving
ahead, the Group’s FFODC ratio is envisaged to hover around 0.20 times, in line
with its rising borrowings; any further weakening of its financial profile beyond
our expectations is likely to result in a negative rating action.

Meanwhile, the ratings continued to be weighed down by its exposure to vagaries
in the plantation sector. The plantation segment is the largest contributor to
Lankem’s earnings, accounting for more than 50% of its pre-tax profit in recent
years. Lankem’s performance is highly susceptible to the vagaries of the
plantation sector such as weather conditions, cost pressures (particularly wages),
rising energy costs and varying fertiliser prices. In fiscal 2012, the segment’s
performance deteriorated owing to adverse weather conditions and an increase in
plantation sector wages.

Furthermore, the Group is exposed to the volatilities in raw material prices. The
Group has been able to pass on cost increases to its customers owing to its good
market positions in its major businesses. That said its margins could be pressured
should its ability to pass on cost increases to its customers on a full and timely
basis be affected amid keen competition.

Lankem’s liquidity position is deemed below-average in line with its increased
dependency on short-term borrowings and relatively low cash reserves. As at
end-June 2012, the Group had cash reserves of LKR 1.47 billion, compared to LKR
5.26 billion of short-term borrowings which made up around 66% of its entire
borrowings. However, we derive comfort from its unutilised funding lines
amounted to more than LKR 1 billion.